Warren Buffett's Berkshire Hathaway (BRK.A 0.10%) (BRK.B 0.55%) completed its $1.3 billion investment into American Express (AXP +1.12%) in 1995. Since then, its investment in the bank holding and payments giant has grown to $32 billion, and it received approximately $352 million in dividends in 2023 alone. Despite not buying any additional shares of American Express since 1995, Berkshire's stake has grown from nearly 10% to 21% stake through steady buybacks.
Today, American Express stock trades near an all-time high, so it might sound ridiculous to consider it cheap. However, when examining the financial giant's recent financial performance, its valuation could be considered cheap by certain metrics. So, let's dive into why American Express is a favorite stock of Warren Buffett's and why it is just as worthy of buying today as it was in the early 1990s.
American Express is putting up record numbers
American Express recently released its 2023 financial results, and it was a record-setting year on the top and bottom lines for the nearly 174-year-old payments company. Specifically, it generated $60.5 billion in revenue in 2023 and produced diluted earnings per share (EPS) of $11.21, a year-over-year uptick of 14% for each metric.
Additionally, management offered strong guidance for 2024, forecasting revenue growth of 9% to 11% and diluted EPS growth of 13% to 17%, which would bring it to a range of $12.65 to $13.15.
In light of its strong revenue and earnings growth, the company raised its quarterly dividend by 17% to $0.70 per share. At the share price as of this writing, that gives it a 1.3% annual yield.
AXP Revenue (Annual) data by YCharts.
American Express excels in retained earnings
One of Warren Buffet's favorite financial metrics -- one that has called out multiple times in his annual letter to Berkshire Hathaway shareholders -- is retained earnings, which measures a company's net earnings minus all dividends paid. Buffett wrote in his 2020 annual shareholder letter that retained earnings allow companies "to expand their business, make acquisitions, pay off debt and, often, to repurchase their stock (an act that increases our share of their future earnings)."
NYSE: AXP
Key Data Points
In 2023, American Express recorded a net income of $8.4 billion and distributed $1.6 billion to its shareholders as dividends, giving it retained earnings of $6.8 billion for the year. Utilizing some of this surplus, it acquired Nipendo, a payments company headquartered in Israel, for an undisclosed amount.
Over the past two years, management has smartly reduced its net debt (total debt minus cash and cash equivalents) by 88%, from $16.9 billion to $2 billion. As a result, it won't be saddled with paying high-interest expenses or relying on expensive debt while interest rates are at elevated levels.
Additionally, management has repurchased nearly 3% of the company's shares outstanding over the past year, lowering its share count to 723 million. The company is in the early stages of a 120 million share repurchase program announced in March 2023.
In Buffett's latest letter to shareholders, he wrote about why stock repurchases are shareholder-friendly: "The math isn't complicated: When the share count goes down, your interest in our many businesses goes up. Every small bit helps if repurchases are made at value-accretive prices."
What could go wrong for American Express?
American Express operates differently from its larger competitors in that it acts as a closed-loop network compared to Mastercard's (MA 0.29%) and Visa's (V +0.36%) open-loop networks. The main distinction is that American Express issues credit and manages its transactions, while other major financial institutions support Mastercard and Visa cards. American Express enjoys the advantage of charging higher fees to merchants and accruing interest from the transactions within its system. However, the downside is American Express is accepted less widely, has higher credit card rewards and member services expenses, and assumes greater risk from defaults.
The stock still looks cheap despite recent performance
Despite some concerns, the expansion of American Express' business has propelled its stock upward. While labeling its stock as cheap might seem contradictory in that context, based on its valuation metrics, the company still appears undervalued compared both to its historical benchmarks and industry peers.
American Express stock currently trades at 8.3 times free cash flow, which isbelow its three-year average of 9.6 for that metric. Moreover, its price-to-free-cash-flow ratio is significantly lower than Mastercard's ratio 39.5 or Visa's ratio of 29.5. The wide difference is partly due to the difference between their business models. Still, given the fact that American Express has a significantly higher three-year compound annual growth rate (CAGR) for free cash flow, the stock looks underpriced.
| Metric | American Express | Mastercard | Visa |
|---|---|---|---|
| Free cash flow (TTM) | $18.9 billion | $10.9 billion | $19.1 billion |
| Market capitalization | $152.7 billion | $428.2 billion | $560 billion |
| Price-to-free-cash-flow ratio | 8.3 | 39.5 | 29.5 |
| 3-year free cash flow CAGR | 69.5% | 18.7% | 26.8% |
Data source: Finance Charts. Chart by author.
Is American Express stock a buy?
When a stock hits an all-time high, it's common for investors to assume it's overpriced, which often leads them to conclude they should wait for a pullback before considering a purchase. However, a more prudent approach is to investigate the reasons behind the surge that lifted it to that record, and analyze the stock's valuation metrics to understand its worth better. In the case of American Express, the company is experiencing rapid growth and returning an unprecedented amount of capital to shareholders. While its stock price reflects this, investors shouldn't hesitate when it comes to investing in one of Buffett's favorite stocks.
