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When the Supreme Court handed American Express a victory last July, John Archer's portfolio looked vulnerable because MasterCard was his biggest position. I have found that when the going gets rocky is when great managers prove their skill. After returning 25.46% in 2017, John is one of the few managers who made money in 2018 when the market turned down. To evaluate his skill, take a look at what he did when his portfolio was the most vulnerable.
Ken Kam: John, last July when MasterCard was looking vulnerable at $206, you estimated its intrinsic value at $170, yet you didn't sell any. How does that make sense?
John Archer: As I said last July, MasterCard has one of the most attractive business models in business today. Its competitive position, operating profit margins, and global scale make it one of the best companies in the world to own.
Its revenue and profits have been consistently growing at double-digit rates for years and this trend is expected to continue. I expect the company to grow revenue and earnings per share at roughly 13% and 15% respectively over the next 5 years.
MasterCard’s profitability is incredible. It sports operating profit margins of 56%, second only to Visa’s operating margins that are in excess of 60% and is perhaps one of the most profitable companies in the world. This compares to other firms such as Facebook, Alphabet and Apple that generate operating margins of 44%, 23% and 26% respectively.
Kam: Yes, but last July it looked like the Supreme Court decision gave American Express an advantage over MasterCard and VISA. Shouldn't that have dampened MasterCard's outlook?
Archer: The payments industry is highly competitive and changing rapidly, but MasterCard’s extensive network of merchants, issuing banks and consumer cardholders makes its position in the industry rock solid.
It’s smaller in size than its rival Visa but its relative size makes it more nimble, winning the new Apple Card business for example. The global market for electronic payments will continue to grow and MasterCard will continue to grow with it, particularly internationally where a majority of the growth is expected to be generated.
Kam: How can MasterCard maintain the growth rates you are expecting?
Archer: Only about 10% or $22 trillion of the $225 trillion global market for payments is card based, meaning that the $120 trillion in business-to-business payments and the $60 trillion in person-to-person and business-to-persons markets are almost completely untapped for card usage. This makes for a huge addressable market and a very long runway for future growth.
Kam: With MasterCard at $249, your decision not to sell was the right call. However, since your estimate of intrinsic value was $170, has the stock gotten ahead of itself?
Archer: I estimated MasterCard’s intrinsic value at roughly $170 per share last July. I have updated my projections and discounted cash flow calculations after its robust first-quarter results and now estimate the intrinsic value at roughly $230 per share, an increase of about 35% in just nine months!
Over the same nine-month period of time, the stock price has increased by 18% compared to the S&P 500 index increase of 4%. If the trend of a company’s intrinsic value is increasing at a faster rate than the price of the stock I will generally continue to hold it because it reflects management’s ability to generate ongoing economic value.
Please keep in mind that intrinsic value is never a specific price but a range of values depending on the estimates used to project future results. With a high-quality company like MasterCard that is generating huge profit margins and has a very long future runway for continued growth, I feel comfortable holding a relatively large position in the company allowing it to compound its value for many years to come.
Kam: How much of your portfolio is in MasterCard?
Archer: MasterCard remains the largest stock position in the TAB fund at 14% of total assets. I expect MasterCard to continue to trade at a premium price above its intrinsic value, but investors wanting to consider purchasing shares in the company may want to wait for a pullback in the stock price to $230 per share or below and consider holding it for 3-5 years or longer.
My Take: Many value investors make the mistake of selling as soon as a stock's price exceeds their estimate of intrinsic value. I really like John Archer's approach better. In order to be in the best stocks for the longer term, he is willing to hold them even when they trade at a premium to his estimate of intrinsic value.
In 2018, John Archer's TAB fund was up 1.53% while the S&P 500 lost 4.38%. Even with a large cash position, John is up already up 12.83% this year.
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