It's "Pitch a Stock" week at Industry Focus! This week, contributors from around the Fool are pitching some of their favorite stocks, and explaining why they're such exciting investments.
In this episode, hosts Michael Douglass and Dylan Lewis examine pitches for Mastercard (NYSE: MA), Square (NYSE: SQ), and Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B), and discuss some of the biggest opportunities and risks for the companies. Listen in to find out how Mastercard still has huge room to grow, even though it's already so big; how Square is teaming up with vendors like Mastercard and Visa (NYSE: V) to create a symbiotic relationship rather than a competitive one; how Berkshire Hathaway makes its money and how it's made so much in the past several decades; and more.
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A full transcript follows the video.
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This video was recorded on Oct. 16, 2017.
Michael Douglass: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Monday, Oct. 16. We're kicking off our "Pitch a Stock" theme week across Industry Focus. Today, it's one sector and three stocks. I'm your host, Michael Douglass, and I'm joined in the studio for this very special episode by my colleague and good friend, Dylan Lewis.
Dylan Lewis: How's it going, Michael?
Douglass: It's great! Happy Monday!
Lewis: Happy Monday! You know, catching you doing that intro, I realized that we all have a slightly different cadence with how we say the intro. And I was waiting for it to hit the tones that mine do, and it's just different. I listen to your show, and I noticed that, but I caught it even more being in the studio with you.
Douglass: It's all in the company name -- The Motley Fool. [laughs]
Lewis: It's that kind of deep analysis that people tune in for.
Douglass: Absolutely. That's what we're known for here.
Lewis: But we will talk stocks.
Douglass: Absolutely. First off, a little background on this "Pitch a Stock" theme week. Fool.com has around 100 freelance and contract writers and editors around the world, and I mean legitimately around the world. And each year, we invite them to Fool headquarters for our annual writers' conference. This year, we figured we'd take advantage of the fact that they were here and have three writers per sector each pitch us a stock. We'll be hearing about Mastercard, ticker symbol MA, from Matt Cochrane; Square, ticker symbol SQ, from Matt Frankel; and Berkshire Hathaway, ticker symbol BRK-B. Well, there's also a BRK-A, but those shares cost legitimately $250,000 a piece, so I'm going to bet that most people are interested in the B shares, from Dan Caplinger. After each pitch, Dylan and I will share our thoughts for a few minutes before going on to the next one.
Here's the thing: We don't have enough time in this episode to really dig into the nitty-gritty with each company. Fortunately, for our prep, we gathered some really top-notch resources that you can use if you want to learn more about Mastercard, Square, or Berkshire Hathaway. If you want those, just drop us a note at email@example.com. We'll be happy to send them along. And that can help you really learn more about each those stocks if you're interested in better examining them for your investing portfolio.
Lewis: And listeners, I'm going to hop in here and give you a little insight into the Industry Focus team and some of the dynamics. Michael is a great host --
Douglass: You're very kind.
Lewis: -- but Michael gets a ton of fan mail and a lot of responses to his call-outs for articles and such things. So he pitched this to us, like, "Oh, this is a great deliverable." And it was like, "This is just Michael wanting to get more emails about the shows that he does." I mean, I love that the listeners are super engaged and interested in the stuff you talk about, but that J&J-Pfizer thing for Healthcare, the Dividend Aristocrats deliverable, you're crushing it right now.
Douglass: Thank you. Yes. Feed my ego, dear listeners, please. [laughs]
Lewis: And it's great. I think we're sending people good stuff.
Douglass: Yeah, absolutely. It's great that we have so much good content out there that we can then pass along to people as you better learn the stock market.
Lewis: But I do like to review for your desperate pleas for listener approval.
Douglass: [laughs] So desperate. All right, let's go ahead and roll that Mastercard pitch from Matt Cochrane.
Matt Cochrane: Greetings, Fools. I'm Matthew Cochrane, and I generally write for the fintech and payment industries for The Motley Fool. Today, I'd like to talk about Mastercard Incorporated, listed on the New York Stock Exchange as stock ticker MA. What is Mastercard? What exactly do they do? I find a lot of confusion exists about exactly what Mastercard's business model is. Do they loan money to customers? Are they a bank? Are they a credit card company?
