Can a Near $600 Stock Be Cheap?

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

When I see a stock trading for nearly $600 a share, I have the same reaction many investors probably have. It’s frustrating that the company chooses to keep the share price so high, as smaller investors like myself would have trouble accumulating a decent number of shares. While I know intellectually this higher price is the same value as 10 shares worth $60 each, there something gratifying about owning 10 shares as opposed to one. That being said, MasterCard (NYSE: MA) trades for nearly $600 a share, but even at this price, you could make the argument that the stock is cheap.

Organic Growth and What This Means for the Company’s Earnings
It should be no secret that more and more transactions are being processed electronically, and MasterCard along with other processors like Visa (NYSE: V), Discover Financial Services (NYSE: DFS), and American Express (NYSE: AXP), all stand to benefit from this continued trend.

The difference between these four companies seems to be that MasterCard and Visa are better positioned to capitalize on the increase in electronic transactions than their competitors. These companies have much wider acceptance than either American Express or Discover. In addition, they generally charge lower interchange fees to merchants, which makes it cheaper for stores to accept Visa or MasterCard. That being said, MasterCard seems to be capitalizing on its opportunities slightly better than Visa at the present time.

Two ways that MasterCard is outperforming Visa is by reporting better transaction and dollar volume growth. For an apples-to-apples comparison, we have to use last quarter’s results since Visa has already reported earnings whereas MasterCard has not.

When it comes to processed transactions, MasterCard reported a 12% increase last quarter, compared to a 6% increase at Visa, a 1% increase at Discover, and a 7% increase at American Express. Looking at dollar volume growth, this trend held again with MasterCard reporting a 12% increase, compared to 9% at Visa, 2% at Discover, and about 7% at American Express. Though analysts have similar expectations of growth from Visa and MasterCard, the diversions in their organic growth profiles suggest analysts may have the numbers wrong.

Slightly Better
When comparing MasterCard to Visa, I found myself thinking several times that MasterCard was performing slightly better in a couple key areas. First, I would make the argument that MasterCard’s valuation is slightly better than Visa's at the present time.

Both companies pay yields that are less than 1%, with MasterCard at about 0.40% and Visa at roughly 0.69%. In addition, analysts expect significant earnings growth from both companies with MasterCard expected to report 17.7% growth in Visa expected to report 18.7% growth. The difference is, MasterCard sells for a P/E ratio that is about 2 lower than Visa's, which makes the overall comparison tilt slightly towards MasterCard. Given these choices, I would be hard-pressed to recommend either American Express at 11.8% growth or Discover at 7.6% growth, even with their slightly more than 1% yields.

The second way that MasterCard seems to be a slightly better performer than Visa is, the company is growing its operating cash flow at a faster rate than its peer. In the last quarter, MasterCard grew its core operating cash flow (net income + depreciation) last quarter by 12.5%. While Visa reported decent growth by the same measure of 11.7%, every little bit helps and MasterCard’s faster growth may lead to better dividends and share repurchases.

Each Company Can Do More, and That Is a Good Thing
Whereas MasterCard is performing slightly better than Visa in a few respects, when it comes to the company’s core free cash flow (net income + depreciation - capital expenditures) payout ratio there is no one better. In the last quarter, MasterCard only used 4.58% of its core free cash flow on dividend payments.

By comparison, Visa paid 12.59%, Discover paid 14.01%, and American Express paid 16.81%. As you can see, none of these companies is exactly stretching their budget to pay the dividend, but with the lowest payout ratio, and significant growth ahead, MasterCard theoretically should reward investors more handsomely.

I realize that paying nearly $600 per share is difficult for smaller investors. However, investors need to remember that buying a stock for $50 doesn’t mean that it’s a bargain any more than a $600 stock is expensive. Given MasterCard’s strong organic growth profile, better financial performance than its peers, and potential for increased dividends, this is a seemingly expensive stock that actually appears pretty cheap.

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Chad Henage has no position in any stocks mentioned. The Motley Fool recommends American Express, MasterCard, and Visa. The Motley Fool owns shares of MasterCard. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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