American Express: No Growth, No Problem

| About: American Express (AXP)


American Express has had a solid investment and business history.

As of late the company's earnings growth rate has begun to slow.

This article looks at what a "no growth' scenario could look like.

On January 22nd of 2016, shares of American Express (NYSE:AXP) fell 12% to $55 per share. This came after announcing full year earnings-per-share of just over $5 (a 9% decline from the previous year) along with guidance for the upcoming years. For 2016 the company expects to earn between $5.40 and $5.70 per share, and for 2017 the company is now targeting $5.60 per share. As compared to the American Express' double-digit earnings growth rate over the past decade, this looks like reasonably poor news. And indeed, the share price reflects this now lower growth expectation.

What's interesting about this sort of situation is that it now makes the "investment bar" much lower. That is, as the share price declines materially, an investment thesis becomes easier and easier to formulate. American Express doesn't need much (or perhaps any) company-wide growth to turn in reasonable results. From there, if a bit of growth does come about, the security could turn into a solid investment rather quickly.

I'll work through an example to illustrate what I mean. Instead of thinking about a low growth situation, let's bake in some prudence and see what "no growth" would look like. Last year the company earned just under $5.2 billion, with just over 1 billion shares outstanding. In order to meet $5.40 to $5.70 in earnings-per-share next year you'd need a bit of growth or strong share repurchases, but we'll ignore management's expectations for now. Instead, let's take a look at what no growth whatsoever would look like over the next decade.

A few assumptions are needed, but we'll keep it basic. Over the past decade American Express has paid out 60% or so of its earnings in the form of dividends and share repurchases, with repurchases making up nearly twice the amount as common dividends. We'll use something close to these numbers moving forward: 23% for dividends (as to not decrease the current per share number) and just over 40% for share repurchases. The idea isn't to predict this perfectly, instead it's about getting an idea for what a reasonably poor scenario could look like. Here's what that would indicate (in millions) over a 10-year period:

That still leaves $1.9 billion for paying down debt, growth projects, etc. You have the exact same profit expectation for every year, to go along with a constant amount of capital allocated for dividends and share repurchases. This is your "no growth" scenario. By the way, the company has spent an average of over $3 billion per year during the last four years on share repurchases alone, so this certainly isn't overly optimistic.

In addition, you need to come up with some share price assumptions along the way. We'll keep it simple, shares currently trade around 11 times earnings and we'll keep this assumption throughout. Here's what the earnings-per-share and dividend payments could look like in this situation:

This is an interesting result. You had total profits, dividends and share repurchases remain at the same level - stagnating for the next 10 years. Yet at the same time, the share count would be decreasing resulting in EPS and dividend per share growth of nearly 4% per year.

In total you would expect to collect $14 or so in dividend payments to go along with an $80 share price. This equates to a total annualized return of about 5.5% per year. A $10,000 starting investment could still be worth $17,000 a decade later. Think about that. If American Express the business doesn't grow at all, investors could still stand to collect a 5% to 6% annual gain. This sort of thing is rarely mentioned when talking about how a company's growth story is "over." A lower valuation and substantial share repurchases can provide reasonable returns even if the business isn't growing.

Of course some might point to the assumed P/E ratio of 11 and suggest that this is far too low. The company's historical mark over the last decade has been closer to 16, and this lower hypothetical value allows the company to retire more shares. Fair enough. However, it's important to realize that this simultaneously implies a higher ending share price. For instance, if you instead used a P/E ratio of 14 throughout you would indeed retire fewer shares, but your total annualized gain would jump up to 7% over the period. Reasonable returns hold with a wide range of possible share prices, given a steady and solid share repurchase program.

In short, American Express has had a very strong investment and business history over the past decade or so. Recently the company has begun to stagnant, leading to a much lower share price. However, this might not be as large of an issue as you first imagine. Even if the company continues to make the same amount of profits for the next decade, investors could still see 4% to 7% annualized gains. From there, if a bit of growth does formulate, more capital is returned to shareholders or you see a higher earnings multiple, the returns can turn to solid rather quickly.

Disclosure: I/we 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.