Ideas for where to find great investments can come from just about anywhere. For instance, by looking at what stocks other successful investors own, individuals can sometimes find potential winners for their own portfolios. It's a useful strategy, provided you take the time to really understand the company and the investment thesis of the investor you are mimicking. And what better investor to emulate than Warren Buffett?
American Express (AXP -0.79%) is currently the third-largest holding in Berkshire Hathaway's (BRK.A -2.00%) (BRK.B -1.83%) $370 billion portfolio. The Oracle of Omaha's conglomerate owns about 20% of the outstanding shares of the financial services business. That's a clear vote of confidence in its prospects.
Buffett's definitely got the view that buying American Express is a good idea. Should his idea become yours? Let's take a closer look at three compelling reasons why this top financial stock is worth a closer look.
1. American Express has affluent customers
In the first three months of 2023, American Express generated 21% of its revenue -- or $3 billion -- from net interest income. This was up 36% year over year, and it was mainly due to the Federal Reserve hiking benchmark interest rates to fight outsized inflation.
During what has been an uncertain economic time, with many market participants expecting a recession in the near term, it could be scary for investors to own a business that lends money to customers and earns interest. That's because in difficult times, default risk is elevated, as borrowers might struggle to pay back their outstanding balances.
But compared to most other banks, American Express focuses on a more affluent customer base that has better creditworthiness and higher discretionary income. This is a huge boon during robust economic periods because these cardholders are able to spend a lot more, propping up Amex's finances.
It can provide some downside protection in recessionary times as well by helping minimize losses. According to data from S&P Global, American Express had the lowest delinquency and charge-off rates in the month of May among the six large card issuers.
Buffett is very familiar with financial institutions and how they operate, understanding all the risks involved. The fact that he has such a large stake in this business right now is certainly a vote of confidence. This should give investors some peace of mind.
2. American Express is posting strong growth
American Express recently reported stellar growth. Revenue (net of interest expense) increased 25% to $52.9 billion in 2022. And this momentum carried over into the current year, with total sales (net of interest expense) in Q1 rising 22% year over year. This strong fundamental performance probably explains why the stock price has climbed 20% in the last 12 months.
For the full year, the management team upped its guidance. Executives now forecast 2023 revenue to jump between 15% and 17%, with earnings per share (EPS) rising 14% at the midpoint compared to 2022. This is a much better forecast than Berkshire's largest holding, Apple, whose EPS is expected to decline this fiscal year.
The long-term outlook is also optimistic. "We remain committed to focusing on achieving our aspiration of delivering sustainable revenue growth greater than 10% and mid-teens EPS growth as we get to a more steady-state macro environment," CEO Steve Squeri said on the Q1 earnings call.
3. American Express has powerful network effects
During the first three months of 2023, the business processed a whopping $350 billion in payment volume. And as of March 31, there were 125 million Amex cards in circulation. According to a Nilson Report, these cards are accepted virtually everywhere credit cards are used in the U.S.
These numbers show that as a card issuer and payments platform, American Express benefits from powerful network effects. Consumers want these cards that often come with great perks and rewards because they can be used anywhere. And merchants, trying to avoid the risk of losing out on the spending power of higher-income customers, almost have no choice but to take Amex cards as a method of payment.
Along with its globally recognized brand -- something that Buffett can certainly appreciate -- these network effects create a durable economic moat protecting American Express' business from competitors. Competitive moats are definitely a criterion for Buffett when selecting stocks to own.
After learning about these important reasons to own American Express, it seems like a no-brainer decision to add the stock to your portfolio.