He's regarded for his stock-picking skills. Yet, the secret of Warren Buffett's success isn't his ability to find the market's next breathtaking winner. Buffett's Berkshire Hathaway (BRK.A 0.61%) (BRK.B 0.60%) consistently outperforms the broad market because the Oracle of Omaha holds several quality stocks for years on end, even when doing so gets a bit uncomfortable.
Nevertheless, if you've only got enough money and room in your portfolio to poach one of his picks right now, I see a standout. That's American Express (AXP 1.23%).
American Express (still) does things differently
Among all of Berkshire's holdings, American Express isn't one frequently mentioned as an idea worth borrowing. That honor usually falls to outfits like Apple or Bank of America, which are the fund's two biggest positions at this time. Investors specifically looking for a credit card company note that Berkshire is also currently holding Visa (V 0.49%) and Mastercard (MA 0.16%), both of which are bigger companies than American Express.
There's a reason Buffett's Berkshire holds a bigger stake in American Express than his stakes in Mastercard and Visa combined, though ... several reasons, actually. Perhaps the most important of these reasons, however, is the way in which American Express differentiates itself.
Older investors may recall the days when American Express wasn't a credit card company, but simply a charge card company facilitating noncash purchases. These no-limit cards were paired with a variety of perks and services that true credit cards weren't offering at the time. These perks were so well-received, in fact, that American Express could charge consumers and companies an annual fee just for the privilege of holding one of its cards.
The line distinguishing American Express's charge cards and Visa's and Mastercard's credit cards has long been blurred. American Express is also a full-blown credit card company these days, while rival credit card players have dramatically improved their perks programs.
Nevertheless, American Express's roots are clearly unique.
Fast forward to today ... or rather, last quarter. For the three-month stretch ending in September, American Express generated $13.5 billion in revenue. Of that, only 58% was discount revenue -- merchant fees paid by organizations accepting American Express cards as payment for goods and services. Another 9% of that top line was made up of fees for services provided to merchants above and beyond transaction fees, while another 3% of its top line reflected things like commissions on travel plans.
Although the company has related interest expenses of its own, the bulk of the $3.1 billion in interest charges it reaped from customers (roughly 23% of its total sales) made its way to the bottom line. The kicker? More than 11% of the company's third-quarter revenue came from cardholders themselves, just to continue using their American Express cards. And last quarter was a relatively typical one in terms of revenue sources.
It's certainly the most diversified revenue stream within the credit card industry. It's also one of the more reliable revenue streams in the business.
American Express is different done right
It's a bit counterintuitive to consumers who aren't American Express cardholders: Why pay for something you can get somewhere else for free?
But there's a reason this payment intermediary can so consistently do what's seemingly unlikely -- generating as much high-margin card fee revenue as it does. It's a testament to the strength of the spending and rewards ecosystem American Express has built for cardholders.
Take its Gold Card as an example. The card's annual fee is an eyebrow-raising $250, although for frequent travelers the cost makes sense. Cardholders receive up to $120 worth of Uber credits each year and earn quadruple rewards points for dining at certain restaurants. Gold Card members also enjoy priority seating at concerts, sports events, and other entertainment.
American Express is a steady, reliable-growth company thanks to its revenue diversity and customer proposition. Data source: Thomson Reuters. Chart by author.
The Platinum Card is even more compelling for a certain set of consumers. While its annual $695 fee is unthinkable to some, its discounts on streaming services, hotel-stay credits, access to airport lounges, and tons of spending credits at several retail stores mean that the card's cost often pays for itself.
None of this is to suggest Mastercard and Visa don't have attractive rewards programs of their own, nor is it to say every American Express card imposes an annual fee. It's simply to point out that American Express has mastered the perks-based credit card business model. With the exception of the height of the pandemic, this has made the company a reliable grower.
Yes, it's safe to use Buffett's idea
Do brewing economic woes -- perhaps even a recession -- leave this card company vulnerable? Maybe. But it's probably not as vulnerable as you might think.
Most investors have likely seen or sensed that cash is slowly losing its place as a means of buying and selling goods, displaced by cards. The Federal Reserve Bank of San Francisco's most recent annual update, posted in May, indicates that within the U.S. only 20% of purchases were made with cash in 2021, down from 2016's figure of 31%. Conversely, in 2016, 45% of transactions were handled with a card, but that figure has grown to 57% as of last year. Similar trends are underway overseas too. The shift reflects the increased usage of cards to buy everyday goods like groceries, drive-thru meals, and clothing.
And that's important to interested investors. While an economic headwind might prompt people to postpone the purchase of a new car or cancel vacation plans, they're not going to stop eating or wearing clothes. Indeed, given the American Express Gold Card's bonus points for using the card specifically at grocery stores, savvy consumers may find paying its annual fee actually makes good financial sense.
In other words, don't sweat the gloomy headlines. American Express is a great all-weather holding, which may be why Warren Buffett's been holding his position for more than a couple of decades now. Long-term investors can safely take the hint.
