If you followed along in watching day-to-day or month-to-month stock price bids, you might be aware of what has happened to American Express (NYSE:AXP) lately. I'll keep it concise: the share price is down materially in the last few years. And for a lot of investors this appears to be awful news. You look at a stock chart and see a free-falling black squiggling line; the world must be ending for that business.
Yet I find that it's useful to keep a level head in these types of situations. Not all falling prices are bargains. Not all businesses will have a comeback. However, a much lower share price without a commensurate decline in the long-term economics of the business can often provide an opportunity.
Let's look at a few examples with American Express in particular to demonstrate what I mean. This isn't the first time that shares have declined so forcibly in such a short amount of time. We have a bit of precedent here.
2000 - 2001
By the third quarter of 2000 shares of American Express were trading over $60 per share. Incidentally, this wasn't necessarily a ridiculous proposition given the valuations being thrown around for hundreds of other companies at the time. Leading up to 2000 American Express was growing earnings-per-share nicely: $1.40 in 1997, $1.60 in 1998, $1.80 in 1999 and $2.10 in 2000. I used round numbers, but you get the idea. At just over $60 per share, that equates to a P/E ratio of about 30 in 2000.
And then the recession came. Earnings-per-share of over $2 per share in 2000 quickly declined to about $1 per share in 2001. In turn, the share price also declined dramatically: from over $60 to under $30.
Now from a short-term prospective this makes some sense: the year-over-year business results were cut in half and the share price followed suit. Yet the long-term earnings machine of the company was still intact. If you were looking at it from a long-term prospective, the question you had to ask yourself was this: "the share price is now 50% lower, are the long-term business prospects also 50% worse off?"
If you could have answered "no" to that second part, it could have been an opportune time to increase your partnership stake with the business. Indeed, the earnings-per-share would bounce back to over $2 in the very next year.
Had you purchased shares under $30 back in 2001, today that investment would have compounded by about 5.5% per annum. This doesn't sound all that impressive, and really its not, but remember that today's share price is also much lower than it was. Had you measured from 2001 through 2014, your annualized gain would have been closer to 10% - turning a $10,000 starting investment into $35,000 or thereabouts.
So that's one example of when shares of American Express halved previously. Granted the business is a bit different now, but it provides some context nonetheless. Let's look at another illustration.
2007 - 2008
Anyone can cherry pick March of 2009 and demonstrate how great your returns would have been had you only timed things perfectly. Assuredly some did, but that's not exactly where I'd like to draw your attention. By the middle of 2007, shares of American Express were trading hands around $65 per share. Towards the end of 2008 shares of the company could have been purchased under $30 per share again.
Now once again you had the same pattern. Earnings-per-share were solid leading up to 2007: $2.40 in 2005, $2.90 in 2006 and $3.40 in 2007. Then in 2008 and 2009 you had earnings decline to $2.50 and $1.50 per share. From a short-term business prospective, earnings were 50% worse off. Yet from a long-term prospective, the underlying earnings machine remained intact.
By 2010 American Express would earn over $3 per share once again and go on to earn over $4 and $5 per share in the next few years. Had you purchased shares at "half price" in late 2008, you would have been a little early. You would have seen the share price decline to $20 and $15 and even $10, before steadily climbing back to $30 in late 2009 and never looking back. People like to think of investing as a nice, linear process but there are real tests out there that can cause even the most seasoned investor trepidation.
Yet had you bought shares just under $30 per share and held on through the much lower share price (whereby some enterprising investor could once more buy at "half price" from your cost basis) your returns today would be quite satisfactory. Your gain would be about 11% per annum measured from 2008 through today, although keep in mind today's much lower share price. From 2008 through 2014, your returns could have been over 20% per year.
2015 - Today
Which brings us to today. At the start of 2015 shares of American Express were trading around $93. As of February 16th 2016, this number was closer to $53. Not quite a 50% decline (closer to 43%) but still a sizable drop in a short amount of time.
And assuredly there are concerns for the business. You have the loss of exclusive partners, ongoing and innovative payment solutions and naturally large and menacing competitors in the industry.
Yet I'd contend you have to ask yourself the same basic question: "the share price is now 43% lower, are the long-term economics of the business also 43% worse off?" Expressed differently, "could there be a disconnect between the short-term share price and the long-term earnings machine of the business?"
Interestingly, this time around you don't yet have the short-term earnings decline as we have seen in the two previous instances. Granted this could certainly come about, but for the moment the company is suggesting that earnings-per-share will be effectively flat in the coming years. So already we could be off to a better start.
Moreover, even if the company were to earn the same amount of profit for the next decade this does not simultaneously indicate that shareholders will see no benefit. In a "no growth" scenario on a company-wide basis investors could still expect 5% to 6% annual gains on the shareholder level.
Obviously if you suspect that the business is in material decline you would not be interested in partnering with the company. Yet at the very least I'd contend that a much lower share price has also lowered the "investment bar." American Express doesn't have to perform spectacularly for shareholders to do well.
In short, American Express has provided reasonable results over the years, but this doesn't always mean that it's a linear or constant process. Indeed, there have been three separate occasions in the last 15 years where the share price declined materially in a short amount time. The past two times it happened, an investment turned in reasonable to exceptional performance. The third time is occurring presently. It should be interesting to see how the business and investment perform in the coming years.
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.