I think it's best to think of them as a giant payment network or a toll road for your money. And every time your money uses this toll road, Mastercard collects tiny fees based on the number of transactions across their network, the payment volume across their network, which is basically how much the items or services cost that were purchased using their network. It's a great business model. It's asset-lite, it's high margin, and it's why Mastercard has been able to return 3,000% to shareholders since 2006. It generated about 85% of Mastercard's revenue last quarter.
But what I think makes Mastercard such an unique opportunity today is that 15% of other revenues that Mastercard generates that's not from its payment network. Mastercard calls these revenues in its earnings presentation "other revenues." They really hype them up. And it's been growing. It accounted for almost $700 million of revenue last quarter, which was good enough for an 18% year-over-year revenue growth in that category. Basically, what it is, Mastercard is able to bundle together a lot of services for data analytics, reward program management, and security features that they can bundle together and sell to financial institutions and merchants that exist outside of these banks' and merchants' core competencies, so they're happy to pay Mastercard for these services. Some of this is bleeding cutting-edge stuff. For instance, one of their most recent acquisitions was NuData Security. What NuData Security does is use passive biometrics to determine if a purchase was fraudulent or not. Passive biometrics is things like how you type in your credit card number on your keyboard when you make a purchase online, or how you hold your smartphone when you make a purchase on your smartphone. And merchants love this, because it doesn't add any extra inconvenience to the customer, but adds an extra layer of security for the merchant.
Like I said, it's grown 18% year over year. But more importantly, it's giving Mastercard an edge now in winning new deals. Last quarter, Mastercard announced new deals with Banco Santander, Kroger, Toys R Us, Belk. In the conference call, CEO Ajay Banga credited these services that Mastercard can offer as the differentiator in winning these new deals. I quote, "In each of these deals, our innovative solutions and value-added services were key differentiators for us." Basically, what you have in Mastercard, you have a company with a history of market-crushing returns, you have a company winning new deals, and at its recent investor day, it raised revenue guidance for the rest of the year. What do I call this kind of combination in an investment opportunity? I call it priceless.
Douglass: So, we're going to try to not make any other priceless puns for the rest of this show. But I'm not sure we're going to be able to restrain ourselves.
Lewis: I think one is good. [laughs] You know?
Douglass: Three is maybe a little too much.
Lewis: He slipped that one in there really nicely. That was a really nice way to put a bow on his pitch there.
Douglass: Yeah. But if we do anymore, it's overkill.
Lewis: I think Matthew Cochrane is probably a name that listeners should get to know. He's an excellent writer for fool.com. And one of the beauties of this pitch week is, we have some voices and some companies being discussed that don't normally get on the show. Hopefully we'll get a little bit more of him down the road, particularly because the fintech space is a very interesting one.
Douglass: And a great opportunity for you and I to collaborate more and more on Industry Focus.
Lewis: I love it.
Douglass: So, let's talk about Mastercard a little bit. It's the second-largest payment processing network in the world. No. 1, not surprisingly, is Visa. One of the real benefits of that is that network effect. When you go to a restaurant, usually they're accepting Visa and Mastercard. Maybe they accept Discover, maybe they accept AmEx. But you're always going to have those two.
Lewis: And AmEx is almost prohibitively expensive for a lot of people to accept. You talk about that as the network effect. I also look at that as a major barrier to entry, and something that really solidifies them in the payments space. For them to have built out this infrastructure, it makes it a lot harder to compete there, because it's expensive to do that. So, they have all of this great legacy work already laid out. And you're noticing, while there are other payment entrants coming into the space, they're piggybacking on a lot of this, rather than innovating and establishing that infrastructure themselves.
