<THE RULE MAKER PORTFOLIO>
American Express for the Long Run
By Matt Richey (TMF Verve)
ALEXANDRIA, VA (July 29, 1999) -- The $500 question is upon us. Over the past two days, you've seen two recommended candidates: Yahoo! and Intel. Both are great, but today I'm going out on a limb with a vote for something different -- something non-tech -- to better diversify our 40% tech-weighted portfolio. Think membership, think status, think global service, think American Express (NYSE: AXP).
Financial services companies don't exactly fit the Rule Maker mold. Our usual financial criteria, such as gross margins, the cash-to-debt ratio, and the Flow Ratio are all rendered useless on a company like American Express, but the company meets our qualitative criteria in spades. Let's take a look.
Dominant Brand: The company's rooty-toot-toot upscale image is a powerful asset, especially for the long-term investor. Bank accounts, credit cards, and other financial products are little more than commodities these days. The only way for a financial services firm to distinguish itself is through a strong brand name built upon a reputation for consistently outstanding service. That's exactly what American Express has done. Brand Consultancy Interbrand ranks AmEx the 19th most powerful global brand, making it the highest-ranked brand of any financial services company and one of only two financial companies to make the top-60 list (at #25, Citibank is the other).
Repeat-Purchase Business: Perhaps we should call this a "repeat fee" business. AmEx has three main ways to pull in fee-based income on a regular basis. First, the company's 43.9 million credit and charge cards generate average annual fees of $38 per card in addition to "discount revenue" each time a card is used. Second, let's not forget that AmEx is the world's largest travel services company. During the recently ended second quarter, the company earned $469 million in travel commissions and fees. Third, AmEx's Financial Advisors (AEFA) business now has $232.4 billion in fee-based assets under management. Through those three business lines, American Express has multiple recurring revenue streams drawn from millions upon millions of customers. That creates predictable future revenue and eliminates any risk associated with the defection of a single customer.
Convenience: Today, American Express is accepted most everywhere and is increasingly accepted at supermarkets, discounters, and colleges. Not too long ago, back in 1991, the company was suffering as merchants began refusing to accept AmEx cards. At the time, the company charged merchants an average of 3.5 cents on every dollar charged on one of its cards. Today, that figure is down to 2.73 cents (but up from 2.72 cents a year ago). By lowering the "discount rate" it charges merchants, AmEx has steadily increased merchant acceptance, while still maintaining a pricing premium over the typical 2 cents charged by Visa and MasterCard issuers. On another level, AmEx is beefing up convenience by moving its business to the Internet, including online banking, online trading, and other e-commerce possibilities.
Expanding Possibilities: The Internet is opening up a world of possibilities for AmEx. In particular, I'm excited about the opportunities for the company's newly announced online banking, which is being marketed as Membership B@nking. I recently demoed the service, and found it to be well-designed and easy to use. Dale Wettlaufer has reported on a number of complaints from customers of online banking upstart NetB@ank. AmEx's strong brand name and reputation for excellent customer service should allow it to steal market share from the upstarts, as well as gain customers through cross-marketing to cardholders and AEFA accounts. Basically, the Internet is providing an opportunity for AmEx to become a bank overnight. If AmEx plays its cards right, the Internet could enable it to become a financial services supermarket.
Your Familiarity & Interest: For better or worse, I'm readily familiar with the full spectrum of credit cards. I have an American Express Optima card, a Citibank Visa and a Discover card. Comparing the three, AmEx is tops for its easy-to-read statement, superior online statement, outstanding customer service, and best-of-class benefits. The Discover is a close second, trailing primarily because it's not accepted in as many places and has fewer cardholder benefits. From a marketing standpoint, I'm impressed by AmEx's television ad campaign. The ads targeting small businesses are very upbeat and do a good job of associating success with the American Express brand.
Beyond the qualitative aspects of Rule Makerhood, AmEx is showing some positive financial momentum, as well. On Monday, the company reported solid second quarter results, including 12.5% revenue growth (ahead of our 10% standard) and 13.7% growth in diluted earnings per share. In addition, Return on Equity (ROE) was 25.3%, up from 23.5% a year ago. The results were in line with the company's long-term goals of 8%-or-better revenue growth, 12-15% earnings per share growth, and 18-20% ROE.
