During the very early months of the pandemic in 2020, Warren Buffett's company Berkshire Hathaway (BRK.A 0.91%) (BRK.B 1.19%) sold off a solid chunk of its bank holdings, which included credit card companies. Buffett said Berkshire was concerned about its exposure to the sector, given the uncertainty at the time.
However, Berkshire didn't sell a penny of the large credit card and payments company American Express (AXP 5.42%), which has long been a Buffett favorite and currently makes up nearly 7% of Berkshire's portfolio. Here are three reasons American Express is Buffett's favorite credit card stock.
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1. American Express has superior credit quality
Buffett knows the banking business quite well, which is why Berkshire has invested in so many bank stocks over the years. In fact, Berkshire actually bought a bank many decades ago called Illinois National Bank and Trust Company, which the conglomerate ran quite well during its time as the owner.
Anyone who knows the business this well knows that the No. 1 thing that can really sink a bank is bad loans. And in the credit card business, loan losses can jump in a hurry in times of duress. At the end of the second quarter, the loss rate for American Express was lower than any of its large-bank peers.
That's because American Express caters to a much more affluent customer base that's likely a lot more resilient during a recession or downturn. American Express has also been in the credit card business for a while and has a lot of underwriting experience.
2. American Express has a powerful brand
American Express has long had one of the most enviable brands in the industry. Buffett once told the company's CEO Stephen Squeri that "the most important thing about American Express is the brand and the customers that aspire to be associated with the brand."
This is a big compliment coming from Buffett, who invests in stocks for this very reason. Just look at the brand power of Berkshire's largest equity holding, Apple.
The company's brand is arguably why consumers will pay almost $700 annually for the American Express Platinum card. Brand power is not always easy to quantify, but in the case of America Express, it's a huge advantage that added a ton of value to the company over the years.
3. American Express has diverse revenue sources
Many credit card businesses rely solely on the net interest income they earn on credit card loans, which is essentially the difference between the monthly interest payments earned on loans and what it costs the company to fund those assets. Interest on credit cards is high, so if you can avoid significant losses, you can do pretty well -- but it's tougher than it looks.
In addition to credit card loans, American Express also runs an end-to-end payments network where it facilitates American Express payment transactions between consumers and merchants. Revenue from these transactions is actually the company's largest revenue generator. American Express also collects a healthy amount of revenue from charging subscription fees on several of its card programs, like the Platinum and AmEx Gold cards.
Relying too heavily on interest income from loans can be a hard business, which is why lots of bank investors like to see complementary fee-income business lines, as well. American Express essentially flips this notion on its head by having a majority of its revenue derived from fees. Payments businesses can also be very attractive once they obtain scale.
