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Why Dividend Mantra Purchased Visa (V)?

Well, opportunities remain a bit limited right now, but vigilance is a character trait of mine.
I remain committed to growing my dividend income on a regular basis, and a major contributing factor is obviously the fresh capital I regularly put to work in the most attractive opportunities I can find.
This most recent purchase was me looking for the best possible quality, while not necessarily shooting for the greatest possible value. This is a bit of a growth stock, which is an unusual investment for me. However, I would never purchase a stock with value if there weren’t possibilities for growth; likewise, I wouldn’t purchase a stock with excellent growth prospects if there weren’t some value there. I think growth and value should go hand in hand, albeit to varying degrees depending on what you’re looking for in a company.
I purchased 5 shares of Visa Inc. (V) on 7/9/14 for $215.30 per share.
As I noted on my most recent watch list article, Visa was tops on my list for capital allocation this month. I wavered a bit as I continued to follow some other interesting opportunities, and the stock price shot up a bit on me in the meanwhile. But a couple bucks isn’t something I’m worried about if I’m truly in this for the next decade or three.

Overview

Visa Inc. is a global payments processing technology company, connecting consumers, businesses, banks, and governments in more than 200 countries by enabling them to use digital currency instead of cash and checks. They provide a fast, secure, and reliable digital payments network. They are the world’s largest such payments technology company.
Visa primarily generates revenue from credit and debit card service fees, data processing fees, and international transaction fees. The company operates under just one segment: Payment Services.

Fundamentals

Visa’s quantitative fundamentals are just impressive, no matter how you slice it. The company went public in 2008, so I’ll be working with a shorter base than usual. I’ll be showing company performance over the last five years. The fiscal year ends September 30.
Revenue is up from $6.911 billion in FY 2009 to $11.778 billion in FY 2013. That’s a compound annual growth rate of 14.26%, which is very impressive.
Earnings per share has grown from $3.10 to $7.59 over this same time period, which is a CAGR of 25.09%. That’s just stunning. Furthermore, that kind of growth may very well continue from here, as EPS is expected to grow at a compounded rate of 18% over the next three years, according to S&P Capital IQ.
Visa processed 81.6 billion total transactions in calender year 2012. That compares to 46.3 billion forMastercard Inc. (MA), and 5.9 billion for American Express Company (AXP). Payments volume increased to $4.3 trillion in 2013, up from $3.9 trillion in 2012. That’s an increase of 10.3% year over year. This bodes well for the company, as the company earns a small slice of revenue from each transaction. Subsequently, increasing transaction volume increases Visa’s revenue.
Dividend growth is of course one of my primary concerns as a dividend growth investor, and Visa has grown their dividend regularly and incredibly since going public. The company has increased the dividend for seven consecutive years, and has a five-year dividend growth rate of 45.9%. I don’t expect this kind of blockbuster dividend growth to continue forever, but double-digit raises are extremely likely for the foreseeable future. And that’s because the payout ratio, at just 18.9%, is very low, and earnings are increasing at a rapid rate.
However, the one major drawback to this investment is the low yield. Shares in V yield just 0.74%, which is much lower than I like. I typically don’t even consider investments with yield that low, but as I’ve noted before I’d like a little more exposure to Stage 3 stocks now that my portfolio has matured a bit. I’m basically counting on pretty aggressive dividend growth with this investment.
The yield is a bit low with this stock because Visa management has been open about their preference to buying back shares as a means to providing value to shareholders and generating a strong return. The company has purchased 151 million shares since the IPO, which amounts to about 20% of shares outstanding. I typically prefer a company with a preference to growing dividends over buybacks, but I’m making an exception here due to Visa’s especially attractive business model.
This company just has so much to like. The balance sheet is flawless, with no long-term debt to speak of.
And the general profitability is fantastic. The company sports fantastic profit margins because there isn’t much cost to run a global payments network. Once the infrastructure is in place, Visa simply sits back and collects the income. As such, the overhead tends to be quite low, and Visa has extremely strong free cash flow.
For FY 2013, operating margin ended at an eye-popping 61%. Furthermore, net margin has averaged34.68% over the last five years. The profitability here is really astounding. Return on equity, meanwhile, has averaged 12.65% over the last five years.

