Initiating a dividend hike is the ultimate sign that a company's management team is confident in a company's ability to generate profit. Responsible management wouldn't hike the dividend if there wasn't enough profit growth to support a higher payout to shareholders.
Financial services company American Express (AXP 0.35%) just upped its quarterly dividend per share by 15.4% to $0.60. This is a dividend that has seen steady growth since the early 2000s and is apparently more focused on returning its profits to investors lately.
Warren Buffett and his holding company Berkshire Hathaway (BRK.A -0.40%) (BRK.B -0.71%) likely appreciate the growing dividend that AmEx provides. But there's another equally important component to why American Express stock has been among Berkshire's holdings since 1994: its share price appreciation.
American Express stock has proven to be an excellent compounder over the long haul, turning a $10,000 investment from 29 years ago (around the time Berkshire first bought the stock) into $351,000 with dividends reinvested. This is significantly better than the $145,000 that the same investment amount in the S&P 500 index would have become over that stretch. Berkshire's initial stake in AmEx was far more than $10,000 and it has purchased more of the stock over the years (it owns about 8% of all AmEx shares). Its holdings in the company are now worth $26.4 billion.
Clearly, AmEx stock has performed for Buffett and Berkshire over the years and given the famed investor plenty of reason to praise the company in that time and plenty of reason to keep holding the stock. But should dividend growth investors buy the stock now? Let's dive into AmEx's fundamentals and valuation to get an answer.
Favorable demographics drove revenue to a record high
AmEx started out in 1850 as an express deliverer of packages and a freight-forwarding company. It wasn't until a century later, in the 1950s, that the New York-based business introduced a charge card that led to it becoming the company that we all know today.
Since then, AmEx established itself as a significant player in the payments-processing industry. After years of playing catch-up to Visa (V 0.69%) and Mastercard (MA 0.07%) in terms of acceptance at retailers across the U.S., the company's credit cards can now be used at 99% of merchant locations in the U.S. that accept credit cards.
AmEx recorded $14.2 billion in total revenue net of interest expense in its fourth quarter (which ended Dec. 31), up a staggering 16.7% over the year-ago period. How did the company achieve a record top-line figure for the quarter?
A few years back, AmEx began a marketing campaign focused on attracting a younger, more affluent, more engaged cardmember base. An example of this was the company partnering with the short-form-video-focused social media site TikTok to promote Small Business Saturday. Such promotion could help AmEx draw more Gen Z customers to small businesses. And since the company earns much of its revenue from swipe fees when customers use their cards at merchants, it could be a win for AmEx as well in the years ahead.
The company also provides exclusive offerings and experiences to new cardholders who meet spending requirements in a given period of time, which boosts total network volumes. The company's total network volume surging 12.3% higher to $413.3 billion during the quarter has proven this thesis correct. Just as important for AmEx's future growth prospects, such a highly sought-after group of cardmembers would also be too lucrative for merchants to ignore.
With the help of these savvy decisions by the company's management team, analysts believe that AmEx's diluted earnings per share (EPS) will move 7.5% higher annually over the next five years.
Image source: Getty Images.
A low payout ratio could fuel robust future dividend growth
As mentioned earlier, AmEx's results inspired enough confidence for management to significantly lift the quarterly dividend per share. This will push the company's dividend yield up to 1.4%. While that's still below the S&P 500 index's 1.7% yield, double-digit dividend growth that has the potential to continue growing offers some compensation for AmEx's lesser starting figure.
And with the dividend payout ratio anticipated to come in at around just 21.5% for 2023, there should be plenty of room for more strong hikes in the years to come. Such a low payout ratio also gives AmEx enough capital to continue investing in future growth opportunities, repaying debt, and repurchasing shares to drive diluted EPS upward. These are all features that Buffett and Berkshire look for in a stock.
The valuation makes the stock a buy
Share prices of AmEx are already 18% higher so far in 2023. Yet the stock's forward price-to-earnings (P/E) ratio of 13.9 is still moderately lower than the credit services industry average forward P/E ratio of 16.5. that suggests AmEx is a wonderful business that is not getting the love it deserves from the market. This is arguably exactly the kind of stock Buffett and Berkshire Hathaway favor, one that has value that the market is missing. It's also what makes the stock an intriguing buy even now for dividend growth investors.
