Visa Beats Earnings, Suffers Downgrade: What You Need to Know

By Markets Fool.com

It's earnings season on Wall Street, and just yesterday, Visa (NYSE: V) reported a blockbuster quarter featuring 19% revenue growth -- and 28% growth in profits. So naturally, Wall Street downgraded Visa stock.

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Wait, what?

That's right. As reported on StreetInsider.com this morning, analysts at Guggenheim announced they are responding to Visa's massive earnings growth with a downgrade from buy to neutral. What's more, over at Stifel Nicolaus, analysts notedthat they are "reducing estimates" for Visa stock going forward, and cutting their price target on the stock from $94 to $93. This is despite Visa having reported earnings beats in each of the past four quarters, including the one yesterday (in which Visa beat estimates by $0.05).

So what's up with that? Here are three things you need to know.


Image source: Visa.

No. 1: The numbers

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Yesterday's earnings reportclosed out Visa's fiscal year 2016 with a bang, growing sales 19% and earnings 28%, to $0.79 per diluted share. The news wasn't all good, however.

For the full year, earnings per share actually declined 4% to $2.48. This was despite revenue growth for the full year of 9% ($15.1 billion total).

No. 2: The guidance

With revenue rising and foreign exchange rate headwinds abating (Visa noted that exchange rates cut about 3 percentage points off of its growth rate last year), things are looking up for Visa in fiscal 2017. According to management's new guidance, Visa expects to grow revenue as much as 18% in the coming year -- and that's after subtracting 1 full percentage point for "negative foreign currency impact."

The profitability of that revenue is rising as well. According to Visa, the company earned operating profit margins of 52% in fiscal 2016. In 2017, however, management says its annual operating margin is likely to reach the "mid 60s," boosting the profitability of each revenue dollar it takes in.

No. 3: Dollars and cents

What this means to investors, therefore, is that with revenue rising fast, and the profitability of that revenue rising even faster, Visa expects to reverse its earnings slide in the coming year, and grow earnings at 30% or better in 2017.

So how does that look from a valuation perspective? Well, crunching Visa stock's latest numbers as reported on S&P Global Market Intelligence, Visa now sells for roughly 32.5 times trailing earnings ($6 billion net profit, $195 billion market cap.) That valuation seems appropriate for a stock growing earnings at 30%-plus, and paying a modest 0.8% dividend yield. The question is whether Visa can grow earnings at this rate long enough to justify its high price.

So can it?

The most important thing: The future

For Stifel Nicolaus's part, they seem to think such growth is achievable.

Although the analyst cut its rating on Visa stock, Stifel noted that it remains optimistic about Visa's ability to grow. Although "initial 2017 guidance" is "a touch below expectations," says Stifel, "Visa is benefiting from multiple tailwinds including major contract wins, currency, pricing and now Visa Europe." Put it all together, and Stifel believes the stock will deliver "material upside to EPS" in 2017 and beyond.

Guggenheim, on the other hand, is less optimistic, more cautious -- and in my view, right to be so. Here's why:

Although Visa looks set to enjoy a strong fiscal 2017, 30%-plus growth is going to be hard for a company of Visa's size to maintain over the long term. Indeed, S&P Global data show that among the 36 analysts who follow Visa stock today -- most of whom recommend buying the stock -- the consensus is that Visa will still only average 17% annual growth over the next five years. Paying 32.5 times earnings for 17% growth doesn't seem like a good bargain to me. For this reason, I'm going to disagree with Stifel Nicolaus, and side with Guggenheim on this one.

Although it's a great business, and has been a great stock for investors so far, Visa stock simply costs too much to buy today.

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Fool contributorRich Smithdoes not own shares of, nor is he short, any company named above. You can find him onMotley Fool CAPS, publicly pontificating under the handleTMFDitty, where he currently ranks No. 324 out of more than 75,000 rated members.

The Motley Fool owns shares of and recommends Visa. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.