Qualitative Aspects

The story here is really strong. Visa is the world’s largest digital payment processor. So you have to like this company’s chances going forward. Mobile payments and e-commerce are both increasing every single day. Whereas mobile payments are seen as a threat, they also open up opportunity. Visa notes that it takes time and investment to build out the infrastructure for a payment network in certain emerging markets, and additional time and investment to get the cards in the hands of millions or billions of consumers. Since mobile phones are becoming increasingly popular, Visa simply needs to connect these devices to their network. This allows them to digitize currency and remain a leader in digital payments.
International transactions are still a huge growth opportunity for Visa: For the second quarter of 2014, the company reported $3.163 billion in revenue. But the US accounted for $1.683 billion of this revenue, or53.2%. So there’s still a lot of growth ahead in other key markets that will drive Visa’s growth well into the future. This growth will be driven by a desire to secure payments, go cashless, and make it easy for businesses to conduct business and get paid. And these transitions will occur as markets around the world develop and mature.
The economies of scale are huge, and are especially effective for Visa because their overhead is so low. Another major economic advantage is the fact that there are switching costs involved. Once you have your credit cards in hand, you’re likely to continue using them over and over again. For instance, I have some of my bills set up on auto-pay. The odds of me switching credit cards is low since that would involve switching all of my billing around.

Risks

There are risks with any investment, and Visa is of course no different. The primary risks revolve around regulation, litigation, and competition. The company specifically maintains an escrow account for litigation, and has settled numerous lawsuits over the past few years specifically relating to processing fees. In addition, the passing of the Dodd-Frank financial reform bill put into place certain restrictions regarding debit card interchange fees.
Competition is primarily in the form of competing digital payment processors, but mobile payment processing could bring about competition that is currently unknown.
And regulation is always a potential risk for any financial institutions, as the recent issues with deposit requirements in Russia have shown. However, major companies like Visa maintain clout due to their infrastructure and global standard.
One thing I love about Visa is that their financial risk is somewhat low due to the fact that they take on no lending risk. They simply process digital payments, while the issuing bank takes on the financial risk. However, Visa has noted that in certain circumstances they can face financial risk due to potential situations that would require them to indemnify issuers and acquirers.

Valuation

Visa shares aren’t particularly cheap, but I think they’re very reasonable considering the anticipated growth. The price-to-earnings ratio is at 25.4, which is a bit higher than my usual limit of 20. However, I don’t think this is stretching too far considering the future prospects. I actually looked at Visa when it was trading at $100, and the valuation and yield was very similar. I obviously regret passing, and I decided to not make the same mistake twice.
I also valued shares using a two-stage dividend discount model analysis to account for the low yield and high growth. I used a 10% discount rate, a 20% growth rate for years 1-10, and a 8% terminal rate. This gives me a fair value on shares of $232.89. So you could say that V shares are more or less fairly valued right now, assuming they’re able to grow at that rate. However, a lower terminal rate means shares are overvalued here, so I’m dipping my toes in lightly with a rather small position. I’m certainly interested in adding to this position over time, however, depending on circumstances including how fast the dividend grows.
I just  think there’s a ton of opportunity here for Visa to grow and expand, especially as e-commerce grows. And growth in profit translates into dividend growth, which makes me a happy investor. And one thing you’ll notice in my portfolio is that I love winners. And Visa is the world’s largest at what it does, and maintains huge profit margins and financial flexibility.

Conclusion

This purchase adds just $8.00 to my annual dividend income based on the current quarterly payout of $0.40 per share. However, a large dividend raise in the fall could quickly change this figure.
My portfolio now holds 48 positions, as this was a new investment for me.
I’m going to include current analyst valuation opinions below, as I use these to concentrate my reasonable valuation estimate:
Morningstar rates V as a 3/5 star value, with a fair value estimate of $223.00.
S&P Capital IQ rates V as a 3/5 star hold, with a fair value calculation of $228.10.
I’ll update my Freedom Fund in early August to reflect this recent purchase.
Full Disclosure: Long V.
How about you? A fan of V at these prices? Think this will be a good long-term investment?
Thanks for reading.

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