It's OK to buy expensive stocks with high price-to-earnings ratios if they meet three criteria -- a large total addressable market, the ability to scale up in size and a wide business "moat," Jim Cramer said in an exclusive video conference with members of his Action Alerts PLUS club for investors.
"When we buy super-high-growth stocks, we are look for several characteristics upfront," Cramer said in his VIP call.
Consider Mastercard (MA) - Get Report , which Cramer's charitable trust owns even though it has a hefty 45.9 trailing P/E -- well above the P/Es of both the S&P 500 (about 22) and rival Visa Inc. (V) - Get Report (around 37). Cramer said that while Mastercard looks looks more expensive on the surface than Visa, a close analysis of the three factors that he looks at for high-P/E stocks reveals that MA is the better bargain.
Total Addressable Market
Cramer said investors need to look at a company's "total addressable market" -- the total size in dollars of the industry that a company participates in.
For Mastercard and Visa, the total addressable market for digital payments is a stunning $100 trillion. Even just payments made via credit cards, debit cards and prepaid cards are on track to hit $78.5 trillion, up from just $23 million 18 months ago.
"I think that Mastercard can have years of growth before it gets tapped out," Cramer said.
The Ability to Scale Up
Cramer noted that Mastercard's five-year compound annual growth rate (CAGR) is 26% vs. 20% for Visa. On an adjusted currency-neutral scale, Mastercard is racking up even-stronger 41% annual growth.
A Good 'Moat'
If you're going to put your money into an expensive high-growth stock, you'd better make sure that it has a good "moat" -- some sort of barrier to entry that keeps rivals away from its business, Cramer said.
"Mastercard is really part of an incredibly difficult-to-crack duopoly with Visa," Cramer said. "That's a fabulous moat -- one that will never be breached. It is the essence of a world where there is more paper than plastic, but plastic is going to win out for certain.
"Sure digital payments like Paypal (PYPL) - Get Report or even Libra from Facebook (FB) - Get Report will be a natural to leapfrog over plastic, but we must never forget that a credit card is still the established way to do things," he said. "Just go ask Apple (AAPL) - Get Report . If there were never going to be a stop between paper and digital, why would the most powerful company in the world have to start its own credit card?"
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