With the Dow Jones Industrial Average in record territory, investors might be struggling to find attractive investment opportunities that are reasonably priced today. But this is why it's smart to dig beneath the surface and analyze individual companies.
American Express (AXP -0.62%) is a constituent of the Dow Jones. It's been a huge winner in the past, and it's also hitting all-time highs. But the shares might still deserve your investment dollars.
Is this top financial stock a buy, sell, or hold right now? Let's take a closer look at American Express.
Strong fundamentals
Despite ongoing macroeconomic headwinds that most businesses continue to grapple with, American Express keeps posting stellar financial results. This explains why the stock has climbed 11% this year.
Strong spending trends among its cardholders, particularly with the younger client base, as well as in travel and entertainment, helped push sales (net of interest expense) up 11% year over year to $15.8 billion. You would imagine that in uncertain economic climates people would be paring back their spending, but the numbers from AmEx show that this just isn't the case right now.
To be clear, there is worrying data out there indicating that credit card debt in the U.S. has never been higher. While this is true, and can be viewed as a significant risk factor, AmEx's default rates are typically well below its banking peers'. That's because this company attracts a more affluent and lower-risk customer. The Q4 charge-off rate of 2% is below pre-pandemic levels.
This business is reporting strong bottom-line growth, too. Diluted earnings per share (EPS) soared 27% in the last quarter, thanks to a 31% surge in net interest income. In the current year, executives forecast a 13% to 17% increase in diluted EPS.
As we look out even further, American Express should benefit from some key trends that can support solid growth. The popularity of cashless transactions can boost the number of AmEx cardholders and the payment volume that the company handles. Moreover, should inflation be a lingering issue, this business is somewhat insulated, as its revenue is directly tied to spending activity.
Defending its economic moat
What makes American Express a special company, and likely a top reason that Warren Buffett-led Berkshire Hathaway owns such a sizable stake, is due to the presence of a wide economic moat. This supports the business's success and strong financial performance over the long term by making it difficult for rivals to compete effectively.
American Express is a powerful brand in the world of finance. This results in merchants paying higher fees to accept these cards, while cardholders are asked to pay high annual membership dues for access to the top-notch rewards and perks.
Perhaps even better, this business possesses network effects. Operating a two-sided platform with those merchants and customers means AmEx has successfully cracked the "chicken-and-egg" problem. If another company tried to launch a competing payments network, it would struggle to attract buyers without any places to spend, and vice versa. This protects American Express's industry position, minimizing the threat of disruption.
Valuation matters
Regardless of the wonderful traits a company might have, if investors overpay, returns aren't going to be satisfactory. In this case, shares are trading hands at a price-to-earnings ratio of 18.6, which is about in line with the stock's historical five-year average. Consequently, I view the shares as reasonably valued right now.
For prospective investors, I believe it's a good time to be a buyer of this stock. And longtime shareholders have no reason to sell, as the prospects remain bright for solid investment gains going forward.
