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. However, investors must learn all they can about this ever-evolving industry to be successful. Read on for an overview of investing in credit card companies.
How Do Credit Card Businesses Make Money?
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 at a later date. Of course, like any loan company, the extended credit comes at a price, which is the interest rate charged on the borrowed money.
Credit can be easily extended to almost 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 to encourage card users to carry the 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 greater use of credit cards. On the flip side, when consumer confidence is eroding, credit card companies are negatively affected. When consumers purchase fewer goods, they usually also cut back on their credit card usage. Monitoring the general fitness of the economy is essential for successful investing.
There are also conditions that can both hamper and help the future growth of the credit card business. Government regulations can impact the bottom line of credit card companies. For example, the fallout from the Great Recessing brought interest in the consumer financials industry and how the government could 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, you need to keep an eye on an industry barometer known as revolving credit, which is a type of credit that has no fixed number of payments. Credit card payments are a perfect example. You should carefully monitor the percentage of increase or decrease in revolving credit. The latter is a sign that consumers are deciding against making big purchases with credit cards, which means a downturn in business.
Late payers can pose a problem for credit card companies, so another barometer to watch is the Consumer Credit Delinquencies Bulletin, which tracks delinquencies based on dollars outstanding. The American Bankers Association publishes this bulletin. Delinquencies cause 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 hurt profits.
A more company-specific indication of a credit card company’s financial condition is the interest rate it charges. During tough economic conditions, companies can always slash interest rates to entice customers into using their cards more often. However, this will mean less money generated from the credit used by consumers, depressing the bottom line.
How to Invest in Credit Card Companies
If you are considering investing in credit card companies, there are a few ways to go about it. 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, however, because both will mix the stocks of credit card companies with those of banks and other financial services companies. The advantage of investing in credit card 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. The four major credit card stocks are American Express (NYSE:AXP), Discover Financial Services (NYSE:DFS), Visa (NYSE:V), and Mastercard (NYSE:MA).
The Bottom Line
An investment in the credit card business will require you to keep an eye on certain consumer indexes and the overall condition of the economy. Although investing in individual stocks is the most direct way to profit in this sector, mutual funds and ETFs can provide risk-averse investors with some exposure to this sector.
There are always new cards, and companies continue to seek new ways to extend credit to consumers. Understanding the business and what affects the profits will allow you to make a sound financial decision when investing in the credit card business.
What are credit card networks?
Credit card networks are the companies that are most commonly referred to as credit card companies. The four networks based in the United States are Visa, Mastercard, Discover and American Express. Visa and Mastercard do not issue credit cards directly to the public but rather do so through member banks such as Chase, Citi and Bank of America. Discover and American Express are both networks and card issuers, however. Card networks primarily function to facilitate merchant payment and settlement in conjunction with issuers of credit cards.
What are credit card issuers?
Credit card issuers are banking institutions that have partnered with one or more of the four major card networks (Visa, Mastercard, Discover and American Express) to issue credit cards directly to the public. Major banking issuers include Chase, Citi, Bank of America, Capital One and Wells Fargo. Credit card issuers actually underwrite the credit risk involved with lending consumers money through credit cards and also are responsible for setting interest rates, customer billing, managing reward programs and reporting account behavior to credit bureaus.
What is the best way to invest in credit card companies
Investors can buy shares in one or more of the credit card networks or in individual issuing credit card issuers. However, these types of companies make up a significant portion of the market share in consumer financial mutual funds and ETFs that track the financial sector, so these investment vehicles can be a less risky way to gain exposure to the potential performance of credit card companies.