Investing in credit card companies can be a very rewarding strategy for investors. The American obsession with easy credit and consumers' unwavering need to use credit cards means these companies have the potential to be long-term winners.
But in order to invest in the credit card business, investors must learn all they can about this ever-evolving industry. Read on for an investor's overview of investing in credit card companies.
Tutorial: What To Know About Credit Cards
The Credit Card Business
The credit card business is all about lending money. Credit card companies issue credit to ease purchases and allow consumers to delay payment on items. Credit cards allow consumers to purchase items they may not have the cash for at the time of purchase but will have at a later date. Of course, like any loan company, the extended credit comes at a price: the interest rate charged on the borrowed money. Credit can be easily extended to most anyone and through the use of credit limits and other devices, credit card companies can protect themselves from riskier borrowers. There are also monthly minimum payments that are purposely set low in order to encourage card users to carry debt for long periods, and thus pay more interest.
Factors That Affect Profitability
The biggest factor that affects this industry is how well consumers are doing financially. Strong consumer confidence translates into more purchases, which generally means a greater use of credit cards. On the flip side, when consumers' confidence is eroding, this will negatively impact credit card companies. When consumers decide to purchase less, they usually also decide to cut back on their credit card usage. The general health of the economy is an important condition that needs to be monitored. (Read Understanding the Consumer Confidence Index and Using Consumer Spending As A Market Indicator.)
There are also conditions that can both hamper and help the future growth of the credit card business. Government regulations of any kind can impact the bottom line of credit card companies. For example, the fallout from the 2008-09 credit crisis brought interest in the consumer financials industry and how the government can improve the credit practices of the companies involved. As such, investors need to keep a close eye on all government decisions regarding the financial services sector and how those decisions will impact credit card companies.
Similarly, investors interested in the credit card business need to keep an eye on an industry barometer known as revolving credit. Revolving credit is a type of credit that has no fixed number of payments. Credit card payments are a perfect example of revolving credit. This barometer will measure the amount of revolving credit and, in percentage terms, the increase or decrease of that number. A decrease is a sign that consumers are deciding against making big purchases with credit cards. Keeping an eye on both the economic conditions as well as consumer conditions should help give investors and potential investors in this sector an idea of what to expect from credit card companies.
Late payers are also a problem for credit card companies. As such, another barometer that you want to keep an eye on is the Consumer Credit Delinquencies Bulletin, which tracks delinquencies based on dollars outstanding. This bulletin is published by the American Bankers Association. Delinquencies cause the credit card companies to cut credit limits for existing customers and make it difficult for new customers to get cards. Pulling in the oars, so to speak, will impact the bottom line for credit card companies and hurt their profits.
A more company-specific barometer of a credit card company's health is the interest rate it charges. During tough economic conditions, credit card companies can always slash interest rates in order to entice customers into using their credit cards more often, but this will mean less money generated from the credit used by consumers. As a result, this move tends to negatively impact credit card companies' bottom lines. (To read about how companies manage this, see Managing Interest Rate Risk.)
How to Invest
If you are considering investing in credit card companies, there are a few ways you can go about this. These companies fit into the consumer financial services sector. When you are looking to place your money here, your choices include mutual funds, exchange-traded funds (ETFs) and stocks. Mutual funds and ETFs will not provide the most direct investment in credit card companies simply because both will mix the stocks of credit card companies with banks and other financial services companies. The advantage of investing in these companies through mutual funds and ETFs is the ability to make a small investment with adequate diversification. Stocks are the most direct course of action for investing in credit card companies such as American Express (NYSE:AXP), Discover Financial Services (NYSE:DFS) (issuer of the discover card), Visa (NYSE:V) and Mastercard (NYSE:MA). (Be sure to read The Importance Of Diversification to learn more on this topic.)
An investment in the credit card business will require an investor to keep an eye on certain consumer indexes and the overall health of the economy. Although investing in individual stocks is the most direct way to profit in this sector, there are mutual funds and ETFs that can provide risk-averse investors with some exposure to this sector. There are always new cards, and credit card companies continue to seek new ways to extend credit to consumers. Understanding the business and what impacts the profits will allow an investor to make a sound financial decision when investing in the credit card business.