Douglass: Right. One of the other things Matt pointed out in his pitch that I thought was very well noted by him was this "other" revenue piece. It's still a relatively small part of the business, but if it's helping Mastercard win away business from competitors, to build and strengthen that moat, that's a win on its own. Secondly, the fact of the matter is, diversifying in any way that's profitable is a good thing. If Mastercard is able to bundle some of these other benefits, that's across the board a win.
Lewis: We mentioned that Mastercard and Visa are the two major players with credit cards. Is there anything in your view that really separates the two of them? Is it that Mastercard is investing in a lot of things that Visa isn't? Is there anything that's particularly compelling about Mastercard rather than Visa?
Douglass: I'm a Mastercard shareholder and not a Visa shareholder.
Lewis: So, that was a perfect question to ask you.
Douglass: [laughs] Right, great question. I think a big piece of it is their investment in some of these "other revenues" areas that Matt really highlighted. What's interesting to me is, Mastercard has held down its profitability for a long time to make these investments and other investments in its infrastructure. And you can see those beginning to really start paying off. If you go all the way back to 2012, I was one year out of college, revenue at Mastercard was $7.4 billion. In the trailing 12 months, revenue has jumped up to $11.4 billion. That's growth of 55%.
Lewis: Not at a compound annual growth rate, but still incredibly impressive.
Douglass: Right. In those five years, they've grown revenue by 55%. Net income they've grown by 59%. So, you can tell that the margins are starting to increase a little bit. For me, the real impressive piece is, diluted earnings per share have increased by 84% from $2.19 in 2012 to $4.03 over the trailing 12 months. That really highlights their work to buy back shares and decrease share count, and improve that operating leverage so they're able to more effectively deploy every dollar they get in the top line and bring that down to the bottom line. And for me, that's a really attractive long-term opportunity for the company.
Lewis: And it sounds like, in looking at how they've allocated capital and looking to buy back shares, and how they've strategically set up their business, this is management looking long-term, it's a company that is building itself for decades.
Douglass: Absolutely. With that, based on all the stuff that we discussed and more, Daniel Sparks, who's one of our really well-respected writers in tech, argues that Mastercard could easily double its dividend in the next five years. I'm happy to shoot you the link to that article --
Lewis: [laughs] I can't help but laugh now, now that we talked about your pining for listener approval.
Douglass: It's a really good article! I don't know, I really enjoyed it. Again, as a Mastercard shareholder with a dividend under 1%, I'm always interested in seeing if there's an opportunity to grow that. So, email us at firstname.lastname@example.org, and we'll be happy to send that along.
Lewis: Michael will be happy to send that along. [laughs]
Douglass: Yes, [laughs] yes he will. All right, let's turn to Square.
Matt Frankel: This is Matt Frankel, financial sector analyst at The Motley Fool. I'm picking Square as my pitch for the day. Square is a company that provides payment solutions to small and medium-sized businesses. A lot of people think Square is kind of expensive right now, because the stock has gone up about 140% just in this year alone. But I think that's well justified and there could be a lot more room to go.
In the past year alone, their payment volume is up by over 30%. They've opened up a whole new line of revenue. Their Square Capital lending program has almost doubled, up about 70% in the past year. They're actually in the process of opening up their own bank so they can loan directly to their customers. They're doing a great job of creating an ecosystem of services to provide to small and medium-sized businesses.
They're in five countries around the world. They just expanded to the U.K. There's a lot of international opportunity, especially in places like Asia and the Middle East. An interesting statistic that explains Square's market potential is that only about two-thirds of the businesses around the world accept credit card payments at this time. Payment volume is expected to reach roughly $50 trillion a year within the next 10 years. And Square is currently processing about $60 billion a year. So, this is a big, big market opportunity. I think, if they keep doing what they're doing and doing it well, and managing risk like they're doing, $30 a share could seem very cheap.
Lewis: I'm glad that we're talking about Square after Mastercard. As I mentioned, you have some of these new entrants to the payments space piggybacking off of legacy infrastructure...
Douglass: And lo and behold, here's one of them.
