American Express (AXP -1.10%) is one of the most established consumer brands, so it's no surprise that it's also one of the largest positions for Warren Buffett's Berkshire Hathaway, with the conglomerate owning 20% of the outstanding shares, worth $26 billion.
Buffett has said the stock is one of the positions he plans to never sell due to how dominant the credit card brand is in the minds of consumers.
This year, shares of American Express have underperformed the broader market, with the stock essentially flat year to date and down around 25% from its highs. The dividend yield is now up to 1.61%, the highest since the March 2020 market meltdown, and its price-to-earnings ratio (P/E) is now well below the market average.
A discounted price makes this Buffett favorite one of the best stocks for dividend-growth investors today. Here's why you should consider joining him and buy some American Express stock and never sell.
A premium brand vs. the competition
Many readers know Amex as one of the leading credit card networks along with Visa, Mastercard, and Discover. But the company runs a slightly different business model than Visa and Mastercard.
Instead of partnering with banks and payment processors, it acts as the payment network, consumer bank, and payment processor on transactions. This vertical integration allows it to earn revenue on payment-transaction take rates, credit card fees, and credit card loans.
Vertical integration allows Amex to customize its credit card program for customers, offering premium services that have enticed many high earners (who are also generally high spenders) to sign up for the cards. Counterintuitively, its credit cards such as the Platinum card can be more attractive to high earners even with higher annual fees than other cards.
Even though the company just raised the annual fee on the Platinum card to $695, it has added over 3 million cardholders every quarter since the start of 2022. It is hard to quantify, but the brand is elevated in the minds of many consumers, which is something a standard credit card from Visa or Mastercard can't match. This gives it a long-term advantage over competitors.
But the majority of the company's revenue still comes from its take rate on card transactions. In 2022, this segment made up 58% of consolidated revenue. For investors, this means that the most important performance indicator is the total payment volume flowing through its network.
Last quarter, payment volume grew 9% year over year to $427 billion, which was on top of 28% growth in 2022. As payment volume rises, so does revenue.
Catching up to Visa and Mastercard
One negative view customers had on American Express (and likely still have) is the lower number of places that accept its cards versus Visa and Mastercard. Management tried to fix this about five years ago and has made lots of progress.
In the United States, Amex got to what it calls "virtual parity" with 99% merchant acceptance in 2019, up from 80% in 2014. This is helping it become the everyday card for more consumers, which can drive higher payment volume and therefore higher revenue.
Internationally, Amex is much further behind in merchant acceptance but is making a lot of progress. From 2017 to 2021, it doubled the number of locations that accept its card outside of the United States. This decade, management has made it a priority to continue growing international acceptance.
The stock is cheap today
This year, the company is expecting to generate at least $11 in earnings per share (EPS). At its current stock price of $148, the shares trade at a forward price-to-earnings (P/E) ratio of 13.5, which is around half the market average of 25. A discounted P/E suggests that investors doubt that Amex can grow its earnings at the same pace as the broader market.
However, I think there is a path for the company to grow its EPS much faster than the market average, and for many years into the future. Thanks to a combination of market-share gains, growth in cashless transactions, inflation, and global growth in gross domestic product, management thinks it can increase revenue by 10% or higher from 2024 onward.
And the company is helping EPS increase by consistently reducing its outstanding share count, which is down 31% over the last 10 years.
AXP dividend per share (TTM) data by YCharts. TTM = trailing 12 months.
All this has led to 239% dividend growth in the last 10 years. You might not think that Amex has an attractive dividend yield today at 1.61%, but if it can grow its dividend by 200% over the next 10 years, it will be yielding 4.80% a decade from now. Grow it another 200% over the following 10 years and it will yield 14.4%. That is why buying dividend growers is a great way to build your wealth.
A cheap P/E combined with durable double-digit earnings and dividend growth is a recipe for long-term market outperformance. American Express is a slam-dunk buy for investors after its recent price drop.
