Since its initial public offering (IPO) in 2006, Mastercard(NYSE: MA) has generated a total return of 12,480%. This means that a $10,000 capital outlay back then would be worth a breathtaking $1.3 million today. This gain is hard to beat. Shares currently trade close to their all-time high as this business continues humming along.
Before you buy this financial stock, though, here are three things that investors should know about Mastercard.
Business model
Because investors associate Mastercard with credit cards, the assumption might be that the business finds borrowers, approves them, and then issues those cards. Consequently, you might believe that Mastercard collects interest payments anytime customers hold balances.
But this isn't how the business works. Instead, Mastercard operates the communications protocol that connects various stakeholders, like merchants, banks, and consumers. This helps to facilitate the processing of card transactions. This is distinct from financial services entities like Bank of America or Capital One, which issue credit cards and take on default risk.
Mastercard generates its revenue by providing a secure, seamless, and reliable way to move money around. It earns a very tiny fraction (much less than 1%) of the dollar amount of each transaction. This activity represented 63% of its revenue in the third quarter, with value-added services, like fraud detection, cybersecurity, and data analytics, making up the rest.
Because Mastercard relies on robust spending behavior across the economy, one could argue that the business is somewhat cyclical. However, its operations aren't as negatively impacted as those of lenders in recessionary scenarios. For example, Mastercard doesn't have to set aside reserves for potential credit losses.
Network effects
As of this writing, Mastercard sports a market capitalization of $479 billion, making it one of the most valuable companies on the face of the planet. This position has come about from tremendous investment returns, which I mentioned earlier. Clearly, Mastercard is a corporate success story.
What makes this company special is its wide economic moat. The business benefits from powerful network effects. The company counts a whopping 3.4 billion credit cards in circulation around the globe. These are accepted by 150 million merchants worldwide.
This creates a massive two-sided ecosystem that gets more valuable to all stakeholders as it grows. Consumers want Mastercard cards in their wallets because they are accepted virtually everywhere. And merchants realize that if they don't accept these cards, they will miss out on a sizable revenue opportunity.
It would be almost impossible to mimic what Mastercard has built. An upstart payment network would need to bring on cardholders and merchants without having any users to begin with. That's a tall task.
Financial position
A scaled payment processor like this one operates a very asset-light business model. Capital expenditures are low, totaling 4.3% of revenue in 2023. And expenses are largely fixed in nature. The result is an extremely profitable enterprise. Mastercard's operating margin was an outstanding 54.3% in Q3, indicating its ability to translate revenue into earnings.
Producing copious amounts of free cash flow isn't an issue. Mastercard uses its excess cash profits to return capital to shareholders. Last quarter, the company paid out $611 million in dividends and repurchased $2.9 billion worth of its outstanding stock. This capital allocation policy boosts investor returns.
As of Sept. 30, Mastercard carried $17.6 billion of long-term debt on the balance sheet. However, its interest payments totaled just 2.2% of sales in Q3. Management clearly uses leverage in a responsible way. There is no risk that the business will run into financial troubles.
Investors looking to buy Mastercard now have a better understanding of its business model, its economic moat, and its current financial standing.
Should you invest $1,000 in Mastercard right now?
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Bank of America is an advertising partner of Motley Fool Money. Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Bank of America and Mastercard. The Motley Fool recommends the following options: long January 2025 $370 calls on Mastercard and short January 2025 $380 calls on Mastercard. The Motley Fool has a disclosure policy.