Lewis: It's almost like we planned out the show. [laughs] But, you think about how most consumers interact with Square, they're out at farmer's markets or some type of trade show or something like that, and they're swiping their credit card on one of Square's digital readers, one of those little dongles that you plug into an iPhone or an iPad or something like that. That's kind of how we think about their business. That leans pretty heavily on the legacy credit card processors.
Douglass: Right. It's interesting, because Square is really focusing on the huge market opportunity in payment processing. This is something that also very much affects Mastercard. But, the fact of the matter is, worldwide, about 15% of payments are coming through on credit and debit card transactions. About 85% in cash and check. So, while, dear listeners, probably for many of you, certainly for me and Dylan the vast majority of our lives are credit card based. I spend cash and checks, my rent check, two or three other things a month, usually, actually, at a farmers market when they don't have Square yet. The fact of the matter is, most of the world still isn't operating that way. So, that's a big opportunity potentially for both Mastercard and Square.
Lewis: And I think this market feels a lot like the e-commerce market. It feels like, because of our everyday, like, I just ordered something off Amazon before the show. It was something that I easily could have gotten at a brick-and-mortar store. And yet, I think within the U.S., 10% of total retail activity is online. The vast majority of it is brick and mortar. So, while your everyday might have you in this mind of, "Everything is digital, this has to be pretty far down the growth runway at this point, this megatrend," nope. There's still a large way to go, worldwide in particular, but even within the U.S.
Douglass: Right. And the fact of the matter is, in the U.S., we're still 90-10, something like that, then that means worldwide is more like, spitballing here, 99-1, or something along those lines.
Lewis: And looking at Square's business, they're moving outside of this reliance strictly on transaction payment and facilitating that. They're looking to get into the capital game and the loan game as well. And that's something they've seemed to do pretty well so far. You look at what they've done in terms of making loans available. Their default rates are crazy low for the industry. I think they're in the low single digits. Most banks would be pretty envious of that kind of track record. And I think that really speaks to what financial institution type businesses can do when they have an alternative data set.
Douglass: The other piece for that is, you look at Square, they're also getting into payroll, accounting, they're getting into a lot of the back-office issues that a lot of small businesses face. And their hope is to create this one-stop shop that businesses can just use, "OK, yes, we're using Square for everything," so they don't have to think about, "Well, we have to put this in QuickBooks, and move over with this other vendor for this other thing." If they can get that all under one house, that's an opportunity for them to get sticky relationships with the businesses and scale with them, particularly on the capital side, as they get bigger.
Lewis: Yeah. Any time I see a business like this, I always want to see them building out their portfolio of offerings. The more and more something starts to look and feel like a one-stop shop, the stickier it's going to be for the end users and small businesses that are trying to get off the ground. And if they have something set up where it scales with the success of the business, that's going to build a nice, long-term symbiotic relationship.
Douglass: Yeah. And the fact of the matter is, most businesses aren't really passionate about getting the best possible pay software. What they're really passionate about is getting paid. So, if somebody can make that easy for them, and cheap, that's going to be a very clear win. And, frankly, when you look at Square, they are not profitable. That's OK, because they're putting a lot of money into this R&D to make sure they stay ahead of any competition and can create that one-stop shop, that long-term will hopefully drive really tremendous profits for shareholders.
Lewis: Matt mentioned that they're an expensive stock, and I certainly wouldn't disagree, especially after the run they've gone on so far this year. But, you look at their financials, they've been posting roughly 20% revenue growth. I think, when you see them making these other investments, that gives you some sense and some hope that I think they can continue doing that long term, even as their bread and butter, Square transaction facilitating dongles and the market for small businesses for that type of stuff reaches a little more saturation. If they're able to build out that portfolio of things, the long-term growth runway for them looks really interesting.
Douglass: Yes. So, when you think about those Square and Mastercard, think of them as two different ways to play on similar, not exactly the same but very similar, megatrends. I would say, if you're interested in stocks that are on the safer side, but perhaps don't offer quite as much upside, Mastercard can be a really interesting stock. On the flip side, Square is a lot more speculative, but there's a lot more upside -- of course, that also means a lot more risk. So, you have to balance what makes sense for your portfolio.
