Visa is preferred over Mastercard due to superior margins and valuation relative to DCF.

Visa and Mastercard are among the most dominant financial services companies in the world. What makes it even more special is that they do not compete fiercely with each other.

In fact, the competition between them is so weak that regulators have accused them of colluding with each other.

But this was great news for investors, because it led to significant and increasing profitability for the sector as a whole. Taking all of that into account, which of these two companies is the better stock to buy now at current market prices?

This is the question I want to answer in this video.

Visa and Mastercard have been successful in growing their businesses well over the past decade.

Visa's revenues grew from $15 billion in 2017 to $44.5 billion, nearly tripling in a decade. These two companies generate their revenue by facilitating transactions through their financial network.

Each transaction made using their network generates a small fee for Visa or Mastercard in addition to a percentage of the total transaction value.

This allowed both companies to grow very well as a result of growth in the overall economy as well as growth in prices. The recent rise in inflation was good news for Visa and Mastercard because it means an increase in nominal spending by their customers around the world.

As I mentioned, the limited competition between them has led to excellent profit margins, among the best in the world.

As for Visa, when you measure the operating profit margin over 10 years, it is the best among any company I follow, at 67%. In recent quarters, some semiconductor companies such as Micron have achieved better operating profit margins, but when measured over a full cycle or a full decade, Visa remains the undisputed leader.

These margins are likely to remain the same or increase, because the hard work of these two companies has been done in past decades when they were investing to develop their networks.

The two sides of the transaction, the consumer side and the merchant side, have led to a positive and constructive cycle where merchants need to accept these cards, and the fact that many merchants accept Visa and Mastercard makes them more attractive to consumers.

Therefore, more consumers want to obtain credit and debit cards that use the Visa and Mastercard network, and because more consumers are using them, more merchants want to accept them.

Traders have long complained that these two companies do not compete with each other, and therefore the fees are higher than they would have been if they had competed and lowered prices. But that didn't happen in reality.

Regulators have tried to intervene to force these companies to compete more aggressively, but this has only really succeeded by imposing some legal fees and fines on these companies' operations.

Ironically, their shares are trading at almost identical valuations. Visa and Mastercard shares are trading at a forward price-to-earnings ratio of 24. This is lower than the average valuation at which these shares have traded according to this metric over the past few years.

The risks are increasing for both of these companies. One of the main risks is that regulators and governments around the world have become more hostile toward US-based financial networks, including Visa and Mastercard, and some governments have taken steps to try to decouple their economies from the Visa and Mastercard network.

Another growing risk is that innovators such as stablecoins and cryptocurrencies may overtake Visa and Mastercard and capture a market share of this network that has been dominated by Visa and Mastercard for many decades.

I also like to look at the valuation using the discounted cash flow model, and based on this estimate, I calculated that the value of Visa stock is $377 today. This is slightly higher than the current market price of $364.

Therefore, given that Visa achieves a better operating profit margin, its growth rate is slower compared to Mastercard and it has fewer opportunities compared to Mastercard.

However, if I had to choose between these two companies today, I would buy a Visa instead of a Mastercard. But you don't have to make that choice. You can own both. In fact, that's what I did.

I own Visa and Mastercard shares in my investment portfolio.

I think these are two excellent companies. In fact, I think they could be called "Hall of Fame" companies, and they trade at relatively fair prices, making them an excellent long-term investment for investors.