Should American Express Be in Your Portfolio?

Justin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Consumer spending took a hit when the recession took hold in 2007-2008. Since then, however, consumer spending in the United States has been making a slow but steady recovery:

source: St Louis Fed  

At the same time, the estimated usage of cash is expected to decline.

What does this mean? It means we - the consumer - are swiping our cards again, and more often as time goes on! I suppose you might want to own a company to benefit from this macro-economic trend. You want to own a credit card company, but which one? Ladies and gentlemen, I present to you American Express (NYSE: AXP).

Brand power is the strongest kind

The first and foremost strength of American Express is the established brand power it possesses. American Express is ranked by numerous business magazines and surveys as one of the world's most valuable and respected brands. It is also ranked at the top in customer satisfaction according to J.D. Power & Associates. You can ask any customer about their Amex Card, and you will likely have to hear them gush about the rewards system, customer service, and "warm feeling" when using their Amex.

Being picky can offer protection

Credit card companies are at risk of default when doing business. When a customer doesn't pay the credit card bill, that company takes a loss on that customer. American Express helps to hedge against that risk in the segment of the market it goes after. American Express requires a higher credit score than the competition in order to qualify for its credit cards. It also tends to market towards the higher end consumer with more disposable income. This strategy helps limit losses due to customer default.

Oracle backed

American Express is a favorite of famous investor Warren Buffett. Buffett' Berkshire Hathaway currently owns about 13% of the company, making it the company's 4th largest holding. While everyone should do their own due diligence when investing, it is an added bonus to be backed by the Oracle of Omaha.

On a roll

With the economy starting to rebound, it is encouraging that American Express had a strong 2013 Q1 and holds a positive outlook. Sifting through the Q1 report will highlight:

  • Diluted EPS increase of 7% from this quarter last year.
  • Card member spending growth of 6%.
  • $3.2 billion in share buy backs during remainder of 2013.
  • 15% dividend increase.
  • Company-wide credit indicators remain at a high level.
  • Continued customer loyalty through growth in card membership fees.

American Express also remains focused on controlling expenses through aggressive cost control structuring to keep the balance sheet in order.

The competition

Capital One (NYSE: COF) is one of the main competitors American Express faces. Capital One also stacks up well with American Express. Its debt/equity ratio of 0.9 is a bit lower than that of American Express. It also pays a higher dividend. Not only that, but Capital One is currently trading at a price to cash flow ratio of 7.2x vs 15.4x for American Express. 

Capital One doesn't target customers with quite as high credit score. This leads to a slightly higher delinquency rate than that of American Express. Capital One offers very strong competition for American Express, and due to current valuations of each - may actually be a better value in the short term.

Discover (NYSE: DFS) is another competitor that American Express must face. Discover has come on strong of late. Previously a part of Morgan Stanley until just before the recession, it has been expanding its programs, planning to begin offering home equity loans as its push into direct banking has helped shore up its balance sheet.

Discover has also brought down its delinquency rate as it was forced to tighten on customer credit during the recession. Its acquisition of Diners Club in 2008 from Citigroup has kick started its expansion into international markets. While American Express has the brand power now, Discover is taking steps to make those much needed strides over the long term.

An unparalleled advantage

With all this in mind, this brings us to a company that may end up rising above them all. Visa (NYSE: V) just recently announced a very good quarter. Revenue jumped 17% from a year ago, and earnings beat estimates by $0.09 a share. Management has maintained its forecast throughout the rest of the year.

You have to also consider Visa's sparking fundamentals. Visa has a 5 year sales growth rate of 23.76%, while it carries essentially no debt with a total debt to equity of 0.0. It has raised its dividend every year, and currently yields 0.68% on recent share prices. Visa is doing this while paying out only 13.8% of its earnings as dividends.

While the credit card sector as a whole has really excelled in the last year, Visa's immunity to consumer credit risk combined with its clean balance sheet put it in perhaps the best position to reward shareholders long term. Visa also has the easiest path to international growth as a payment processing company. The Visa name is on various card makers, while American Express, Capital One, etc. are motsly limited to its own brands.

Bottom line:

With society slowly moving towards plastic, credit card and financial service companies are poised to prosper over the long term. These companies have tightened up on who they lend to, and are now starting to reap some benefits. American Express is the top name among lenders, but don't sleep on Capital One and Discover. However, given the lack of a credit risk and less debt, Visa may make the best choice of all in the long term.

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Justin Pope has no position in any stocks mentioned. The Motley Fool recommends American Express and Visa. Try any of our Foolish newsletter services free for 30 days. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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