Investing in the financial services industry can be difficult given the often complex and opaque business models. This view was bolstered by the recent turmoil facing regional banks -- negative developments that can turn investors away for good.
But not all financial stocks are created equal. In fact, some have wonderful business models that have stood the test of time. One such enterprise is American Express (AXP -0.70%), a global leader in the credit card industry. Here's why it might be time to buy the stock.
Benefiting from a favorable business model
When thinking of financial stocks, investors might immediately turn to traditional banks like JPMorgan Chase or Bank of America. Card networks like Visa and Mastercard might also come to mind. Plus, younger fintech companies like Block and PayPal could spark your interest. These businesses provide various services, and they have their own investment merits, to be fair.
However, American Express is in a truly advantageous position, which might help explain why Warren Buffett loves the stock so much. Not only is it a credit card issuer, but the company is also a merchant acquirer and a payments network. As of Dec. 31, 2022, the business had 133.3 million card members, up 10% year over year.
And these cards are accepted at 99% of merchants that take credit cards in the U.S. Moreover, the company's total payment volume was $413 billion in the latest quarter, up 12% year over year.
Operating an outstanding business model like this at scale benefits American Express because it can capture a greater share of the economics of the transactions that run across its network anytime one of its cards is swiped.
Visa and Mastercard collect a tiny assessment fee from the transactions that run across their payment rails. JPMorgan Chase and Bank of America earn interest income and fees from their cardholders, plus they take the biggest slice of what merchants pay to accept card payments, called an interchange fee.
American Express collects all of these, thanks to its powerful closed-loop system. It assesses credit risk and approves a cardholder, signs on merchants to its network, and processes the transactions. The company's discount revenue, which is what merchants pay to accept American Express cards, increased 25% year over year to total $30.7 billion last year. Net interest income, a figure that includes the interest earned from the company's card loan receivables, was up 28% in 2022 to $9.9 billion.
And because American Express targets a more affluent clientele willing to pay hefty annual dues to become members, the business collects valuable card fees. This segment generated $6.1 billion of sales last year, a 17% uptick from 2021.
These are the types of people whom merchants want as their shoppers, primarily because they have greater spending power, so American Express is able to charge higher fees to merchants.
And being on all sides of a transaction allows American Express to collect more data on its customers and their spending patterns, information that is then used to bolster the company's fantastic rewards programs, further driving customer growth.
Take a look at the valuation
Over the past five years, shares of American Express are up 74% (as of March 28). That's a 22% better return than the S&P 500, and about an 18% better return than the company's largest shareholder, the conglomerate Berkshire Hathaway. But American Express is down 8% in the past month, a decline likely spurred by general investor sentiment shying away from financial stocks.
Investors are now presented with an opportunity to buy a durable, steady, and predictable compounding machine at a price-to-earnings (P/E) multiple of 16. This valuation is cheaper than the stock's trailing three-, five-, and 10-year average P/E ratios. Despite macro headwinds, management expects double-digit revenue and earnings growth this year, so investors would be wise to consider buying shares today.