The term "growth stock" has historically been applied to publicly traded companies in industries that are expanding because of broad societal forces, rather than just competitive pressures or economic cycles.
The problem for conservative investors is that these industries -- such as pharmaceuticals and consumer nondurable goods -- are getting harder to find as once-solid double-digit returns in these sectors have been stymied.
But one Wall Street analyst, Montgomery Securities' Richard K. Weingarten, says he is focusing on a sparsely followed industry that fits perfectly into the growth stock model: payment processors and financial technology outsourcing firms.
Mr. Weingarten, whose varied background includes a stint helping develop the Apollo computer reservations system owned by United Airlines and other major air carriers, spoke about the prospects for financial technology stocks in recent interview at Montgomery's headquarters in San Francisco.
Q.: Why do you think Wall Street has underappreciated financial technology firms as a group -- companies like First Data Corp., First Financial Management Inc., National Data Corp., Sears Payment Systems, Bisys Group, and others?
WEINGARTEN: Well, a lot of them are pretty new to the market, so a few years ago there wasn't enough to cover as a group. Over the last two years, enough have gone public with sizable market capitalizations, the biggest being First Data coming out of American Express, but other companies like Bisys [Group Inc.] and Fiserv have gone public as well.
This sector has been covered mostly as one-off companies, and nobody fully understood what the hell they did. I think the market is just beginning to understand that these firms have a lot in common.
Q.: So, are financial technology companies good investments because of this lack of understanding?
WEINGARTEN: That's the opportunity from the investor's standpoint, because these companies have generally been covered by the wrong people, analysts mainly with banking or financial services backgrounds instead of technology, and therefore the companies get valuations that really aren't consistent.
Q.: What's an example of financial technology company that is misunderstood by Wall Street?
WEINGARTEN: One company that can be confusing is SPS Transaction Services. When the market gets very excited about them, they think SPS is 100% a processing company. But they also own a lot credit card receivables, so if there ever is a credit problem, the market would probably overreact and slam them.
Q.: What attracts investors to growth stocks?
WEINGARTEN: The stock market pays a premium for companies with very steady earnings growth at high rates. It's difficult to find companies that you can go to sleep at night and know no matter what the environment is tomorrow, these companies are going to produce very high levels of earnings.
Q.: What are the attributes that make payment processors and other financial technology outsourcers fit the definition of a growth stock?
WEINGARTEN: I believe these companies can grow twice as fast the general market for the next 10 years. With these companies, you're making a bet on two major trends: credit cards and other forms of electronic payment replacing cash and checks, as well as growth in outsourcing in general.
Both of those trends are very, very compelling stories, and they are going to continue for years to come.
Q.: What is driving that growth?
WEINGARTEN: Today, over 80% of all consumer purchases, in dollar terms, are made with cash and checks. When you look at it that way, credit card usage is still [quite low], especially when you look internationally.
In a report I recently wrote on payment processors, I spent a lot time trying to prove why I believe these companies are going to far outperform the overall market for the foreseeable future.
The point I make is that the short-term story is the growth of credit cards in the United States, the medium-term story being the growth health care payment processing, and the long-term story being the growth in credit cards internationally.
Most people talk about the credit card business being very mature and ultracompetitive, and I see 10-year charge volume growth of 16% compounded. Last year it was 17%, compared with 1992. How many businesses grew 17% last year?
And unlike a bank, these card processing companies make money on usage, not revolving credit balances. It's to the point where the growth rate in charge volume is higher than the growth rate in revolving balances.
Longer term, the market for processing health care payments is nascent and starting to develop. Plus there are other forms of electronic payment emerging like debit cards and the automation of foods stamps.
Q.: But aren't firms like First Data, National Data Corp., and Bisys already trading at relatively high price-to-earnings ratios?
WEINGARTEN: One thing people on Wall Street talk a lot about is comparing the price-earnings ratio to growth rate: You want a company that's trading at a low PE with a high growth rate. The concept is good, but it's very misused on Wall Street.
My argument is: If these companies are growing twice as fast as the market, why shouldn't they trade at double the market multiple? If you look over the past few years, I admit you'll see these companies are trading near their peak relative PEs.
But you if look back to the 1980s, outsourcing companies traded at much higher relative PEs than they are today. A company like [payroll processor] ADP, for example was trading at a 60% premium to the overall market. Today, companies like Bisys and Fiserv are trading at about a 30% premium.
To me that's a supply and demand issue. And I would argue that the supply of less volatile growth stocks today is about as low as it's ever been.