Year-to-date, American Express stock is up 40% as of yesterday, so it may be overextended in the near-term. You never know what a stock might do over short periods of time. But over the long-term, I expect AmEx to continue to outperform the market, just as it has for the past 5, 10, 15, and 20-year periods:
Annualized Return Period AmEx S&P 500 1 year 27.0% 20.8% 5 years 42.1% 24.6% 10 years 18.8% 14.8% 15 years 21.1% 15.8% 20 years 19.7% 13.8%
With each additional $500 that we add to the Rule Maker Portfolio, my goal is to increase our positions in the companies that are most likely to outperform the market not over the next quarter or year, but over the next decade, if not two or three decades. Probably the least difficult aspect of such long-term decision making is assessing a company's potential to thrive for many years. Much more difficult is simply avoiding an obsession on near-term performance.
As an investor, I know how good it feels to buy a stock and watch it climb steadily from day 1. I'm even more familiar with the sinking feeling of buying a stock and watching it trade sideways or down for months on end. I think you know what I'm talking about. More than a few of you have posted on our Rule Maker Beginners board that you have the extraordinary power of driving any stock down 10% or more simply by purchasing shares in the company.
Focusing on the here and now isn't the right way to assess investment returns. Instead, I hope that over the next decade and longer, this online portfolio demonstrates the market-beating returns that inevitably accrue to investors who buy and hold dominant, brand-rich companies. Companies like American Express, which has reinvented itself many times since its 1850 founding as a package delivery service, and yet has continued to adapt to new technologies and build value for shareholders at a market-beating pace.
If you'd like to continue this discussion, bring your thoughts and opinions to the Rule Maker Companies board. Your Rule Maker managers are listening.
[And by the way -- if you know of some friends who might like to learn more about American Express or what we're up to in the Rule Maker nook, scroll up and click on the "E-mail this to a friend" link in the upper-right-hand corner.]
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Day Month Year History R-MAKER -2.52% -2.47% 10.69% 39.39% S&P: -1.78% -2.31% 9.67% 35.66% NASDAQ: -2.43% -1.70% 20.40% 59.72% Rule Maker Stocks Rec'd # Security In At Now Change 6/23/98 68 Cisco Syst 29.21 61.75 111.44% 5/1/98 82 Gap Inc. 23.05 46.31 100.90% 2/3/98 54 Microsoft 45.13 86.94 92.62% 2/13/98 44 Intel 42.34 69.50 64.16% 5/26/98 18 AmExpress 104.07 138.56 33.15% 2/3/98 66 Pfizer 27.43 34.00 23.94% 6/3/99 11 *Delphi Au 17.19 19.00 10.53% 8/21/98 44 Schering-P 47.99 50.19 4.57% 2/6/98 56 T. Rowe Pr 33.67 33.88 0.60% 2/27/98 27 Coca-Cola 69.11 61.50 -11.01% 2/17/99 16 Yahoo Inc. 126.31 137.00 8.46% Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Exxon 64.34 77.88 21.05% 3/12/98 20 Eastman Ko 63.15 69.63 10.26% 3/12/98 15 Chevron 83.34 91.38 9.64% 3/12/98 17 *General M 61.28 63.94 4.33% Rule Maker Stocks Rec'd # Security In At Value Change 2/3/98 54 Microsoft 2437.28 4694.63 $2257.35 6/23/98 68 Cisco Syst 1985.95 4199.00 $2213.05 5/1/98 82 Gap Inc. 1890.33 3797.63 $1907.30 2/13/98 44 Intel 1862.83 3058.00 $1195.17 5/26/98 18 AmExpress 1873.20 2494.13 $620.93 2/3/98 66 Pfizer 1810.58 2244.00 $433.42 8/21/98 44 Schering-P 2111.7 2208.25 $96.55 6/3/99 11 *Delphi Au 189.09 209.00 $19.91 2/27/98 27 Coca-Cola 1865.89 1660.50 -$205.39 2/6/98 56 T. Rowe Pr 1885.70 1897.00 $11.30 2/17/99 16 Yahoo Inc. 2020.95 2192.00 $171.05 Foolish Four Stocks Rec'd # Security In At Value Change 3/12/98 20 Eastman Ko 1262.95 1392.50 $129.55 3/12/98 15 Chevron 1250.14 1370.63 $120.49 3/12/98 20 Exxon 1286.70 1557.50 $270.80 3/12/98 17 *General M 1041.80 1086.94 $45.14 CASH $255.59 TOTAL $34317.28
Notes: The Rule Maker Portfolio began with $20,000 on February 2, 1998, and it added $2,000 in August 1998 and February 1999. Beginning in July 1999, $500 in cash (which is soon invested in stocks) is added every month.
*Although DPH is not a Foolish Four stock, it was spun-off from GM on June 3, 1999