The stock has a 60% operating profit margin — comparable with Nvidia's — and is said to benefit from a powerful "networking effect."

March 31, 2024 | 07:15pm

This payments firm has Nvidia-like profit margins — and it's even more sustainable, investor says

The stock has a 60% operating profit margin — comparable with Nvidia's — and is said to benefit from a powerful "networking effect."

The rapid rise in Nvidia 's share price amid the artificial intelligence hype has left some investors questioning the sustainability of the company's valuation. With the stock trading at a lofty 2.5% free cash flow (FCF) yield for next year, some investors are urging caution. Historically, Nvidia traded at a 4% FCF yield before the pandemic. Hannah Gooch-Peters, global equity investment analyst at Sanlam Investments, believes that Nvidia's current valuation is pricing in a continued and rapid increase in sales and profit. "If you've got 75% gross margin, and it's a hardware company at the end of the day, you've got to ask yourself, what is the company's ability to sustain those gross margins?" Gooch-Peters questioned Wednesday before CNBC Pro Talks ' live audience at London Business School. Gooch-Peters pointed to Visa — which has a 60% operating profit margin — as a more sustainable investment opportunity. "What is the sustainability of that versus the sustainability of Nvidia's margins today when you're already pricing in a massive pull forward in demand?" She explained that Visa also benefits from a powerful "networking effect," the phenomenon in which the value of a product or service increases as more people use it. V NVDA 5Y line In Visa's case, the more banks, merchants, and consumers adopt its payment network, the more valuable and indispensable it becomes. This creates a strong competitive moat and helps to sustain the company's high profit margins over time. "I think it really epitomizes a high quality company," Gooch-Peters added. Visa is a top-10 stock in Sanlam's Global High Quality equity fund, which manages more than $585 million in assets. The stock has risen by 7% this year, and analysts expect it to rise another 9.3% over the next 12 months. Gerry Fowler, chief European equity strategist at UBS, echoed the sentiment about the importance of a company's competitive moat while picking stocks. "Visa is one of these companies that operates in an oligopolistic sector that seems to be very hard to break into," Fowler said. The UBS strategist pointed to the attempts of Apple, then the world's biggest company, to break into the payments network sector. Ultimately, Apple instead decided to use MasterCard as its payment network provider for its Apple Card service. "There's lots of these sorts of attempts to break down that oligopolistic industry, but no one's done it yet," Fowler added. While Fowler acknowledged that Nvidia may also have a good position in the chip market because of the time it takes to develop and manufacture chips, he admitted that there is still a question of how to value the company's long-term growth prospects when AI's widespread use and implications are yet to be seen. The UBS strategist also cautioned that impenetrable moats might sometimes pose a downside risk to investors. Flower pointed to academic research suggesting that governments often take regulatory action when very large companies dominate their sectors and weaken competition to accrue monopolistic or oligopolistic benefits. Earlier this week, Visa and Mastercard entered into a $30 billion settlement with the U.S. government — one of the largest ever — to limit fees over the next five years.

This story originally appeared on: CNBC - Author:Ganesh Rao