We continue our series looking into each of the stocks in the Dow Jones Industrial Index by examining if now is the right time to buy the legendary American Express Company (NYSE:AXP).
AXP has gone way beyond just being a credit card company. It is a multi-layered, multi-product financial services company that serves consumer and businesses, alike.
Obviously, American Express charge and credit card products are what the company is known for and for good reason. As its 10-K says, about 118 million of its cards are circulating and in 2015 it generated — sit down — just over a trillion dollars in charged purchases.
The Backbone of American Express Stock
There are other elements to AXP, not all of which are of interest to every cardholder, but are of enough interest to elevate American Express into a different plane. There are merchant acquisition and processing services, expense management services, POS, cash servicing and settlement products, both business and consumer travel services, the stored value cards that almost every company must have nowadays and thanks to all the data it naturally collects, it provides market and trend information.
Indeed, most of American Express stock’s revenues are the result of charge card services and cardmember loans. When referring to charge card services, I refer to the fact that American Express makes money on the transaction fees that they hit merchants with on every swipe.
AXP stock is a consumption-linked business. Thus, if the economy stinks, and consumers aren’t consuming, that can harm the overall American Express business. Provided that default rates don’t get too high, it does benefit from rising consumer debt levels — a trend that picked up a couple of years ago.
American Express stock is also a bit of an odd duck because, as a financial services company, it is difficult to value on a traditional basis. It’s easier to compare it to competitors to get a sense of relative value. That’s because the “discount revenue rate”, which is the percentage fee AXP gets from each swipe can fluctuate by a few basis points from quarter to quarter. In addition, the size of transactions is always going to vary.
AXP stock has robust financials. Rather than carry debt, American Express basically just has to pay vendors and the companies that it is floating consumer purchases on behalf of. Together, this comes to about $62 billion.
The good news is that it has $26 billion alone in cash, and $62 billion in receivables from consumers, so there’s plenty of cushion. In addition, American Express is a fantastic cash flow machine. Operational cash flow is just under $11 billion, and with only $1.3 billion in capital expendeture, it has over 9x what is necessary to pay the dividend.
Bottom Line on AXP Stock
However, AXP has been running into headwinds, lately. Competition is a real problem. Losing the Costco Wholesale Corporation (NASDAQ:COST) business was a huge blow to American Express stock. Thus, analysts looking out five years on AXP see annualized earnings growth at 6.7%. This is distressing for a world-class company, but it isn’t entirely surprising, either. All the big “blue-chip” stocks have been struggling to grow earnings organically.
At a stock price of $67, on FY 2016 earnings of $5.74, American Express stock presently trades at a price-to-earnings ratio of 12. However, Mastercard Inc (NYSE:MA) trades at a 26x, Visa Inc (NYSE:V) at a 28 P/E, and Discover Financial Services (NYSE:DFS) at a mere 11x. Given this, plus its 1.92% yield, along with its anemic growth rate, I feel AXP stock is pricey but not outrageously so.
When I add 1.92% yield to 6.7% growth, I get 8.6%. I add a 10% premium each for its free cash flow and brand name, so I could justify American Express stock at a 10x P/E ratio. If AXP stock fell about 20%, then it seems like it would be a buy.
Lawrence Meyers is the CEO of PDL Capital, and manager of the forthcoming Liberty Portfolio stock newsletter. As of this writing, he has no position in any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
