With Warren Buffett at the helm as chief executive officer and chairman for the last 50-plus years, Berkshire Hathaway has transformed into an investment holding company juggernaut.
With more than 50 positions, there is no shortage of companies with promising growth stories within Berkshire Hathaway’s $350 billion investment portfolio. But if I had to pick a stock from the Berkshire portfolio, shares of Visa (V 0.22%) excite me the most. Let’s explore the payment processor’s fundamentals and valuation to elaborate on why Berkshire Hathaway owns a stake in the company valued at $1.9 billion.
Unstoppable trends plus industry leadership equals a bright growth outlook
It’s not a secret that cash use has been steadily declining around the world for many years now. The share of Americans who completed none of their purchases with cash in a typical week has surged from 24% in 2015 to 41% in 2022, according to Pew Research Center. The prevalence of alternative payments will likely only continue to grow.
This is especially good news for the payments processor Visa. The company’s operations in over 200 countries and territories make it the largest player in its industry. For context, Visa’s $472 billion market capitalization is significantly larger than the $358 billion market cap of the next biggest competitor, Mastercard.
Sizable investments made by Visa over the years to improve its payment network and grow its cards in circulation count have allowed it to widen its competitive moat. For instance, the company’s total cards in circulation were 4.1 billion as of Sept. 30. That was substantially higher than Mastercard’s 2.7 billion cards in circulation during that same time.
Simply put, more cards in circulation translate into a larger potential customer base for merchants to win over as customers. That’s why Visa’s merchant base should continue to grow considerably from a base of over 80 million merchant locations at which its payment methods are currently accepted.
Existing customers using their cards more frequently as cash is further displaced and new customers opening credit or debit cards could mean hefty future growth for the company. Along with bolt-on acquisitions to further strengthen its competitive positioning, this is why analysts expect Visa’s non-GAAP (adjusted) diluted earnings per share (EPS) will grow 15.5% annually over the next five years. Putting this into perspective, analysts expect the credit services industry to generate 14% annual earnings growth through the next five years.
Dividend growth is just getting started
Visa’s 0.8% dividend yield seems small compared to the S&P 500 index’s 1.6% yield. But this is only because the tremendous capital appreciation of the last 10 years has offset the sky-high dividend growth.
Visa’s exceptional dividend growth was powered by high earnings growth, which is how the company’s dividend payout ratio will clock in at just 21% for fiscal year 2023– despite outsized dividend growth. This allows Visa to reinvest its earnings, repurchase shares, and reduce debt. That’s why I believe that the company’s dividend will likely grow slightly ahead of earnings for the foreseeable future. This should translate into more dividend boosts like the most recent of 20% over the medium term for Visa’s shareholders.
Retaining a significant amount of earnings and ploughing them back into the business has been highly rewarding with its return on equity clocking past 40%. This commitment to growth and lucrative return on equity has resulted in 20%-plus adjusted diluted EPS growth in the last five years. Such high returns on equity and rapid earnings growth are two metrics that are high on Buffett’s list, which is what makes the stock such a compelling holding within Berkshire Hathaway’s portfolio.
The valuation is reasonable for a world-class business
Visa is fundamentally an excellent business. And while the share price has nearly doubled over the last five years, the valuation doesn’t appear to be excessive.
Visa’s forward price-to-earnings (P/E) ratio of 23.5 is higher than the credit services industry average forward P/E ratio of 17.5. But since the stock has a history of outperforming the market and the business is poised for above-average future growth, dividend growth investors should consider Visa for their portfolio. These reasons are precisely why the stock is one of the largest holdings in my investment portfolio.
Kody Kester has positions in Mastercard and Visa. The Motley Fool has positions in and recommends Berkshire Hathaway, Mastercard, and Visa. The Motley Fool has a disclosure policy.