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Low price and limited downside

Posted By Christopher Grey On 12/13/2010 @ 8:54 pm In Commentary | Comments Disabled

In the current market that is generally overbought and expensive, Visa is one of the few companies out there that seems to be both inexpensive on fundamentals and also is in a good position to buy from a technical perspective.

Visa’s business has a cloud over it at the moment because of fears about limits on debit card fees, but these fears are overblown. Visa’s earnings growth of about 15 percent to 20 percent per year likely will continue regardless of what the regulators decide on debit card fees. This regulatory action will impact banks much more than Visa.

Visa has a clean balance sheet, consistent earnings growth, great cash flow and is levered to increases in spending as well as the ongoing shift from cash and checks to plastic. It’s one of the least risky ways to invest in the continuation of an economic recovery and the expectation of higher spending next year as employment an confidence improve because of the recent tax cut deal in Washington.

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If you apply a multiple of 20 times 2011 consensus earnings estimates to Visa, the stock could easily reach over $110 next year versus its current $80. This multiple is reasonable when you consider the consistent 20 percent earnings growth that Visa has been delivering combined with its solid balance sheet and dominant market position. There is strong technical and fundamental support on the downside at $75 if the market declines and multiples contract to 15 times. Risk of substantially lower earnings than projected is possible, but it’s not likely unless the economy and spending turn out to be much worse than expected in 2011.

From a purely technical perspective, Visa has spent the last several months building up a base between $70 and $80 and has just started to break out to the upside. This is typically a good time to buy a high quality growth stock. Although the overall market is overbought right now, Visa has not been a momentum stock. If the market does weaken, Visa could stall or even decline. However, it could also be a beneficiary of investors moving out of declining momentum names and into higher quality, less risky, and more conservatively valued stocks like Visa.

Lastly, Visa is also cheap relative to Mastercard and Discover even though it has the dominant market position and the business model of these companies is basically the same. For all of these reasons, Visa should outperform the overall stock market in the coming months. I have bought Visa and expect to hold it at least until it reaches $95 and possibly longer.

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