I am writing today to help inform people who are new to the stock market and want to begin learning the link between Visa Inc (NYSE:V)’s return fundamentals and stock market performance.
Purchasing Visa gives you an ownership stake in the company. Your equity share is granted in return for the capital provided to the business to operate, and in order for an investment to be successful the business has to create earnings from the funds that make up this capital. This is because the actual cash flow generated by the business dictates the potential for income (dividends) and capital appreciation (price increases), which are the two ways to achieve positive returns when buying a stock. To understand Visa’s capital returns we will look at a useful metric called return on capital employed. This will tell us if the company is growing your capital and placing you in good stead to sell your shares at a profit.
Visa’s Return On Capital Employed
As an investor you have many alternative companies to choose from, which means there is an opportunity cost in any investment you make in the form of a foregone investment in another company. The cost of missing out on another opportunity comes in the form of the potential long term gain you could’ve received, which is dependent on the gap between the return on capital you could’ve achieved and that of the company you invested in. Hence, capital returns are very important, and should be examined before you invest in conjunction with a certain benchmark that represents the minimum return you require to be compensated for the risk of missing out on other potentially lucrative investments. A good metric to use is return on capital employed (ROCE), which helps us gauge how much income can be created from the funds needed to operate the business. This metric will tell us if Visa is good at growing investor capital. V’s ROCE is calculated below:
ROCE Calculation for V
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = US$12.46b ÷ (US$69.04b – US$9.55b) = 20.94%
As you can see, V earned $20.9 from every $100 you invested over the previous twelve months. This shows Visa provides a superb return on capital that is above the 15% ROCE that is typically considered to be a strong benchmark. As a result, if V is clever with their reinvestments or dividend payments, investors can grow their capital at a fast rate over time.
Can any of this change?
Although Visa is in a favourable position, you should know that this could change if the company is unable to maintain a strong ROCE above the benchmark, which will depend on the behaviour of the underlying variables (EBT and capital employed). So it is important for investors to understand what is going on under the hood and look at how these variables have been behaving. Looking three years in the past, it is evident that V’s ROCE has deteriorated from 25.67%, indicating the company’s capital returns have declined. Over the same period, EBT went from US$8.57b to US$12.46b but capital employed has grown by a proportionally greater amount in response to a hike in the level of total assets , indicating that the previous growth in earnings has not been able to improve ROCE because the company now needs to employ more capital to operate the business.
Despite V’s downward trend in ROCE in the recent past, the company still remains an attractive candidate that is capable of producing solid capital returns and a potentially strong return on investment. But don’t forget, return on capital employed is a static metric that should be looked at in conjunction with other fundamental indicators like future prospects and valuation. It’s important to account for these factors because you cannot be sure if the downward path is a signal to run, or just a blip in an otherwise solid return profile. If you’re building your portfolio and want to take a deeper look, I’ve added a few links below that will help you further evaluate V or other alternatives.
- Future Outlook: What are well-informed industry analysts predicting for V’s future growth? Take a look at our free research report of analyst consensus for V’s outlook.
- Valuation: What is V worth today? Is the stock undervalued, even if its ROCE is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether V is currently mispriced by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.