The Credit Card Industry: Dividend Yields Worth Pursuing?

This is a guest post by Michael Dolen, who runs Credit Card Forum, a website for credit card deals & discussion.

Credit CardFor many Americans and Canadians, credit cards have become a way of life. By that I don’t necessarily mean for carrying debt (most don’t) but rather using them to pay for practically everything. I definitely fall into that category… it’s not uncommon for several weeks or even months to go by without ever spending cash.

From a lending perspective, that lifestyle isn’t attractive when there’s no balance is carried and hence, no interest paid. However on the flip-side, it’s still extremely lucrative for those making money off the processing fees. Even though the bills are paid in full, skimming 2-3% off every dollar spent adds up to a considerable sum of money.

These processing fees are split between the payment network (such as Visa or MasterCard), the card’s issuing bank (like Capital One), and the merchant processing service. This YouTube video does a good job explaining how the fees are divvied up and who gets what.

The Big 4 Processors

Of course the dominant players in the North American market are Visa, MasterCard, Discover, and American Express. However the latter two have a different business model, because they usually operate as both the payment network as well as the issuing bank for their cards. In theory, this makes them a riskier investment since their business also involves lending money. For that reason, let’s focus on the other two, Visa and MasterCard.

Both operate as payment networks only. They still get paid whether or not a customer pays their credit card bill. This puts them in an extremely lucrative position of having excellent cash flow with fewer liabilities to cover. The question is, where will that money go? Let’s take a look at their dividends:

Visa

Trailing Annual Dividend Yield: $0.60 (0.70%)
Payout Ratio: 10%

MasterCard

Trailing Annual Dividend Yield: $0.60 (0.20%)
Payout Ratio: 4%

stats from Yahoo Finance, 8/31/2011

As they stand today, it goes without saying these yields are quite pathetic. But what does the future hold in store for them? MasterCard has zero debt and Visa essentially has none (only $35M). Funding future growth is essential, but with operating margins greater than 50%, I don’t think that will be a problem.

Due to regulatory scrutiny, I do believe their cash reserves need to be bolstered (both are currently below $4B) but after that happens, then what will they do with their money?

What’s next?

But as it stands today, do either belong in your portfolio? That is a decision you will have to base on your future expectations, since their yields today are minuscule. Where do you think they will stand 3, 5, or 10 years from now? If you had bought in on MasterCard’s IPO (in May 2006) at $39, today your yield would equal out to be around 1.5%… hardly impressive, until you consider that’s with only a 4% payout ratio and arguably plenty of room to grow. It’s a similar story for Visa’s IPO (in March 2008) at $44, which would equate to a yield of about 1.36% today.

Both companies currently have PEG ratios below 1 (largely fueled by international growth) but only time will tell what their actual growth will be. Although neither endures the risk of lending money, a potential risk I could see which would impact earnings (and dividend growth) is if there were to be a crackdown on processing fees (similar to what we saw with debit cards). Merchants complain about the costs of accepting credit cards, but they fail to realize the benefit in doing so. Studies have shown those who pay with plastic spend significantly more than cash. Now that the Durbin Amendment allows for merchants to set minimum purchase amounts for card payments, I believe the chances of a future regulatory crackdown on the credit card industry is less likely.

This is a guest post by Michael Dolen, who runs Credit Card Forum, a website for credit card deals & discussion.

5 Responses to “The Credit Card Industry: Dividend Yields Worth Pursuing?”

  1. MoneyCone

    Sep 01. 2011

    The yields may not be impressive, but MA has returned over 600% since 2006!

    Reply to this comment
  2. My Own Advisor

    Sep 01. 2011

    Nice post!

    Until I get many more and higher paying, dividend-payers in my portfolio, I won’t be buying V or MA. These are great companies though.

    I recall Derek Foster is a fan of Visa. I too, believe these companies are recession-proof.

    Reply to this comment
  3. MoneyCone- Yes, the price appreciation on MA has been spectacular since its IPO!

    My Own Advisor- I am in the same boat as you… neither are a priority for me to buy at the moment, but nonetheless once I free up some funds, I would like to own a chunk of both for the long run.

    Reply to this comment
  4. The Dividend Ninja

    Sep 01. 2011

    Michael brings up a couple of really great points in this post regarding Visa and MasterCard:

    1. With Dividend Payout Ratio’s (DPRs) well below what other companies are paying, and such a low dividend yield, there is certainly no reason why Visa and MasterCard could not pay a much higher dividend.

    2. That these financials are much safer than the U.S. banks, or other companies that have financing, therefore they are a a safer investment. As MOA points out, these companies are recession proof!

    But MoneyCone is correct, you have to look at more than just the yield and take into account the captial appreciation, and your total return (ROI). The capital appreciation on MasterCard is phenomenal! And Visa has also had exceptional captial appreciation since the financial crisis in 2008.

    As I pointed out in my MoneySaver article on the dividend payout ratio, lower yield stocks can give you far more capital appreciation over time. But yes, if you are only buying for dividend yield, then you will be dissapointed 😉

    Thanx for your post Michael!

    Reply to this comment
  5. I have actually had VISA in my cross-air for quite a while when it IPO’d after seeing the crazy growth MA was going through. Back in those days I was buying AAPL and RIM though … Those weren’t dividend days for me 🙁 I do have it in my screening list though.

    I would probably invest in it only as a value play though rather than the dividends.

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