Barnett Helzberg Jr., whose family sold the eponymously named Helzberg Diamonds to become part of Warren Buffett’s collection of subsidiaries at Berkshire Hathaway, said that the hardest part of growing his business involved (1) the high capital expenditures necessary to open up new jewelry stores and (2) the difficulty in determining the highest and best use of Helzberg’s business opportunities, as it is not always apparent ahead of time whether resources should be dedicated towards strengthening high-performing stores or combating the weaknesses at low-performing stores.
I have made no secret of the fact that Visa stock is the most essential stock that can be owned in one’s collection of investments because of the company’s market dominance (it processes more transactions daily than its nearest competitors Mastercard, Discover, and American Express combined) and the long-term megatrend in favor of electronic rather than cash transactions (this latter insight is not original to me at all and is beat over the reader’s head in any article discussing Visa or one of the credit processors as an investment).
As Visa stock has increased thirteen-fold over the past decade, increasing in value from a split-adjusted price of $10 per share to the current price of almost $130 per share, I am drawn to additional competitive reasons that explain why it is likely that Visa will continue to grow earnings per share at a 10% to 15% clip between now and 2023.
The first is that, unlike most businesses, Visa does not have proportionate capital expenditures. It needs to build out its processing networks and make sure that the system has “integrity” so that transactions are adequately exchanged and that it avoids the hacking results that have become increasingly common.
Visa benefits from the fact it does not have to lay out a proportionate amount of cash for each escalation in earnings. For businesses like Helzberg’s, it knows that it needs to spend $1 million or so on a new jewelry location that will generate $1 million in sales and $200,000 in net profits. There is a somewhat of a fixed relationship between expenditures and growth.
Visa’s infrastructure costs do not proportionately rise with expenses. In 2008, it spend $400 million in capital expenditures for its network while generating $1.7 billion in net profit. This year, Visa is on pace to spend $700 million in capital expenditures (nearly the same as last year) to generate $9.0 billion in net profits. Profits roughly quintiple–tacking on $7 billion–while capital expenditures only increased by $300 million. Visa’s net profit margins are 44%. That is “top 20 businesses in the world” category.
The second underrated advantage that Visa enjoys is that its use of capital is clear–it needs to improve its network, advertise at big name events, and facilitate the use of electronic payments as it shifts from the card to the phone.
This adds clarity to Visa’s highest and best use–process money quickly with leading technologies and let the rest of the world know that they can use Visa. Money should be spent towards that end.
This means that Visa’s reinvested earnings tend to be put towards self-evidently efficient and highest uses because it does not have to worry about underperforming business lines (should Procter & Gamble invest in enhancing Gillette’s brand strength or shoring up slugging sales growth with Head & Shoulders shampoo?) or geographic difficulties (should Coca-Cola try to improve the insane Coke product consumption in the state of Georgia or try to stop the moderate declines in Coke and the rapid declines in Diet Coke in Texas?).Those are difficult, complex questions that most businesses have to grapple with daily.
Visa benefits from the fact that its use of capital has a one size fits all approach. If it can improve transactions via phone, that will carry over to all markets. If it enhances the security if its infrastructure, everyone wins. As a result, not only are Visa’s profits incredibly high, but of the amount that does need to be retained, it is unusually clear how the funds should be allocated.
Visa has a long runway ahead of it. It’s not done minting wealth just because it has excellent performance recently.
This is a publicly available version of an article shared with The Conservative Income Investor’s Patreon followers on May 20, 2018.