Dividend stocks are everywhere, but many just downright stink. In some cases, the business model is in serious jeopardy, or the dividend itself isn't sustainable. In others, the dividend is so low it's not even worth the paper your dividend check is printed on. A solid dividend strikes the right balance of growth, value, and sustainability.
Today, and one day each week for the rest of the year, we're going to look at one dividend-paying company that you can put in your portfolio for the long term without too much concern. This isn't to say these stocks don't share the same macro risks that other companies have, but they are a step above your common grade of dividend stock. See last week's selection.
This week, we'll take a closer look at American Express (NYSE: AXP ) and I'll show you that while its yield may not be much to look at now, it could be a dividend juggernaut of the future.
It's a party and everyone's invited
If you recall, back in March I proclaimed the credit card services industry as the dividend juggernaut of the future. Although financial lessons learned tend to be short-lived, consumers have been using credit more wisely since the recession, and delinquency rates have hit record lows for many credit servicers.
As of June, American Express led its peers with a delinquency rate of just 1.31%, well ahead of Discover Financial Services (NYSE: DFS ) at 1.88%, and Capital One Financial (NYSE: COF ) at 2.89%. A lot of this has to do with better credit screening practices at AMEX, which is well-known for having a more financially savvy client for its credit customer. Capital One, on the other hand, has drastically improved its delinquency rate, but is still much more exposed to macroeconomic downturns because of the lower income base of clients it lends to. Discover also gets a special mention here for its record-low delinquency rates.
AMEX doesn't come without its own set of risks though, which include the aforementioned potential for lending charge-offs. Credit processors like Visa (NYSE: V ) and MasterCard (NYSE: MA ) offer investors a practically ideal investing situation because, as processors only, they have zero lending exposure and are only affected by consumer spending and government regulatory actions.
American Express' plan for growth
But have no fear, AMEX shareholders and potential investors, the company has a plan.
For starters, American Express is utilizing a concept that's been gold for Visa, MasterCard, and smaller card issuers like Green Dot, which is its appeal to the massive prepaid debit card market. Prepaid debit cards aren't free, but they are still one of the few viable solutions for the droves of people in this country with credit scores that are too low to get a credit card. AMEX's prepaid card now allows for direct deposit, has a much easier to understand cost structure relative to its peers, and offers consumers purchase protection -- something previously reserved only for AMEX credit account members.
Second, AMEX is going to continue to focus on keeping its costs in check. The credit services industry is highly competitive, but AMEX's cardholder perks are well known on a word-of-mouth basis, which may allow it to keep marketing spending flat, or even drop it slightly.
Finally, AMEX is going to turn its focus to international and emerging markets, which are still largely untapped. Excluding the effect of negative currency translation, net revenue ticked higher by 2% for the company's international card segment in the second quarter, while global merchant service revenue, net of interest expenses and adjusted for currency translation, rose 6%. These results are decent, but I expect growth in international markets to soar in the coming years.
How American Express is becoming a dividend juggernaut
Now let's get to the meat and potatoes here: American Express' dividend.
At its current yield of 1.4% I can understand the hesitance from income investors to get excited. But, once you understand the incredible growth potential AMEX has to offer, the probability of that payout exploding higher seems very realistic.
Source: American Express Investor Relations. *Assumes quarterly payout of $0.20.
Again, I can almost hear the income investors tapping the table and proclaiming "Where's the dividend growth since 2008?" To that, let me remind you that many financial service companies shelved their dividends completely during the recession -- but not American Express. AMEX's superior financial position and balance sheet allowed it to continue to pay out a reasonable dividend given the seriousness of the recession.
It's also worth noting that AMEX's payout ratio is currently just 19% of trailing-12-month earnings, which leaves it plenty of room to boost future payouts. It isn't unreasonable, following the worst financial downturn in 70 years, for AMEX to be conservative with its cash payouts in the interim, but I would look for this payout to rise dramatically by mid-decade as lending rates begin to rise once again.
Much of the credit services sector seems poised to rally over the long term as credit trends and balance sheets improve and American Express seems in line to be one of the biggest beneficiaries. AMEX's affluent clientele, focus on international markets and prepaid debit cards, superior balance sheet, and brand name should transform the company into a dividend powerhouse by the end of the decade.
The recession proved to be shaky ground for countless big banks. To learn more about the most-talked-about bank out there, check out our in-depth company report on Bank of America. The report details Bank of America’s prospects, including three reasons to buy and three reasons to sell. Just click here to get access.