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Is a Put Strategy a Good Way to Acquire Shares of Mastercard?

- By Ben Reynolds

In every market, there always seems to be stocks that investors find to be too expensive. No matter how much they like the company or its sector, many investors are willing to wait for their price to be achieved before buying shares. Instead of waiting for their target price, some investors may be inclined to use a cash secured put income strategy to acquire shares at a more attractive price.


Per theoptionsguide.com, a stock option is a contract between two parties in which the stock option buyer purchases the right, but not the obligation, to buy 100 shares of an underlying stock at a predetermined price from the option seller within a fixed period of time. This predetermined price is referred to as the strike price. Cash secured puts are not for every investor, as they require sizeable sums of capital. They can, however, allow you to acquire shares of a company at a much lower price while generating a little extra return.

One stock that seems to trade at an elevated multiple is Mastercard (MA). Investors who struggle with buying expensive stocks may want to use a put option strategy to add this name to their portfolio.

Company background

Mastercard is second to only Visa (NYSE:V) in terms of number of transactions in the electronic space payment industry. MasterCard has partnerships with more than 25,000 financial institutions around the globe, enabling it to create a massive electronic payment network.

As the world moves away from cash to plastic, companies like Mastercard will likely be a major beneficiary. Mastercard takes a small percentage of both transaction volumes and dollar volumes from every card swipe. With so many people around the world using credit and debit cards for everything from gas to groceries to big-ticket items, the company has created a reoccurring revenue stream for itself.

Recent Earnings Release

This revenue stream has led to some impressive earnings growth for Mastercard. The company last reported earnings on July 26. MasterCard earned $1.66 in the second quarter of 2018, $0.13 above the average analysts' estimate. This is also a massive 51% increase in earnings from the second quarter of 2017. Revenue increased more than 20% to $3.67 billion, topping the market's expectations by $20 million.

In the second quarter, transactions volumes increased 13% overall (17% excluding Venezuela) while gross dollar volumes improved 14%. Mastercard saw 9% growth in dollar volumes in the U.S. and 16% in international markets. With cash falling as a method for payment in favor of plastic, Mastercard and the other electronic payment names are likely to see increases in both transactions and dollar amounts in future years. Mastercard saw an increase in cards in use of 5% during the quarter. A total of 2.4 billion Mastercard credit and debit cards have been issued in U.S. around the world.

The company's effective tax rate for the quarter fell to 18.8% from 27.7% and new revenue recognition rules required by U.S. tax reform each added 4% to sales growth. Even with these added benefits, sales still grew double digits. Mastercard expects to earn $6.26 per share in 2018.

Mastercard next reports earnings on Oct. 30, 2018.

Dividend history and valuation

MasterCard has only increased its dividend for the past seven years, but the growth has been impressive. The company has increased its dividend:

  • By an average of 26% annually over the past three years.

  • By an average of 53% annually over the past five years.



Growth rates of this magnitude are unlikely to continue indefinitely, but the recent dividend growth should still excite dividend growth investors. Shareholders received a 13.6% increase for the payment made this past February. For the first dividend payment of 2017, the raise was nearly 16%. Shares currently yield just 0.49%, while the S&P 500 yields 1.89%.

Given the past earnings results and the opportunity for future growth, investors have bid up Mastercard's stock in recent years. Even including last week's sell off, shares of the company are up nearly 35% year to date. Since the beginning of 2017, just 22 months ago, Mastercard's stock has nearly doubled in price.

As you might imagine, the stock has reached a very high valuation. The stock closed Friday at $203.96. Using the company's midpoint for earnings guidance ($6.26), shares have a price to earnings multiple of 32.6. According to Value Line, Mastercard's the average price-earnings ratio over the past five and 10-year periods is 26 and 22.3, respectively. The multiple of the S&P 500 is just 23.6. Mastercard is currently expensive compared to its own history and that of the market.

Using put options to buy Mastercard

While Mastercard likely has a long run way for growth, the stock has gone up more than $100 straight points since the start of last year. This has probably prevented some investors from acquiring shares of the company. Instead of waiting for a significant pullback, investors could use a put option to purchase the stock, all while collecting some additional income along the way.

If a price-earnings ratio of 32.6 is too expensive, lets target a lower multiple, say 28. This is below the current price-earnings, but above the stock's historical averages. Using the midpoint for earnings per share guidance again, this equates to a price target of $175.

To calculate possible annualized return of selling a put use the following calculation (premium for selling a put/collateral) X (days in a year/days until option expires).

Fidelity's option chain says we can sell a Nov. 16, 2018, put option at a $175 strike price. In order to do this, investors would have to use $17,500 as collateral (remember, it's the strike price multiplied by 100 shares). This amount of cash is locked until the option is exercised or allowed to expire. However, the investor receives $83 in premium in exchange for this collateral. With the option expiring in 34 days, the total annualized return is 5.1%. If shares of Mastercard have declined to $175 by Nov. 16, the investor can now purchase shares of the company at its desired price. The investors also keeps the premium. If the stock hasn't dropped to this price, the investor still keeps the premium, makes 5% on their investment in a little more than a month and the collateral becomes available for use once again.

Final thoughts

Mastercard's business and stock have performed quite well recently. Earnings and revenue are increasing at high rates and the electronic payment space is likely to continue to see ample growth in the years to come. While Mastercard's dividend yield is on the low side, its average annual raises are still in the mid double digit range. While the stock might be expensive right now, investors could use a put option strategy to increase their gains while waiting for shares of Mastercard to hit their price target.

Disclosure: I am not long any of the stocks mentioned in this article.

Read more here:

David Herro and Bill Nygren Comments on Mastercard

5 Companies Hit 52-Week Highs

Mastercard's Strategy Suggests Further Stock Price Growth Ahead After 60% Rise

This article first appeared on GuruFocus.


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