Lewis: I think, for context, Square is about a 10th of the size of Mastercard right now. So, there's that. And I think, even looking at the relationship that these two companies have, it's pretty clear to me that this is not a "one company taking all"-type space. You think about how, I've talked about it before and I'll touch on it again, the legacy processing infrastructure for Mastercard is something that enables Square's business. Well, Square is also taking a lot of transactions that would not be credit card enabled and putting them on that platform, that otherwise, they would be cash. So, it's creating business for Mastercard. It's a niche that Square can operate in. I think there are a lot of players that can win this trend.
Douglass: Absolutely. With that in mind, let's go ahead and turn to our No. 3, Berkshire Hathaway.
Dan Caplinger: I'm Dan Caplinger. I cover stocks in all kinds of sectors for The Motley Fool. Today, I'm pitching Berkshire Hathaway. It's my oldest holding. I bought it back in 1999, and it has delivered pretty amazing returns for me without too much effort, which is exactly what a good, conservative yet long-time-horizon investor wants from a stock.
The business is incredible. It basically involves Warren Buffett taking money that he takes from premiums from insurance company products and investing in businesses that produce really amazing returns. That's the recipe for success. It's been a big boost to the stock. Now, more than ever, it's a really good business to be in. The insurance business is kind of a funky deal in that, even though when big loss events happen, they have a big short-term impact, the long-term impact on profitability can be really positive. So, take the environment we find ourselves in now. Major hurricanes have hit highly populated areas in Texas, Florida, Puerto Rico and elsewhere in the Gulf Coast region. That's going to cause big losses for Berkshire in the short run. But what it's going to allow the company to do is raise premiums going forward. In the long run, that's going to more than make up for the losses that get suffered, and lead to more revenue and more profit for Warren Buffett to deploy in any way he sees fit.
With such a big conglomerate that includes so many different businesses, all focused on developing profit, I don't have to worry when I have my shares of Berkshire Hathaway that anything's going to get in the way of long-term future success.
Lewis: I think something that Dan did a really good job there is breaking down Berkshire's core business, and explaining the mechanisms that give them this money to work with. Maybe it's worth spending a little bit of time just talking about what he does with that money and what he has historically done with that money.
Douglass: Sure. I think it's also important, for those who are familiar with insurers, regularly, insurers talk about investing their float, and most of them invest their float in short-term bonds. So, their returns have been pretty awful lately. [laughs] Frankly, low interest rates mean those bonds are going to tend to yield relatively little, which means when they reinvest in that float, they're not getting much of a return for it. Of course, the problem with float is, often, you're running a slight loss in your underwriting to get that float to generate returns. Then, of course, you end up having to pay out that float in claims, especially when major natural disasters strike. One of the interesting things about Berkshire Hathaway is, they've run an underwriting profit for the last 14 years. Now, 2017 is not over so we'll see how things go this year. But, that's a pretty darn strong track record of being able to have that float, and also recognize and know that not all of it's going to get eaten up, because they're able to price so aggressively and so thoughtfully. So, let's talk about the businesses now, to circle around to your original question.
Lewis: Thank you for getting back to what I wanted to talk about. [laughs]
Douglass: Well, no problem. I figured this is a good beginning primer to give us the background as to why he's able to deploy this capital with such a long-term mindset, instead of the short-term or medium-term bonds we see a lot of other insurers in. He does, essentially, two things with that money. He either buys business, these are things like BNSF Railway, Dairy Queen, Fruit of the Loom, a lot of brands that you'll recognize and probably a few that you won't, with the basic idea that he can buy this company for a certain price, have a management group that he really trusts, continue running that company -- that's actually one of his core metrics, that he wants management that he can trust running it. Then, he basically gives them the additional capital they need to scale appropriately. If you think about this, we talked about this on Financials last week or the week before, I think it was last week, you can buy a company, let's say the market says is worth $1 billion, you buy it for $1.5 billion. So, instantly, it's like, you lost some money. But, perhaps that company, if given another $1 billion, so $2.5 billion total into it, with that extra money, you might be able to scale, and then be worth $10 billion in five years. Suddenly, your returns look really good. This is what Berkshire Hathaway and Buffett in particular is very good at.
