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American Express Company(AXP-N)

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Buy One of Warren Buffett's Favorite Stocks Before It's Too Late

Motley Fool - Tue Aug 22, 7:45AM CDT

Warren Buffett, the legendary investor, has some strong words to say about American Express: "I could do all kinds of things with hundreds of billions of dollars. But I can't put in the minds of people what is in their minds about American Express."

The Oracle of Omaha's company owns more than 20% of American Express(NYSE: AXP), making it the third-largest holding in Berkshire Hathaway's investment portfolio. Processing more $1.5 trillion in payments volume in 2022, American Express has been an economic mainstay in the U.S. for years and is the third-largest digital-payments network behind Visa and Mastercard.

But at a market capitalization of $118 billion, is there any room left for American Express to grow? Buffett famously bought his stake in the 1990s and hasn't touched the shares since. Don't get fooled by this large market cap. American Express is setting itself up to grow for years to come through its new two-pronged strategy of increasing merchant distribution and bringing on younger customers.

Here's why this makes now a perfect time to add the stock to your portfolio.

Increasing merchant distribution

Setting up credit cards and digital payments can be a difficult task for merchants. You aren't going to accept dozens and dozens of payment methods, which means you need to choose platforms that the majority of your customers can use. Otherwise, sales will be lost due to increased friction. That is why merchants almost always choose the big payment networks like Visa, Mastercard, and American Express for payment acceptance because it allows virtually every customer who walks through its doors (or visits its online store) to pay for things seamlessly.

Before Stephen Squeri became chief executive officer in 2018, American Express had lost some touch with its merchant base. Its cards were only accepted by about 85% of merchants in the U.S. -- its top market by payment volume -- causing frustration for its cardholders. Squeri fixed this issue quickly, and now American Express has a 99% merchant acceptance rate in the U.S., bringing it to virtual parity with Visa and Mastercard.

Squeri and the company now are investing heavily to increase American Express's distribution internationally. From 2017 to 2021, American Express increased its international merchant locations by 128% to 36.5 million. But there is still a long way to go. In 2021, only 17 of the company's 48 priority cities had 75% merchant acceptance. By 2024, management wants this number to double to 34 cities.

Growing merchant acceptance does two things for American Express. First, it should increase spending volume from current customers because they can now pay for more things with their American Express cards. Second -- and perhaps more importantly -- it makes American Express cards more valuable to prospective cardholders.

Acquiring younger customers

Squeri has also put intense focus on adding younger millennial and Gen Z customers who can age up with their credit cards. If you can acquire a customer in their 20s and keep them around for decades, that is a tremendous amount of lifetime value.

In each of the past six quarters, American Express has added at least 3 million new credit card accounts. According to management, about 60% of these new accounts are in the millennial age cohort or younger.

Durable growth at a reasonable price

By increasing distribution and acquiring younger customers, American Express believes it has created an engine for increasing its revenue by 10% or more annually from 2024 onward. Due to the rapid economic recovery coming out of the COVID-19 pandemic, 2023 revenue is expected to grow by 15% to 17% year over year.

With consistent share repurchases and operating leverage, company forecasts call for earnings per share (EPS) to compound at a mid-teens percentage annual rate, or about 15%. In 2023, the company expects EPS to hit at least $11. Today, American Express stock trades for about $160, giving it a forward price-to-earnings (P/E) ratio of 14.4 if this $11 EPS target is hit.

This seems like a cheap multiple for a business that expects to increase its per-share earnings by 10% or more a year, making now a perfect time to buy some American Express shares for your portfolio.

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American Express is an advertising partner of The Ascent, a Motley Fool company. Brett Schafer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Berkshire Hathaway, Mastercard, and Visa. The Motley Fool recommends the following options: long January 2025 $370 calls on Mastercard and short January 2025 $380 calls on Mastercard. The Motley Fool has a disclosure policy.

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