Are Visa and Mastercard About to Correct?

Visa (NYSE:V) and Mastercard (NYSE:MA) have been two of the best-performing large-cap stocks in the S&P 500. The reasons for this are fairly straightforward: More and more consumers and businesses are using credit and debit cards in order to transact, and if these consumers and businesses are getting their credit and debit cards through their banks, then they are getting Visa and Mastercard cards.

As a result, both Visa and Mastercard have seen their sales and operating profits climb regularly and rapidly. This has sent the shares of the two companies soaring, especially since there aren’t many companies that are growing in this difficult market. In the past five years, both companies’ stocks are up more than fourfold, and in the past year, Visa shares are up 30 percent and Mastercard shares are up 40 percent.

However, no asset no matter how great is going to rise in a straight line, and Visa and Mastercard are no exceptions. We are seeing evidence of this in 2014, as in the first three months, shares of both companies have begun to underperform. Visa shares are down about 2 percent and Mastercard shares are down nearly 10 percent for the year, whereas the S&P 500 is marginally higher.

I think this could be the start of a prolonged and much needed correction that will ultimately weed out the more speculative shareholders in these names who were simply buying the stocks because they were rising.

That’s the bad news. The good news is that for those investors who missed out on the upswing, there should be a great buying opportunity in the coming months. But when is a good time to buy and which of the two companies is the better investment?

Investors looking to take a position in either Visa or Mastercard should consider doing so when the prices become more attractive. While there are many ways of determining whether a stock has good value, one metric that investors should consider is the PEG ratio. The PEG ratio takes the P/E ratio and divides it by a company’s growth rate. The rationale behind using the PEG ratio is that faster-growing companies deserve to trade at a higher multiple to earnings. Typically, a good entry point for a growing company is reached when the stock trades at a 1 PEG, meaning that the P/E ratio equals the company’s growth rate.

For Visa, over the past four years, the company’s earnings have been growing at 18.5 percent per year, which means that Visa should trade at about 18.5 times earnings. Since Visa is expected to earn about $9 per share this year, a good long-term entry point would be about $166.50 per share. This would mean that the stock needs to correct about 25 percent from here, which is perfectly normal in a long-term secular bull market.

For Mastercard, over the past four years, the company’s earnings have been growing at about 20 percent per year, which means that Mastercard should trade at about 20-times earnings. Since Mastercard is expected to earn about $3 per share this year, the stock should trade at about $60 per share, or about 20 percent lower than the current $75 per share level.

Regarding which company you should buy, a major difference between the two is that Mastercard has significantly more European exposure, including Eastern Europe. It also has more emerging market exposure. Visa has more exposure to the United States and North America. While this has favored Mastercard over the past few years, we may see Mastercard’s growth decelerate so that it is more in line with Visa’s growth given Europe’s sluggish economy and given that growth is slowing in the emerging markets.  I suspect that this is partly responsible for Mastercard’s underperformance in the past few months with respect to Visa.

Thus, if you want more emerging market and European exposure, go with Mastercard. Otherwise, Visa is the better choice. However, the best solution might simply be to buy both. Even if one outperforms the other, I don’t think it will be by much, and there is no reason to leave one of these companies out of your portfolio unless you are particularly bearish about one of the regions that is more heavily served by one company or the other.

With that being said, I wouldn’t buy either of them now. While I am not selling my current position in Visa, I want to wait for lower prices until I buy either of these companies’ stocks. I will be looking to buy at the price points discussed above — about $166.50 per share for Visa and about $60 per share for Mastercard.

Disclosure: Ben Kramer-Miller is long Visa.

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