This article was originally published on Simply Wall St News.
Adapting to the latest trends, Visa recently announced that customers spent over US$1b through cryptocurrency payments in the first half of this year, partnering with 50 platforms that offer digital currencies to 70 million merchants worldwide.
With a price-to-earnings (or “P/E”) ratio of 52.2x, Visa Inc. ( NYSE: V) may be sending bearish signals at the moment, given that almost half of all companies in the United States have P/E ratios under 19x. Yet the company keeps sailing on, just closing at the all-time high of US$248.55
However, its declining earnings do mandate skepticism for the elevated P/E. Although a useful metric, P/E doesn’t tell us much on its own, you need to dig a little deeper to determine if there is a rational basis behind it.
A renowned money manager Howard Marks argues that the greatest danger is not in investing in poor companies, but in investing in overvalued ones.
It might be that many expect the upcoming earnings performance to recover substantially, which has kept the P/E this high. You’d hope so; otherwise, you’re paying a pretty hefty price for no particular reason.
NYSE: V Price Based on Past Earnings July 12th, 2021
What Are Growth Metrics Telling Us About The High P/E?
There’s an inherent assumption that a company should far outperform the market for P/E ratios like Visa’s to be considered reasonable.
Taking a look back first, the company’s earnings per share growth last year wasn’t something to get excited about as it posted a disappointing decline of 13% This was thanks in large part to Visa generating much of its revenue from international transfers, which were lower by almost 20% in the last yea r – with less travel of course. That put a break on the good run it was having over the longer term as its three-year EPS growth is still a noteworthy 22% in total. Yet, the last year was anything but ordinary, and many companies are trying to dig out of the hole 2020 left in their earnings reports.
Looking ahead now, EPS is expected to climb by 23% per annum during the coming three years, according to the analysts following the company. The company is positioned for a more robust earnings result, with the market only predicted to deliver 14% per year.
In light of this, it’s understandable that Visa’s P/E sits above most other companies. It seems most investors are expecting this future solid growth and are willing to pay more for the stock.
What Can We Learn From Visa’s P/E?
Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.
Unquestionably, VISA built a solid moat over the decades, dominating the market with accessibility, SaaS profit margins, impressive economics of scale, and above all, an exceptional brand name – regularly ranked among the top brands in the world.
Visa Fact Sheet, source: Visa.com
As we suspected, our examination of Visa’s analyst forecasts revealed that its superior earnings outlook is contributing to its high P/E. At this stage, investors feel the potential for a deterioration in earnings isn’t significant enough to justify a lower P/E ratio.
However, an overblown price doesn’t change the company’s quality — it just changes the quality of your potential investment. Those companies are worth having on close watch while waiting for a pullback.
We don’t want to rain on the parade too much, but we also found 2 warning signs for Visa that you need to be mindful of.
Of course, you might also be able to find a better stock than Visa. So you may wish to see this free collection of other companies that sit on P/E’s below 20x and have grown earnings strongly.
Simply Wall St analyst Stjepan Kalinic and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.