At the depths of the recession, fears of a knocked out American consumer kept valuations low and investors scared; to this day, inflows from retail investors remain limited and beyond historical expectations. This has impacted several sectors, but it has not hit technology, which always attracts hot money seeking growth. Facebook (FB), Google (GOOG), LinkedIn (LNKD) and Amazon (AMZN) have high P/E ratios as the market expects and prices in high growth for a long period. Tesla (TSLA) and Twitter (TWTR) have seen substantial growth even without a P/E at all, since they operate at a loss.
But high and sustainable growth has actually come from a different part of the public market, no matter how you measure it. That sector is dull, the technology is old, and the market has faced disruption from a number of sources in recent years. What is it?
Credit cards.
Strong and low-beta performers Mastercard (MA), Visa (V), and American Express (AXP) have steadily risen over the past five years, providing a CAGR of between 20% and 27.6%, all without rebalancing or major drawdowns. Add in Verifone (PAY), which has been much more volatile and arguably more prone to disruption, and you get some more volatility, but the same gains:
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These are boring, old, large cap stocks. Young investors are excited about disruptions that will squeeze these companies out of existence. Whether it’s Apple Pay (AAPL) or bitcoin, eager and energetic investors look for something that will improve transactions and end these companies’ reign.
We have not seen any disruption to these companies’ business models. This is startling; high smartphone penetration was reached in 2011, but mobile payments still is not a thing. And the few innovations we are getting this late in the game just solidify the importance of AXP, MA, V, and PAY. Apple Pay does not disintermediate any of these players—it relies on them. It also relies on companies like Rite Aid (RAD) and CVS, both of which have stopped accepting Apple Pay as they work towards a different standard, CurrentC.
How is an investor supposed to think about these developments? As always, with some questions:
- Do the new technologies disrupt or solidify the market position of V, MA, and AXP?
- Are these companies adapting to the mobile payments world? If so, how?
- To what extent will mobile payments be embraced by the public? If so, when and how fast?
- How will other competing technologies (bitcoin, Alipay) disrupt these companies’ business models?
Answers to these questions can be achieved through the due diligence part of research. At that point, they need to be quantified. If the analyst sees a threat to their businesses, that threat will need to be translated into a change to the company’s revenue growth rate, which in turn will need to tell us to what extent the company’s earnings will be constrained. Then we’ll need to compare that to the discount rate that the company’s future earnings currently offers at its present day share price, and compare the two. If our analysis shows that future earnings are cheaper than the market is offering, we buy until that is no longer the case. The same in reverse if it is more expensive.
The important point is that the analyst combines the due diligence process with the quantification of that information. Quantifying these competitive threats requires a bit of personal judgment and assumptions, which an analyst can decipher based upon previous experience and knowledge of the field.
A good analyst takes the time to do this to see when and how a company’s market and business model are threatened. Simply betting that a company or technology will revolutionize the world, without translating that insight into how it will impact different companies’ top and bottom lines, is the opposite of good financial analysis. The past performance of MA, V, and AXP is proof of that.