Visa (V 0.05%) is arguably one of the best businesses in the world. And its stock reflects this fact, soaring almost 380% in the past decade, a gain that beats the broader S&P 500.
Even Warren Buffett, considered to be the greatest capital allocator ever, is a shareholder through Berkshire Hathaway‘s public equities portfolio. Berkshires stake is small, but that’s still a vote of confidence.
However, this card payments giant isn’t without risks. In fact, the single biggest threat to Visa might surprise you.
What’s not to like?
It’s important to understand what makes this business special. For starters, Visa benefits from powerful network effects that support its competitive standing. Billions of its cards are in the wallets of consumers across the world, and they are accepted at 130 million merchant locations. More merchants mean more acceptance points and utility for cardholders. And more cardholders result in merchants having a wider customer base.
Visa is also incredibly profitable. It reported a ridiculous operating margin of 64% in fiscal 2023, with free cash flow of about $20 billion last year. It’s hard to find businesses in the same league.
Because Visa doesn’t lend any money to borrowers, it’s also an asset-light operation with minimal exposure to credit risk. “The best business is a royalty on the growth of others, requiring little capital itself,” Buffett once said. Visa essentially grows on the back of banks’ lending activity. That has clearly been a lucrative deal.
The stock is also reasonably valued today. It trades at a forward price-to-earnings ratio of 26.7. That’s a premium to the S&P 500, but it’s probably warranted given that this is a high-quality company.
Everything I just discussed is likely what Buffett likes about Visa as well, which is why the stock is in Berkshire’s portfolio.
A possible risk factor
As a provider of the communication infrastructure that connects consumers and their banks to merchants and their banks, Visa is critical to facilitating commerce in the global economy. Its stranglehold on the industry and outsize financial success have put it on the radar of regulatory agencies, something Visa has paid significant fines for.
Moreover, the promise of cryptocurrencies to speed up transaction processing times, while lowering costs, can be a potential disruptor to a payment network like Visa.
But a threat most investors aren’t thinking about is the possibility of direct payment channels between merchants and consumers, which completely bypass the card networks. Target, a huge retailer that generated $25 billion of revenue last quarter, is already doing this with its RedCard debit card. When customers make a purchase, the service links to their bank account so that funds can be pulled.
To incentivize people to sign up for this program, Target offers a 5% discount on these purchases. The issue, though, is that the business is likely only saving 2% to 3% by not using Visa’s network, so this might actually be a losing proposition.
However, you can easily see how other major merchants and retailers, especially subscription-based services, could do something similar. After all, card processing fees are a significant recurring expense that all businesses must pay.
Imagine if Netflix, Chipotle Mexican Grill, or Costco Wholesale, for example, did something similar. This could translate to meaningful amounts of lost revenue for Visa.
Before you rush to dump your Visa shares, it’s best to maintain an optimistic outlook. Consumers absolutely love their general-purpose rewards credit cards. Credit card debt in this country just exceeded $1 trillion. And this doesn’t seem likely to change course anytime soon. So for the time being, Visa’s competitive position seems safe.
Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Berkshire Hathaway, Chipotle Mexican Grill, Costco Wholesale, Netflix, Target, and Visa. The Motley Fool has a disclosure policy.
