Famed billionaire and legendary investor Warren Buffett has picked some big winners over the years. Buffett has led Berkshire Hathaway for decades, and countless investors have tracked the holding company's portfolio as a way to glean insights and ideas from arguably one of the most successful investors of all time.
Stocks have come and gone from Berkshire Hathaway's portfolio, but there's no question that American Express (AXP 2.24%) is one of Buffett's favorites. The credit card giant has resided in Berkshire's portfolio since the 1990s.
Investors should always conduct their own due diligence and avoid copying and pasting someone else's ideas, including even Warren Buffett's, for their own portfolios. That said, there is much to like about American Express.
Here is what makes the company special, and why investors may want to consider buying shares on the stock's recent decline and holding them tight for the foreseeable future.
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A powerful brand with a lucrative customer base
Credit cards have been around for decades. They are a financial tool, and yes, credit cards are destructive to your finances if you carry a balance each month. But American Express occupies a somewhat unique space within the credit card industry.
American Express isn't targeting the consumer who uses credit out of necessity, but rather the high earners and business accounts -- the discretionary spenders.
The company reinforces that business model with a famously generous and perk-filled rewards program, high annual card fees, and by charging merchants higher swipe fees on transactions. If you've ever gone to a restaurant or other business that doesn't accept American Express cards for payment, those higher fees are typically why.
Now, American Express is technically a lender, so yes, it faces default risk, especially during recessions. However, its credit card customers tend to have prime-grade credit, so American Express has lower default rates than the industry average.
Spending trends favor American Express
The upcoming generational wealth transfer will be monumental for American Express over the next decade and beyond. Experts estimate that approximately $124 trillion in wealth will shift from baby boomers and other older Americans to younger consumers, like millennials and Gen Z, by 2048.
American Express is aware of this and is successfully capturing its next generation of customers. Management reported in its most recent quarter that Gen Z and millennials represented 63% of its new accounts. Young spenders now represent about a third of American Express's billing volume.
The continuous rise of home prices, the weight of student loans, and broader inflation in recent years have discouraged many young people from prioritizing savings. Instead, many are choosing to spend on travel and other life experiences. That may change over time as people age and incomes rise, but this trend is a clear boon for a credit card company like American Express.
What investors might expect moving forward?
Analysts currently estimate that American Express will grow its earnings by an average of 12% annually over the next three to five years. The stock's current price-to-earnings (P/E) ratio of 20 is quite reasonable given the growth. Barring any dramatic valuation swings, the stock could deliver annualized total returns in the 13% range.
The longer-term outlook also looks promising. In the United States, the top 20% of earners account for nearly two-thirds of consumer spending, so American Express's position in this demographic bodes well for it.
Yes, recessions are a risk, but as I mentioned earlier, American Express tends to experience lower default rates. The company also operates its own payment processing network, resulting in 75% of its business being non-interest-bearing revenue.
As long as American Express can navigate economic cycles as it has in the past, it's easy to see the stock continuing to perform in a manner that has made it a core holding in Berkshire Hathaway's portfolio.
