Mastercard Inc. (MA, Financial) has been one of the greatest compounders in the stock market. Since its initial public offering in 2006, the stock has gained 8,175%, equivalent to an impressive compounded annual return of 28.70%. In addition, the company's shareholders have been getting consistently increasing dividends over time.
Because of its growing operating performance and high return on invested capital, Mastercard's share price has continued to rise, recently reaching an all-time high of nearly $476.70. Despite this peak, the stock still presents a compelling investment opportunity at its current price.
Earning transaction fees without credit risks
Mastercard is one of the two largest companies in the global payment processing industry, with an extensive ecosystem of more than 100 million acceptance locations worldwide. It facilitates transactions in more than 150 currencies across over 210 countries and territories. While many investors perceive Mastercard primarily as a credit card company, it does not give loans to users. Instead, it earns revenue by charging a small fee—known as an assessment fee—whenever customers make payments through its global network. Accrding to Merchant Maverick, this fee typically ranges from 0.13% to 0.15% of the transaction value.
In contrast, banks that issue credit cards, and not Mastercard, are the ones that actually loan money to consumers. These banks charge interchange fees, which represent a higher percentage of the transaction value, to cover the credit risk they assume by lending. Mastercard, however, does not bear this credit risk.
Growing revenue and operating income
Mastercard has consistently increased its revenue in 19 of the past 20 years. The sole year it witnessed a decline in revenue was in 2020 due to the Covid-19 pandemic, when global lockdowns significantly impacted the company's operational performance. Over the period from 2003 to 2023, its revenue grew from $2.23 billion to nearly $25.10 billion. This growth translates to a compounded annual rate of 12.80% over the 20-year span. The operating income has followed a similar trend. Since becoming profitable in 2004, its operating income has increased from $346.70 million to $14.63 billion, delivering a compounded annual growth rate of nearly 21.8%.
What impresses long-term investors is the company's consistently high return on invested capital. Over the past 15 years, Mastercard's ROIC has ranged from 39.44% to 73.37%, settling at 42.78% in 2023. Legendary investor Warren Buffett (Trades, Portfolio) favors businesses that can grow revenue and profitability without having to reinvest significant capital back into the business. He said, "The best business to own is one that, over an extended period, can employ large amounts of incremental capital at very high rates of return."
Strong cash flow generation
Mastercard is also a growing cash cow. Its operating cash flow and free cash flow have been on an upward trajectory for two decades. Its operating cash flow increased from $190.5 million in 2003 to nearly $12 billion in 2023, while its free cash flow surged from $47 million to $10.90 billion over the same period. As a result, the free cash flow experienced a high CAGR of 31.30% .
Robust balance sheet and committed shareholders' return
Mastercard has a quite strong balance sheet with a reasonable amount of leverage. As of December, the company recorded nearly $7 billion in shareholders' equity and $8.60 billion in cash. The total interest-bearing debt came in at around $15.68 billion. At first glance, the debt-to-equity ratio may appear quite high at 2.24. However, upon closer inspection, it becomes clear the low shareholders' equity is the result of significant share buybacks accumulated over time. The company has spent $60.40 billion on share buybacks, returning money to shareholders and consequently reducing the total shareholders' equity.
Regarding debt, Mastercard's long-term debt maturities extend all the way to 2051. Over the next five years, the company's annual principal payments will range from $750 million to $1.89 billion. Given its operating cash flow, which was $12 billion in 2023 and continues to grow, Mastercard should easily meet its interest and debt obligations for many years to come.
Source: Mastercard's 10-K filing
Huge upside potential
Let's calculate Mastercard's intrinsic value using the discounted free cash flow model. We will assume the company's free cash flow will grow by 30% annually for the next five years. After this period, the terminal growth rate will drop to 5%. Applying an 8% discount rate, Mastercard's enterprise value is estimated to be nearly $991 billion. Accounting for the current net debt of $8 billion, its equity value is projected to be around $983 billion. With the current total shares outstanding of 946 million, Mastercard's equity value per share will be approximately $1,056, which is 120% higher than its current share price.
Key takeaway
Mastercard has been a great compounder since its debut in 2006. Despite its current all-time high share price, the analysis reveals a significant 120% upside, with shares being worth around $1,056. Mastercard has successfully delivered an impressive track record of revenue growth, profitability, robust cash flow and an exceptional return on invested capital. Moreover, its strong balance sheet and strategic share buybacks reflect a financially sound and growth-oriented company.
The company's consistent performance and strategic positioning in the global payment processing sector affirm its potential for continued value creation for investors, making it a compelling value opportunity.
