Value investors know that the time to buy into wide-moat, high-ROIC businesses is when they are on sale, i.e., when the rest of the world goes into fear mode. Fear often blinds investors from judging objectively underlying value, preventing them from buying businesses well below instrinsic value. We have argued in recent weeks that American Express (NYSE: AXP) represents such a wide-moat, high-ROIC business -- and that investors have been running away from the shares based on fear rather than thorough analysis of the underlying fundamentals.
The Q1 results American Express reported yesterday confirm the strength of the company's franchise even as the business continues to deal with unprecedented weakness in consumer spending and consumer credit. Despite rising delinquencies and lower cardmember spending, American Express earned a 16% return on equity in the quarter, a number that many companies would love to report in good times. In the case of American Express, good times come with ROEs of 35% or more. That's quite a business.
Undoubtedly, bears will continue to focus on what's not to like. They can do so quite easily -- all you have to do is quote management:
While we did see some recent improvement in early delinquency rates, overall credit indicators reflected rising unemployment levels and the broad-scale weakness in the economy. Based on current indicators, we expect second quarter U.S. lending write-off rates on a managed basis to rise between 200 and 250 basis points over the first quarter levels. We expect an additional increase of 50 basis points or less in the third quarter, before leveling off during the fourth quarter. We continue to be very cautious about the economic outlook and plan to initiate additional reengineering efforts in the second quarter to help further reduce our operating costs. Our goal is to remain in a position to generate profits in excess of our dividend and be able to take competitive advantage of opportunities as the economy begins to rebound.
We have never disputed that the near-term outlook is grim and will remain grim for some time. But for American Express to be able to cover its dividend with current earnings when the business is going through one of the most difficult periods in company history is quite an achievement.
More importantly, as value investors, we know that successful investing is neither about fundamentals nor price. It is about connecting fundamentals to price in a way that allows investors to make a judgment on the risk-reward of a particular company as a long-term investment. In the case of American Express, the risk-reward remains exceedingly favorable.
Disclosure: No position.