## an introduction

Assuming that the stock market is now in a correction mode, it is interesting to note that Mastercard (MA) and Vone (fifth) Been in this position for the third month already. Now, I think it’s a good time to compare how close these companies are to their bottom line.

## what should I do

In my opinion, the core value or rational price of a firm is a function of three variables: (1) revenue, (2) margin, and (3) risk. In turn, the first two variables are unified by a single concept of free cash flow. Or the free cash flow can be exchanged for dividends if the company pays them. By the way, this is our case.

Thus, to estimate the underlying value of both companies, I will build discounted cash flow models and dividend discount models. Yes, there will be many tables.

## The basic parameters of the models

For the models to be less subjective, I will take as a basis the average forecasts of analysts regarding revenue and EPS to companies in the next decade.

I also want to note the following. The business models of both companies appear to be fairly stable. So, over the past five years, in the case of Visa, the average operating margin has been about 65%, and in the case of Mastercard, about 55%. I proceed from the assumption that average margin levels will continue.

The relative volume of capital expenditures is fairly stable in the long run:

Both companies pay dividends. When forecasting this parameter, I proceeded from the average forecast of analysts for the coming years and the assumption that the payout ratio would tend to the historical average. In the case of Visa it is 21.6% and in the case of Mastercard 20.8%. As you can see, the values are approximately equal.

Finally, both companies continue to actively buy back. On average, the number of diluted shares in both companies is reduced by 2% annually. I suppose this dynamic will continue into the future.

In general, it is remarkable how similar the two companies are in the context of the dynamics of the main financial indicators. But now let’s move on to the models.

## Visa

Below is the calculation of the weighted average cost of capital for obtaining a visa:

Notes:

- In order to calculate the market rate of return, the values of the equity risk premium (4.72%) and the current return of UST10 were used as the risk-free rate (1.46%).
- I used the present value of the beta coefficient for three years. For the final year, I used a beta equal to 1.
- To calculate the cost of debt, I used 2020 interest expense divided by the average debt in 2019 and 2018.
- The relative size of capital expenditures is assumed to be 3.5%, which is the five-year average.

This is the discounted cash flow model:

The DCF-based target price for Visa shares is around $253 (+14%).

Here is the dividend discount model:

DDM-based target price for Visa shares is $103 (-54%).

## Master Card Credit Card

Now let’s take a look at MasterCard. This is the WACC account:

Here is the discounted cash flow model:

The DCF-based target price for Mastercard shares is around $346 (+1%).

This is the dividend deduction model:

DDM-based target price for Mastercard shares is $123 (-63%).

Now to summarize the main findings:

DCF | DDM | WACC | |

Visa | + 14% | -54% | 5.48% |

Master Card Credit Card | + 1% | -63% | 6.15% |

## put everything together

- The first thing to highlight is how aggressively both companies are overestimated in terms of potential earnings. This indicates that from the investors’ point of view, Visa and Mastercard are essentially growth companies. They are valued by the market in terms of cash flow. Dividends, in this case, are just an added bonus.
- In terms of DCF modeling, Visa is undervalued. Meanwhile, MasterCard’s base value now matches the market price.
- If you focus on dividend models, the value of Visa is less than that of Mastercard.
- Thus, I think Visa is probably a better investment than Mastercard.