American Express’ Impressive Run Likely to Continue

Shares of American Express (AXP +1.18%) gained an impressive 46% in 2013. In the first twenty eight days of this year, the company's stock has continued its impressive run and rallied a huge 5% on Jan.17, 2014 after it delivered spectacular fourth-quarter 2013 results. So what is this love affair that investors have with Amex's stock, and can the huge run-up be sustained?

American Express is not the only card company flying high. The other "kings of plastic," namely Visa (V 0.47%), MasterCard (M 0.79%), and Discover Financial (DFS +0.00%), also killed the market in 2013 with impressive share gains and healthy top and bottom-line growth.  MasterCard's rip-roaring 60% share gain was the icing on the cake. Let's have a look at why Amex's stock is roaring, and what the future holds for the credit card company.

Solid fourth-quarter results
American Express reported highly impressive fourth-quarter results for fiscal 2013, with net income climbing an astounding 100% to hit $1.3 billion. American Express has strong holiday spending among its card members to thank for its solid quarterly results, with card member spending rising 8% during the holiday.

From the chart above, you can see that American Express has a market cap comparable to the much-venerated MasterCard's but delivers 1.5 times as much net income. This is despite sporting a considerably lower profit margin of 15.4% vs. MasterCard's 38.2%. This is mainly because Amex caters to higher-end customers and commands higher annual card fees. American Express operates as a closed network, acting as a card issuer, merchant acquirer, and as a network; this enables the company to access valuable data. American Express cards are also very popular due to the fact that the company has a very low fraud rate and enjoys higher credit quality. The firm's closed-loop network helps it run an effective single fraud screen that rival companies that operate an open-loop network would be hard-pressed to match.

American Express' management says that its billing revenue has a levered play on U.S. economic growth. Past trends show that customer billing, its main source of revenue, tends to increase by approximately 4.5 times relative to the country's economic growth. That means that if the American economy grows by 1%, the company's revenue from billings grows by 4.5%. With the projected growth rate for the U.S. economy of 3% in 2014, American Express can expect its billings to climb a solid 13.5% in 2014.

The downtick in billed business growth in 2012 was caused by rampant worries that the Chinese economy was overheating and would soon slow down. The firm's solid performance in 2013 has largely allayed those fears.

American Express' stronger billings and austerity measures taken to control spending should elevate the credit card company's profits in 2014.The firm's bottom line is expected to grow a healthy 11% from last year's $4.91 per share, to 5.46 in fiscal 2014.

Rivals thriving too
As I had pointed out earlier in the article, other card companies are doing well also. You will note from the chart above that despite its impressive run of good results, American Express and Discover Financial Services both command considerably lower P/E multiples than both Visa and MasterCard. There is a good reason why this is so.

Visa and MasterCard are mere payment processing companies, while American Express and Discover Financial Services act as both payment processors and lenders. Although this double play obviously helps the two companies to double dip in profits (and is responsible for American Express' better overall revenue than MasterCard), it unfortunately increases their risk of bad-debt write-offs such as what was witnessed in 2008. Investors do not like this kind of uncertainty, resulting in the lower valuations of their shares. Visa and MasterCard carry no bad debt exposure and this plays into their higher valuations.

Visa's shares have has been trending north after it appeared that the Fed's application to the court of appeal to have the $0.21 debit fees cap reinstated would succeed, much to the chagrin of The National Retail Federation. Visa's shares took a huge plunge in July of last year after the historic debit fees ruling that judged the $0.21 debit fees cap as "too high" and threw it out.

Visa has managed to grow its top line at an impressive 20% annual clip and its bottom line at a blistering pace of 22.4% per annum between 2010 and 2013. Visa's high profit margin of 42.3% is also the highest in the industry. The debit card company's fair valuation compared to MasterCard's offers some downside protection that shields its shares against excessive losses in case the current bull market takes a downturn.

MasterCard is regarded by many investors as the true leader of the space due to its high top and bottom-line growth, strong dividend growth, and an ultra-high return on equity (ROE.) Although the company's shares shot up an amazing 61% in 2013, several analysts, including Barrons, expect Visa shares to outperform it 2014. Shares of both Visa and MasterCard might be strongly affected by the direction that the Fed's case will take, however; if the court grants the Fed's wish to reinstate the swipe fees cap at $0.21, which looks like a strong possibility at the moment, both companies' shares are likely to shoot up.

Meanwhile, Discover Financial Services traces its roots back to big box retailer Sears Holdings, which introduced the credit card company back in 1985. The firm was later sold to Dean Witter, which was in turn acquired by Morgan Stanley. Discover Financial does not have American Express' huge global reach, and its cards are accepted at 25 million locations worldwide. The company delivered solid fourth-quarter results and has managed to beat consensus earnings estimates in three of the last four quarters. Its shares have been upgraded to a "Buy" at Zacks.

Foolish bottom line
American Express shares have a consensus "Buy" rating which looks fully justified by the firm's long run of good results. Solid results are expected in 2014 as well. With the ongoing secular trend of greater credit card adoption in emerging economies around the world, companies such as American Express and Discover Financial will continue to be good long-term investments.

Note: A previous version of this article incorrectly stated the number of locations that Discover is accepted. The Fool regrets the error.