Berkshire Hathaway, the conglomerate headed by Warren Buffett, holds numerous stocks in its enormous investment portfolio. The third largest holding, American Express (AXP -0.08%), has been a choice for the legendary investor for decades. That's a wonderful endorsement any company would love to have.
American Express is a unique business in that it combines a credit card payments network with the best aspects of a traditional bank. Add these traits to a powerful brand, and that might be why Buffett is a fan of the company. So, is the stock a buy today?
What makes American Express special
As I noted above, American Express is a payments network, connecting its 136 million cards outstanding to millions of merchants around the world. This puts it in competition with the likes of Visa and Mastercard. AmEx is a lot smaller, to be sure, processing $399 billion in total payment volume (TPV) in the latest quarter, up 14% year over year. That's compared to $3 trillion for Visa and $2.1 trillion for Mastercard.
Nonetheless, it still benefits from network effects, and it collects fees for every transaction that passes through its platform.
This is a great business because it makes American Express somewhat of an inflation hedge. When prices rise, consumers are forced to pay more, and this boosts the company's TPV and revenue. American Express's discount revenue, which is the fees that it charges merchants accepting its cards, increased 16% to $8 billion in the first quarter of 2023.
American Express also issues its own credit cards. Big banks like JPMorgan Chase and Bank of America, along with a seemingly endless number of other financial institutions, do this exact same thing. This part of the business is extremely competitive, but AmEx has a premium and coveted brand.
Funding customer purchases does expose the company to credit risk, because these customers could default on their outstanding balances if they run into financial problems. This would leave American Express on the hook. But it's worth understanding that these customers tend to be wealthier with greater spending potential.
In fact, AmEx's loss rate of 1.6% in the latest quarter reflects this. JPMorgan Chase, which has credit cards like the Sapphire Reserve and Sapphire Preferred that compete directly with American Express's Platinum Card and Gold Card, posted a net charge-off rate of 2.07% in its most recent fiscal quarter in its Card Services division.
A surge in travel
American Express posted revenue of $14.3 billion in the first quarter, up 22% year over year, and diluted earnings per share (EPS) of $2.40, down 12% year over year. These were mixed results according to Wall Street analyst forecasts, but the shares are still up more than 16% on the year. Net interest income soared 36% during the quarter, a direct result of rising rates implemented by the Federal Reserve.
The rebound in travel demand is benefiting AmEx in a huge way. Travel & Entertainment spending was up 39% year over year. "Consumer travel demand also remains high with Q1 bookings through our consumer travel business reaching their highest levels since pre-pandemic," Chief Executive Officer Steve Squeri said on the first-quarter earnings call. Management expects mid-teens percentage revenue and diluted EPS growth in 2023.
Looking at the valuation
Before finally deciding to buy a stock, investors should take a closer look at a company's valuation. Even some of the best businesses in the world can produce lousy investment returns if the purchase price is too high.
Over the past five years, AmEx shares have traded at an average price-to-earnings (P/E) ratio of 19.3. But as of this writing, they sell for a P/E of 17.3. That modest discount only makes this opportunity even more appealing. The business is performing well in what should be a difficult operating environment. And its stock's valuation isn't unreasonable. This makes it a buy.
