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| Use
Credit Cards to Make Money Rather Than Spend it |
Published: November 2, 2006
In today's fast-paced world, it's hard to remember a time when we couldn't ring up an online purchase by simply typing in our credit card number, or pay for a combo meal at a fast food restaurant by sliding a debit card.
However, not too long ago, credit cards were a rare luxury reserved primarily for wealthy consumers. But the plastic revolution has changed all that, and the industry continues to evolve.
It All Began . . .
Around the turn of the century, major hoteliers and department stores began issuing paper charge cards to their most valued customers, who could then present them in lieu of an up-front payment.
These early cards were a win-win deal for both consumers and merchants. Customers enjoyed the perks associated with charging their purchases, and storeowners quickly realized that establishing lines of credit eventually led to a more loyal customer base.
In 1949, Diners Club introduced the first "general-purpose" charge card. Within the Diners Club network, consumers could charge goods and services at merchants nationwide. Not surprisingly, the success of that innovation quickly attracted a number of competitors.
Within a decade, Bank of America launched the first credit card as we know it today. Eventually, those operations spawned a separate entity that would soon become known as Visa. Meanwhile, American Express was also busy rolling out a card of its own in the late 1950s.
Encouraged by the success of Visa, a consortium of banks began issuing a rival card in 1966 that grew into the now familiar MasterCard. Finally, two decades later, Sears gave birth to the Discover card in 1986.
Thanks in part to deregulation and readily available financial information on prospective cardholders, the industry has exploded over the past few decades. Today, nearly three-fourths of all U.S. families carry a card from one or more of the four leading networks: Visa, MasterCard, American Express, and Discover.
Slicing the Pie
The average American family holds around six credit cards, as well as a total credit card balance in the neighborhood of $9,000 -- a figure that has spiked +75% over the past decade. On an aggregate basis, the nation's consumer debt is fast approaching the $2 trillion mark.
While those numbers are sobering from a personal finance perspective, they do underscore one very pertinent fact: many of us have simply fallen in love with our cards. For investors, this type of insatiable demand typically leads to enormous profits for well-placed companies.
Of course, considering that there are at least five parties to any credit card transaction -- the buyer, the bank that issued the buyer's card, the merchant, the merchant's bank (known as the acquirer), and the card association -- many different companies have their hands somewhere in the credit card pie.
 Here's how a typical transaction works:
A shopper charges $100 for a new vacuum cleaner at a local retailer. Assuming the purchase is authorized, the issuing bank will send approximately $98 to the card association (retaining an "interchange fee" of around 2%.)
The card association (Visa, MasterCard, etc.) will then send the $98 to the acquiring bank, which will take a small cut of its own before depositing a net of $97.50 in the merchant's account.
Merchants have accepted these interchange fees, which generated $25 billion in revenues for issuing banks in 2004, as a cost of doing business. In fact, they often pass the added expense onto consumers in the form of higher prices. As might be expected, though, they are not exactly happy about the situation.
In fact, a group of leading merchants has filed a class action lawsuit against Visa and MasterCard alleging price collusion. While this litigation is pending, MasterCard has agreed to make its pricing structure more transparent by posting the fees publicly on its web site.
As for the card associations, they don't exactly come out empty-handed. For their efforts, they naturally collect a small transaction fee -- not to mention authorization fees, currency conversion fees, etc.
The transaction fee is usually only a fraction of a percent, or maybe a few pennies per purchase. However, when multiplied by millions of transactions per day, all those pennies add up to billions of dollars in revenues over the course of a year.
Cashing in
For investors looking to capitalize on the continued growth of the credit card industry, there are several choices.
The most obvious segment would include the firms that issue the cards and pocket billions in interest charges, late fees, and other ancillary revenues. However, consolidation has put many of the leading pure-play card issuers, including MBNA and Provident, in the hands of giant financial institutions such as Bank of America and Washington Mutual. And because these banking giants are involved in a variety of other business lines, credit cards represent only a sliver of their total income.
Leading transaction processors like First Data (NYSE: FDC) or Total System Services (NYSE:
TSS) are also solid options. However, competition is cutthroat, and a number of banks have brought some of their credit card operations in-house. Furthermore, the top ten card issuers control 90% of the nation's accounts, and that concentration could cause leading banks to exert more pricing pressure over the processors.
When it comes to making a pure-play on the industry, the best options just might be the companies whose names actually appear on the plastic.
| Company |
Recent
Price |
Fair
Value |
Discount
to Fair Value |
2005
Revenues |
2005
Operating Income |
| American
Express (AXP) |
$57.31 |
$68 |
16% |
$24.2B |
$5.2B |
| MasterCard
(MA) |
$72.54 |
$69 |
-5% |
$2.9B |
$0.4B |
| Morgan
Stanley* (MS) |
$76.58 |
$95 |
19% |
$52.0B |
$31.8B |
| *
Owner of the Discover Network |
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Note:
The above article was free advice given by Nathan
Slaughter and Paul Tracy -- the editors of Half-Priced
Stocks. The mission of Half-Priced Stocks is to
help readers identify securities that are trading at a steep
discount to their intrinsic net worth. In some cases this
discount can reach up to 50% or more, giving savvy value
investors the chance to purchase quality stocks for just pennies
on the dollar. To learn more about our Half-Priced Stocks
service, please visit the following link:
https://www.StreetAuthority.com/subscribe-hps.asp |
Thanks for reading!
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Nathan Slaughter
Editor
Half-Priced Stocks, The ETF Authority
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in-depth guidance on today's leading value opportunities, plus educational guidance, please subscribe to
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