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1 Reason American Express Company Is an Exceptional Stock

By John Maxfield – Mar 29, 2014 at 8:00AM

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Among all of its competitors, American Express has proven itself to be the most adept at risk management.

Over the last couple weeks, investors have been reminded on two separate occasions that few companies are as good at what they do as American Express (AXP 0.62%).

Despite cutting its teeth almost exclusively in the riskiest niche of lending -- i.e., credit cards -- the New York-based company was far and away the top performer in this year's stress test. Even under the Federal Reserve's "severely adverse" economic scenario, which presupposed a deep recession and double-digit unemployment rate, American Express' Tier 1 common capital ratio hardly budged, falling from 12.8% down to 12.6%.

By comparison, the average drop among the 30 participating companies was 34%, with the worst performance coming from Utah-based regional bank Zions Bancorp. Even the next best finisher, The Bank of New York Mellon, saw its core capital ratio drop by 7%, or three and a half times that of American Express.

A week after these results were made public, the credit card company announced the fruits of the performance. It will increase its quarterly dividend to $0.26 per share beginning in the second quarter of 2014 and repurchase up to $4.4 billion of common stock this year and up to an additional $1 billion in the first quarter of 2015.

With this in mind, what is it that separates American Express from its peers? Particularly given the fact that it's concentrated in credit card lending, how is it possible that its capital base held up so much better throughout the Fed-administered stress test?

The answer to this is simple. American Express is an exceptional risk manager. Check out the following chart, which illustrates the projected losses suffered by seven major credit card portfolios.

As you can see, American Express' portfolio was estimated by the Fed to suffer the smallest loss, at 10.6% of its size. By comparison, Capital One Financial was forecasted to experience a 20.5% loss rate on its credit card loans and even the notoriously conservative Wells Fargo would hypothetically be subject to a 16.4% loss rate.

The key to American Express' success is its focus on upper-income customers -- that is, people with a greater ability to service their debts during difficult economic times. And the moat around this strategy is its brand name. It's the reason Warren Buffett loves the stock, and why virtually all of its current shareholders likely feel the same.

John Maxfield has no position in any stocks mentioned. The Motley Fool recommends American Express. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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