Buffett’s Berkshire Hathaway owns a piece of this financial services firm.
American Express (AXP 2.10%) has long been a top holding in the Berkshire Hathaway portfolio. The great Warren Buffett knows a thing or two about analyzing financial services entities, so it’s a vote of confidence that his conglomerate owns more than 21% of the credit card giant’s outstanding shares.
But is this leading financial stock a smart buy right now for your personal portfolio? Here is what investors should know before deciding.
Standing out in a crowded field
There are other well-known credit card issuers out there, but Amex has found tremendous success over a long period of time. Part of the reason for this is the company’s strong brand presence, which presents itself as a luxury option in the industry.
American Express charges high annual fees for some of its popular credit cards. Naturally, this draws in a higher-income customer base that has the ability to spend more than the typical consumer. This means that Amex generally has industry-leading charge-off rates. These people can better navigate times of economic stress.
Because these people aren’t likely to hold revolving balances on their credit cards, they might not generate a lot of interest income. But for Amex, this isn’t an issue. That’s because the company also operates the payments network that facilitates transactions. This is exactly what Visa and Mastercard do as well.
Consequently, American Express generated $12.6 billion, or 77%, of its total revenue from non-interest income in the second quarter. Things like discount revenue earned from merchants and fees from cardholders drive the bulk of the financial performance. In essence, Amex earns a significant chunk of the money any time one of its cards is swiped.
There are also network effects at play here, which underpin the company’s wide economic moat. Merchants want to accept Amex as a method of payment because of the spending power and number of cardholders. Customers, drawn by top-notch rewards and perks, and the ability to use their cards almost anywhere, want to be Amex cardholders. This creates a positive feedback loop.
Fundamental strength
This business has a history of steady revenue and earnings gains, and this is on full display right now. Driven by strong new customer additions and robust international spending activity, sales were up 8% in the latest quarter. For the full year, the executive team predicts revenue growth of 10% (at the midpoint).
The changing macro backdrop could provide a boost to American Express’ near-term outlook. In September, the Federal Reserve cut interest rates for the first time in about four and a half years. A more accommodative central bank could be the start of a more favorable economic situation, one where people are more inclined to borrow and spend. This would benefit American Express.
It’s also worth noting just how profitable this business is. Amex’s net profit margin has averaged a solid 14.3% in the past five years. Strong earnings help to fuel consistent share buybacks and dividend payouts.
What about the stock’s valuation?
There’s a lot to like about this business. However, investors must also be mindful of the valuation that they are willing to pay. If you pay too much, the potential to generate adequate returns is diminished.
As of this writing, American Express trades at a price-to-earnings ratio of 20.5. This represents a premium to the trailing five- and 10-year averages. Consequently, one could argue that shares are fully valued and that they reflect the market’s optimism surrounding the business.
I still think the stock is investable at these levels. But maybe it’s better to initiate a small position and use dollar-cost averaging over time.
American Express is an advertising partner of The Ascent, a Motley Fool company. Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Berkshire Hathaway, Mastercard, and Visa. The Motley Fool recommends the following options: long January 2025 $370 calls on Mastercard and short January 2025 $380 calls on Mastercard. The Motley Fool has a disclosure policy.
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