Why American Express Company Is One of the Biggest Warren Buffett Stocks

When it comes to legendary investors you'll have a hard time trumping the Oracle of Omaha, Warren Buffett, who has managed to turn around $10,000 into what Forbes estimates is more than $68 billion as of this past Friday.

Though Buffett isn't infallible, as his investment in Tesco has shown, he has a darn impressive track record that has been enhanced by his approach to buy quality companies and hold them for the long term. Whereas most investors think of buying a stock as, well, buying a stock, Warren Buffett views each purchase as buying a stake in great businesses. That's the difference that has made Buffett one of the most successful investors of all time.

Considering Buffett's success in the investing arena, he's developed an almost cult-like following of investors who will gladly piggyback on any investment he makes. In other words, the "if Buffett bought it, it must be good" mentality takes over.

With that in mind, I'd suggest we take a closer look at one of the biggest Warren Buffett stocks based on his holdings, American Express (AXP 0.26%), and examine not only what it is about the company that attracts Buffett, but whether or not the company is still worth investors' money.

Why Buffett is charged up by American Express
When it comes to Buffett's holdings, or should I say the holdings of his conglomerate, Berkshire Hathaway (BRK.A -0.45%) (BRK.B -0.79%), American Express is the third-largest in terms of value. With 151.6 million shares, Berkshire is currently holding onto $13.1 billion worth of American Express, which also works out to 14.6% of American Express's shares.

What is it about American Express that continues to keep Buffett satisfied? I believe it's a combination of factors.

Source: Flickr user TaxRebate.org.uk. 

To begin with, most financial stocks tend to be cyclical, which is a fancy way of saying that if the economy is doing well, then they'll do well, and if the economy is dragging, then profits for the industry are often struggling. However, American Express can sidestep a lot of these cyclical concerns because it targets a more affluent customer. Don't get me wrong -- this doesn't mean affluent individuals and families are impervious to economic downturns. However, affluent consumers have more consistent income and healthier savings rates, which allow them to continue spending during economic downturns. For American Express, a company that can double-down on profits by making money off of loans (e.g., credit charges) as well as from payment processing, this is great news.

Secondly, and extending the last portion of my previous point, American Express is a dual threat on the credit front. Whereas rivals Visa (V 0.68%) and MasterCard (MA 0.07%) do not directly lend money to consumers, American Express does. Thus, in an expansionary economic environment where consumers are willing to charge more and carry interest-bearing balances, American Express can deliver superior margins to investors thanks to also being able to charge payment processing fees to merchants.

Third, according to Interbrand, a research company that formulates brands' tangible and intangible value into a dollar amount and then ranks the top 100 global brands each year, American Express is the 23rd most valuable brand in the world. Per Interbrand, AMEXs value rose 11% year over year in 2014 to $19.5 billion, putting it ahead of companies like PepsiCo., UPS, and Facebook. Recognizable brands are important for Buffett because it means little in the way of marketing needs to be done to promote the brand, and the product or service essentially takes care of itself.

Finally, American Express offers decades of double-digit growth potential in foreign markets. According to MasterCard, 85% of the world's global transactions are still conducted in cash, giving AMEX plenty of opportunity to garner additional customers over the coming decades. Admittedly, as I mentioned earlier, AMEX is geared toward a more affluent consumer base, but that isn't to say there aren't burgeoning middle- and upper-middle-class citizens emerging in overseas markets. Add this to the company's efforts in the prepaid card market, and you have a recipe for strong growth potential.

What could hold American Express back
Of course, not even Warren Buffett is perfect, nor is American Express without some potential headwinds. Let's take a quick look at what might keep American Express from heading higher.

Source: Flickr user PT Money.

First and foremost on that list is the possibility that a global recession, or even growth stagnation, could hurt its bottom line. Because American Express "double-dips" by lending money to consumers via their credit cards, it's also exposed to delinquent loans, which historically rise when recessions occur. The higher the rate of credit delinquencies, the more AMEX could potentially charge off, which ultimately hurts its profitability.

Secondly, while American Express is somewhat protected by its focus on affluent consumers, it could also miss out on a big opportunity in emerging markets to introduce consumers to the banking world. Here it could cede considerable market share to its rivals, Visa and MasterCard, which could make it difficult to sway these ex-U.S. citizens to become American Express customers when they do move up the economic ladder.

Lastly, I'd suggest keeping industry regulation changes as a possible negative in the back of your mind. After witnessing Russia threatening to lock Visa and MasterCard out of the fold, and noting U.S. regulators' tougher stance on banking fees in recent years, it's possible other countries around the world could adopt regulations that could adversely impact American Express' profits.

Is American Express still a buy?
Now that you have a better idea of why American Express is one of the biggest Warren Buffett stocks, as well as an understanding of why American Express could fall, let's return to our original question and answer whether or not American Express is still a buy.

Source: Pixabay.

Based on the company's third-quarter report, which is admittedly just a small snapshot of how the company is doing, I believe American Express remains on track to deliver for shareholders. The percentage of loans delinquent by 30 days stands at a minuscule 1.1%, while card member spending and net interest income were on the rise. 

This doesn't mean American Express is going to double overnight by any means. Its longer-term growth rate, which should hover in the mid-single-digits, is unlikely to allow its forward P/E ratio to get much beyond 15 to 20. However, it's not out of the question to expect American Express stock to gain 5% to 10% per year on average. When you also tack on a growing 1.2% dividend yield, you have, what I suspect, is a fairly safe investment for conservative to modest-risk investors.