Are the Credit Card Stocks Overvalued?

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

The credit card services industry in the United States contains three stocks for investors to choose from. Each has demonstrated solid growth in recent quarters, showing the benefits of a steady global economic recovery and a more confident consumer.

It’s understandable that these stocks would rally. They have the tailwinds of well-run businesses and a recovering consumer. As consumers pay down debt, get back into the workforce and begin to feel better about their personal finances, they’ll spend more. This means more volumes and traffic for each of these companies, and in turn, higher sales and profits.

At this point, though, some of these stocks appear to be trading ahead of themselves, with lofty valuations that likely shake the nerves of value-conscious investors. Is there still value to be had among the credit card companies?

The major industry players

American Express (NYSE: AXP) reported first-quarter revenue and diluted earnings per share growth of 3% and 7.5%, respectively, year over year.

This followed a decent full-year 2012, in which the company grew revenues net of interest expense by 5% and earnings per share by 7.6% as compared to full-year 2011.

Moreover, the company recently raised its dividend by 15%, which dividend enthusiasts likely appreciate.

The high-growers in the space are competitors Visa (NYSE: V) and MasterCard (NYSE: MA). Visa has had an incredible run since its initial public offering in 2008. At the time, the IPO was the largest ever, at a record $17.9 billion. Shares began trading at $44 per share. Since then, Visa has quadrupled in price.

Operating performance has been equally impressive, with operating revenue increasing at a compound annual rate of 13.5% since 2008. Full-year diluted earnings per share, meanwhile, have increased 34% per year over the same time period.

Visa has continued this trend to begin 2013. The company reported fiscal second-quarter net revenue and net income per share growth of 15% and 20%, respectively. Moreover, the company remains committed to buying back its own shares, thereby enhancing shareholder value in the future. During the second quarter, Visa repurchased 12 million of its own shares, with $1 billion remaining in its current share buyback authorization.

MasterCard has performed strongly as well recently. The company’s shares have doubled over the last two years. MasterCard reported positive results for its fiscal fourth-quarter, with revenues rising 10%. Earnings per share clocked in at $4.86, beating analyst expectations by five cents.

MasterCard followed this with strong performance in the first quarter of the current fiscal year. Net revenue and diluted earnings per share increased 8% and 16%, respectively, and the company’s future outlook is encouraging. The company’s already strong execution and additional focus on emerging markets has led it to predict 20% compounded annual growth of earnings per share from 2013-2015.

The Foolish takeaway

Visa gets a lot of attention for being one of the market’s best growth stocks, which it is. However, only those investors who can shrug off valuation would consider Visa’s current price to be truly attractive. I appreciate high growth as much as the next investor, but no company can exponentially grow into perpetuity, as a matter of mathematical inevitability. Visa trades for 50 times trailing earnings and 21 times forward earnings according to Yahoo! Finance.

At some point, Visa's growth trajectory will come down, and its valuation multiples will likely follow.

American Express is the most modestly valued of the three stocks, trading for ‘just’ 18 times earnings. American Express offers a 1.2% dividend, which isn’t very attractive considering the S&P 500 yields 2%, but looks like a hefty yield when compared to its two industry peers. Visa and MasterCard both yield less than 1% annualized.

MasterCard is more reasonably valued than Visa, exchanging hands for 25 times trailing EPS, but that’s still a level I’d consider too high for prudent value investing.

I’m sure that all three of these companies will continue to grow sales and profits at strong rates going forward. But at a certain point, investors buying stocks at these levels are veering dangerously toward gambling on stock prices instead of making sound investment decisions.

While each of these companies are highly profitable and are sure to keep growing at decent rates due to the gradual economic recovery, I don’t consider these stocks to carry enough margin of safety to be buys at this point.

Robert Ciura 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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