Why Buffett Is Sticking With American Express

Jun.17.13 | About: American Express (AXP)

It's no secret that Warren Buffett is one of the best investors of all time, and it's also no secret that Buffett has been increasing his share count in American Express (NYSE:AXP). Buffett has built his holding up to around 10% of American Express through his holding company Berkshire Hathaway (BRK.A, BRK.B). Buffett has owned the stock since 1991.

Why Does Buffett Like AXP?

The primary reasons why Buffett likes AXP? He sees it as an undervalued stock with room to grow, a stable dividend, and knows American Express as an excellent brand power with customer loyalty. Buffett has been quoted as saying American Express is "synonymous with financial integrity and money substitutes around the world."

Buffett sees the opportunity, and believes that any minor setbacks are simply buying opportunities of what is a great long term hold. Any losses in market share are to be justified by a loyal customer base that enjoys using their Amex card. Two of their key strengths are superior customer service, and excellent rewards for using their cards. Although there are critics who state that the prestige of using an American Express card is weakening, Buffett is betting against those naysayers.

Why You Should Like it:

1.) Increased Consumer Spending- As the economy continues to improve, consumer spending is sure to increase. Amex naturally makes money both on interest paid on purchases by the consumer, as well as with a fee charged to the business or vendor who is accepting the payment. Profit margins for Amex have grown from around 9%, to as high as 16% more recently.

2.) Cost Cutting and Excellent Management- American Express has done a great job at cutting costs, resulting in a better bottom line. Management has also done an excellent job combating market share losses by increasing innovation and developing new ExpressPay swipe free purchasing at large companies such as CVS (NYSE:CVS) and McDonald's (NYSE:MCD).

3.) Brand- There is a certain level of pride in using an Amex card to pay for something, and that prestige is something that many people enjoy and aspire for. Both Businessweek and Fortune magazines have ranked American Express as one of the most valuable and well respected brands in the world.

4.) Financials- Financially speaking American Express seems to be very fairly valued right now at around $70 a share. American Express is priced just shy of its all time high, but is trading at around 15 times earnings, which is typical based on historical price to earnings ratios for the stock. AXP's PEG is currently around .86, which means it is currently trading at a multiple less than its growth rate. With a historically accurate P/E, and a PEG less than one, the 1.3% dividend is just an added bonus to this fairly valued company.

Potential Downsides:

The stock has run up quite a bit since the Buffett news, which always poses a risk. It is always difficult to buy a stock that has run up so much, in fear of potentially buying at the top. The stock has risen about 27% year to date, versus just 14% of the S&P. Additionally; there is always the risk of a setback and poor economic conditions, which would lead to lower spending, and to increasing defaults. Fortunately, American Express' customers tend to have higher credit scores than the average consumer, which is good for keeping loan loses down.

Conclusion:

Overall, American Express is a solid company, with excellent long term appreciation potential. In addition to their growth potential, American express has always been a very shareholder friendly company. Management has repurchased 13 million shares in the first quarter of 2013, and share buybacks should continue. With a fair valuation, a solid dividend, and excellent appreciation potential, American Express is a great portfolio holding for a long term investment.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.