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Better Buy: American Express vs. Visa

By Matthew Cochrane - Updated Jul 13, 2017 at 3:34PM

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Which of these two credit card giants make for a better investment today?

Many investors probably think of American Express Company (AXP -0.15%) and Visa Inc (V -1.18%) as being nearly identical businesses. After all, both companies are listed on the Dow Jones Industrial Average, and most consumers might only think of either company when they pull out their respective cards from their wallets or look to redeem their credit card reward points. Both companies have also comfortably beaten the market over the past year as investments.

The truth is, though, that there are significant differences in the two companies' business models; differences that, in recent years, have played a significant role in the valuations the market is willing to support for both companies. Of course, growth rates, valuations, and a look at the opportunities and risks facing each company are also important things to consider before buying stock in a company. So, without further ado, let's take a closer look at American Express and Visa to see which is more deserving of an investment at this time.

V Chart

V data by YCharts

The case for American Express

American Express operates in what is known as a closed-loop credit card system. In American Express's case, this simply means that company issues its own branded cards and facilitates the payments on those cards. The primary advantage to this model is that consumers pay lots of interest on credit card debt each year and, as the issuer of this debt, American Express collects this revenue for itself.

Another advantage is the data American Express has on its card holders, giving the company the chance to better personalize its reward offerings to attract and retain customers. American Express does this better than almost anyone else in the business and recently tied for having the most loyal customers in the credit card industry.

The chief downside to this business model is that it exposes American Express to lots of credit risk. And, remember, while American Express only sported a 1.7% net write-off rate in the first quarter -- the best in the credit card business -- it should still be noted that credit card debt is far riskier than any other type of debt in today's economy.

At first glance, the numbers from its most recent quarter do not look great as total revenues net of interest expense declined 2% and net income was down 13% year over year. However, those numbers don't tell the whole story. Still recovering from the major loss of Costco Wholesale, once the numbers are adjusted for that and foreign exchange rates, adjusted revenue growth was actually up a healthy 7% year over year.

There are several reasons for investors to be optimistic about American Express' immediate future. First, the company emerged in good condition after the Federal Reserve's recent stress tests. In addition, after a huge spike in marketing costs at the end of 2016 (where it spent a company record $1.2 billion in the fourth quarter alone!), its first quarter's marketing and promotion expenses dropped more than 40%, and management is projecting 2017's spending level on this category to closely reflect 2015 levels, not 2016. The company is also gaining broader merchant acceptance through its OptBlue campaign.

Based on the midpoint of the company's full year EPS guidance for 2017 of $5.60 to $5.80, the company's forward P/E is about 14.8. After this year's stress tests were complete, the company announced it was planning to raise its dividend by 9% and authorized the buying back of up to $4.4 billion in shares over the next year. If the dividend increase is approved by the company's board, the stock's yield will be 1.66% based on today's price. The buyback represents almost 6% of the company's market cap.

An American Express card, Visa card, and Mastercard card

Image source: Pixabay.

The case for Visa

Unlike American Express, Visa and Mastercard Inc (MA -1.50%) operate in a four-party open loop credit card system. This means it merely facilitates the payments for each of the transactions across its network and does not issue the debt. While this means Visa does not collect interest on credit card debt like American Express, it also means it is not exposed to any credit risks. While the pros and cons of each model can be debated, it should be noted that the market has been generally inclined to assign much higher valuations to companies that do not face credit risk since the financial crisis in 2008.

Visa shines nearly every time it reports earnings and last quarter was no exception. Adjusted earnings rose 21% to $0.86 per share while net operating revenue came in at $4.5 billion, a 23% increase year over year. Processed transactions improved to 26.3 billion, a 42% increase over the prior year's quarter.

New CEO Al Kelly faced a number of challenges when he took the job but has nevertheless excelled, namely by ensuring the process of integrating Visa Europe with the rest of the company continues to go well.

In its most recently reported quarter, the company announced its board had authorized a new $5 billion share repurchasing program. While Visa does issue a quarterly dividend, its current yield is a paltry 0.7%.

Visa expects 2017's adjusted EPS to show growth in the mid-teens over 2016's results. Given a trailing twelve-month adjusted EPS of $3.19, Visa is currently valued with a 29.4 P/E ratio.

Final verdict

Investors in both companies have reason to be optimistic. Given Visa's much higher valuation, American Express's stock price might very well out-perform Visa's in the immediate quarters ahead. But picking stocks based on potential short term price movements is a fool's game. Truly Foolish investors know that investing with the long game in mind is the best way to win in the stock market.

That is why I prefer Visa's shares. I believe its business model gives it a clear advantage over American Express and other credit card issuers. While it is richly valued, Visa has earned that valuation by executing well, sometimes even at American Express's expense, nearly every quarter.

Matthew Cochrane owns shares of Mastercard. The Motley Fool owns shares of and recommends Costco Wholesale, Mastercard, and Visa. The Motley Fool recommends American Express. The Motley Fool has a disclosure policy.

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Stocks Mentioned

American Express Company Stock Quote
American Express Company
$157.28 (-0.15%) $0.23
Visa Inc. Stock Quote
Visa Inc.
$213.32 (-1.18%) $-2.55
Mastercard Incorporated Stock Quote
Mastercard Incorporated
$352.16 (-1.50%) $-5.35

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