The second thing that they do is buy stocks, and buy significant shares of those stocks. We're talking some really well-known companies like Wells Fargo and Coca-Cola. Berkshire Hathaway is so big that they tend to go for a large-cap stocks, because they really can't buy small caps and meaningfully move the needle for Berkshire Hathaway anymore, just because it's so darn big at this point.
Lewis: This leads into something that, even as a casual financials follower, I'm somewhat privy to, this idea that Berkshire Hathaway has gotten so large that, for them to really meaningfully move the needle, whatever they need to be buying or taking a stake in needs to be pretty big. They can't really do it with small businesses. So, is that something that, at a certain point, hinders growth for them?
Douglass: Absolutely. And Buffett has been very upfront about that. He basically says, listen, there are tremendous opportunities that are just not big enough for Berkshire to go after. Think about it this way: Buffett could spend $1 million a day on behalf of Berkshire buying companies, and it would not move the needle at all. This company is so big that it just doesn't matter. So, you really have to look at larger-scale transactions when you're in that mindset. So, that, by its very nature, these larger-scale transactions, they're in stocks or companies that are better known, that are perhaps more heavily covered, so it's harder to find a really amazing deal. So, that's something that's going to continue to plague Berkshire.
Lewis: But, as an investor, if you're buying shares of Berkshire, what you're really doing is saying, "Hey, Warren Buffett, I trust you with my money."
Douglass: [laughs] "Take my money."
Lewis: "I think you're going to do a pretty good job." That's really what this boils down to.
Douglass: Right. And Buffett has been upfront about the possibility that buybacks, maybe even dividends one day, could be on the table if he can't find better ways to allocate that capital. But it's pretty clear to me, at least, that Buffett still thinks he can find ways to allocate that capital effectively. I think the last time they paid a dividend was in the 1960s, and buybacks haven't really been an issue, either. As Buffett has said, it's very difficult to purchase Berkshire's shares, because he has a certain threshold, which is no more than 120% book value at which point he might be willing to buy back shares. Berkshire regularly trades well above that.
So, there's a lot to unpack there. We've got a lot more detail on Berkshire and Mastercard and Square, some really top-notch resources we put together. Shoot us a note at email@example.com, we'll be happy to send those along. I've also got a great piece that Matt Frankel, who you heard pitching Square, wrote, which breaks down Buffett's investing process step by step. I think that's really useful in terms of new investors and trying to really understand how to approach stocks. You might as well learn from one of the best stock pickers ever.
Lewis: Yeah. You could do a lot worse, right? [laughs]
Douglass: [laughs] Right. Cool. Dylan, thanks for coming on.
Lewis: Thanks. It was nice to hop on the show. I always love doing the show with you.
Douglass: Yeah, ditto. It's nice for me to get to return the favor, since I've been on Tech so many times. That's it for this week's Financials show. Questions, comments, you can always reach us at firstname.lastname@example.org. As always, people on the program may have interests in the stocks they talk about. For example, I own Berkshire and Mastercard. And The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. This show is produced by the ever-awesome Austin Morgan. For Dylan Lewis, I'm Michael Douglass. Thanks for listening and Fool on!
Dan Caplinger owns shares of Berkshire Hathaway (B shares). Dylan Lewis owns shares of Amazon and JNJ. Matthew Cochrane owns shares of AMZN, Mastercard, and Square. Matthew Frankel owns shares of AXP, Berkshire Hathaway (B shares), and Square. Michael Douglass owns shares of AMZN, Berkshire Hathaway (B shares), JNJ, and Mastercard. The Motley Fool owns shares of and recommends AMZN, Berkshire Hathaway (B shares), JNJ, Mastercard, and Visa. The Motley Fool owns shares of Square. The Motley Fool recommends AXP. The Motley Fool has a disclosure policy.