Why Was American Express the Dow's Best Financial Stock in 2013?

If the economic crisis that began in 2007 was largely the story of financial stocks that led the market lower, the rebound that began in 2009 might very well be the story of financial stocks that led the market higher. That was eminently true in 2013, when all six of the financials that have been part of the Dow Jones Industrial Average (DJINDICES: ^DJI  ) led the index in total growth over the course of the year (the lone insurance company also beat the Dow, but could not fit on the following chart).

AXP Total Return Price Chart

AXP Total Return Price data by YCharts

The clear winner out of this pack was upmarket credit card issuer American Express (NYSE: AXP  ) , which also happens to be the Dow's oldest financial stock. AmEx's dominance was subtle, but clear, since late spring, but it has become more pronounced since the company reported strong third-quarter earnings, which included news that credit card spending was up 7.3% year over year. In an economy that still seems determined to deleverage (with the exception of student loans, at any rate), this is great news.

How else has AmEx grown this year? Let's look at the tale of the tape and stack up the company's key metrics for the trailing 12 months against its 2012 results:

Metric

Trailing-12-Month* Result

2012 Result

Change

Revenue

$32.6 billion

$31.6 billion

3.2%

Net Income

$4.7 billion

$4.5 billion

4.3%

Earnings Per Share

$4.26

$3.89

9.5%

Free Cash Flow

$5.0 billion

$4.4 billion

13.6%

Dividends Paid

$920 million

$902 million

2%

Source: Morningstar .
  Includes fourth quarter of 2012, which was reported early in 2013.

Despite these improvements, we can easily see that AmEx's growth this year has been almost entirely valuation-based -- the stock's 46% growth in 2013 has involved a 31% rise in its P/E ratio, from a level of just over 15 to one just below 20. But when you dig beneath the surface, you'll see AmEx making a lot of good moves for a company dependent on customer liquidity.

The company's fourth-quarter earnings reported a very low level of past-due accounts (1.2%) and charge-offs (about 2%). Per-user spending growth grew by 8% heading into 2013, and rose another 7% in the first quarter  -- marking the fourth straight quarter of single-digit growth after nine consecutive double-digit gains in cardmember spending. Sandwiched in between these two reports was news that AmEx continued to strengthen its capital base, as the Federal Reserve's latest stress tests showed a Tier 1 common capital ratio that held up far better than its peers under some rather devastating (but hypothetical) economic turbulence.

AmEx's second quarter marked the 10th consecutive quarter of single-digit growth in cardmember spending, which rose 8% after accounting for foreign currency translation. This disappointing performance led to several analyst downgrades and produced a summer of flatness after a surge throughout the first half of the year -- from 2013's first trading day to the day before second-quarter earnings, AmEx's shares gained 32%, but between the day of the second-quarter earnings report and the day before AmEx released its third-quarter earnings, shares improved only 2% more.

Despite cardmember spending growth of just 8% in the third quarter, continuing the single-digit growth trend, investors reacted positively because of a streamlining-influenced growth in net income that exceeded the growth of both revenue and per-user spending. Shortly before releasing this earnings report, AmEx welcomed its largest credit card peer to the Dow, as Visa (NYSE: V  ) became a component on Sept 20 this year. That addition hasn't yet produced much in the way of gains for Visa, which has lagged AmEx since induction:

AXP Total Return Price Chart

AXP Total Return Price data by YCharts

Visa has lagged AmEx this year despite producing better year-to-date gains in revenue (9.6%) and adjusted earnings (discounting the huge one-time settlement expense paid last year and including a more typical income tax expense for 2012 results in adjusted net income growth of roughly 20%). Visa's dividend payments also improved at a far better rate than AmEx's, as its year-to-date payouts are already 34% higher than 2012's. So what gives? Fool contributor Ian Woller singles out Visa's increasing reliance on debit-card use as a drawback, but it could simply be that investors are expecting more out of Visa than they are from AmEx, making any disappointment all the more acute.

AmEx remains the leader in per-user spending, a status that befits its position as the "luxury" credit card, but its 2013 performance indicates expectations that may have gotten a bit ahead of the reality. Investors will need to be cautious around this stock, as its growth through the past year is not likely to be replicated without a real strengthening in the global economy.

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