DGI Adventure 07-19-16 Sold Cash Secured Put + Investment Thesis – Visa Inc. (V) – $75.00 strike – Aug 12 Expiration

This trade was actually executed yesterday 07/18/16.

Please visit the core philosophies article on my investment thesis process for a deeper explanation of the components of this article.

Dividend Cycle

V will go ex-dividend in early/mid August…right around when this trade will be expiring (it went ex-div on 08/12 in 2015). V is a dividend challenger, boasting 8 consecutive years of increases. The most recent increase came with the Q4 distribution last year, when they bumped it from $0.12 to $0.14, a 16.67% increase. Looking at the history, management likes to make their raises in Q4, so I would expect another one this year in November.

The yield is pretty low, so even if I were to miss out on the Q3 payment, I wouldn’t mind too much since the premium is the equivalent of more than a year’s worth of dividends.

Investment

The QC (Quantitative Case)

*Note: EPS was negative in 2006 and 2007, so I’m using an 8 year history instead of 10…that’s when they started paying a dividend anyway.

SPL (Strike Price Logic)

Since V is such a low yielding stock, using a dividend discount model is kind of silly because your assumed growth rate has to essentially equal your discount rate if the current valuation makes any sense. While I think V will actually exceed a 10% DGR, I don’t like assuming that. I have a rule that maxes out DGR assumptions at 8%.

So what’s a fair price for a growth stock like V? Well let’s look at the FCF yield. $2.78/share FCF divided by $75.00/share = 3.7% FCF yield at the strike. I’ll bet V can grow FCF at a 7% rate (their 5 year CAGR is 15%…). With a 10% discount, that would value shares fairly down to a 3% FCF yield or $93.00/share.

That is a very quick and dirty discounted free cash flow analysis…like really quick and really dirty. But it gives me decent confidence that just about any strike price in the $70’s is probably fine. Low $80s still probably pretty okay. (Morningstar fair value is $104/share).

In other words…I think V is a good buy at current levels, so I’m not going to quibble about strike price I might get assigned at. That being said, I am greedy. So if Mr. Market is going to offer over 13% annualized gain + over 4% of downside protection, I will take it, and I did.

QWaF (Qualitative Warm and Fuzzy)

For all intents and purposes, there are four credit card companies, listed in order of size (market cap): Visa (V), MasterCard (MA), American Express (AXP) and Discover (DFS).

They are the toll takers of the modern consumer economy. Who uses cash anymore? Who writes checks? They own the network, and they get paid their fee. Just look at the quantitative case again…48% profit margin is not a typo.

I really like MA too, but four things swung me towards V:

1) MA trades in the $90’s which would be a pretty big option position. $7,500 isn’t exactly small beer for me either, but it’s quite a bit less.

2) COST just started accepting V, and I think that’s a not insignificant source of growth in the near term.

3) AXP has debt problems…which seriously? You’re a credit card company. You of all people should know the problem with getting overextended.

4) DFS has weirdness in their cash flow statement. I need to figure out what’s going on there before I’m comfortable buying DFS shares.

So there you go. I wanted to invest in a credit card company, and Visa seemed like the best fit.

CPR (Cold and Prickly Risks)

The same way I sarcastically say “Who uses cash/writes checks anymore?”…someday I will just as sarcastically say, “Who uses credit cards anymore?” The payment landscape is changing, and electronic/mobile based systems seem to be where things are headed.

V has a very wide moat right now, but they will have to keep up with the times if they plan to maintain it. Assuming they do, they’ll enjoy a transaction charge on most of the purchases made in the world…and that’s a lot of freakin’ purchases.

Their balance sheet tells me they should have the resources to figure it out.

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