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3 Things You Should Know Before Buying This Top Warren Buffett Stock

Motley Fool - Thu Aug 31, 6:20AM CDT

Berkshire Hathaway has owned many businesses over the years, but not many have been a mainstay in the conglomerate's portfolio quite like American Express(NYSE: AXP). The card payments business has been a holding for about three decades now.

It's not hard to see why Warren Buffett loves the stock, which Berkshire currently owns $24 billion of. This company has strong momentum on its side and a favorable operating model.

But before buying shares, here are three things investors need to know about this top Buffett stock.

1. Latest financial results

Despite worries about a recession and economic uncertainty on everyone's mind, American Express continues posting solid financial results. In the three-month period that ended June 30 (the second quarter of 2023), the company generated revenue (net of interest expense) of $15.1 billion, up 12% year over year. That followed a 22% gain in the first quarter of this year.

Digging deeper, net interest income soared 32%, unsurprising given actions taken by the central bank to tighten up monetary policy. But what might be surprising is that American Express is bringing on more Gen Z and millennial cardholders. This is notable because these customers have greater lifetime value to the company.

The leadership team is optimistic as we look toward the near term. They believe revenue and diluted earnings per share will rise 16% (at the midpoint) and 14% (at the midpoint), respectively, for the full year of 2023 compared to the prior year. That's certainly healthy growth potential that shareholders can get excited about.

Of course, there is a key risk to keep in mind. With the Federal Reserve aggressively hiking interest rates in the past 18 months, the possibility of an economic downturn is still on the table. And this could negatively impact a financial services business like American Express that lends money to customers. Default rates could climb even higher than they already have, leading to reduced profitability.

But perhaps no other investor out there knows more about bank stocks than Buffett, as he has a long career investing in lending institutions. So, I'm sure he understands the risks involved.

2. Unique business model

Like Bank of America or Capital One, American Express approves borrowers and issues credit cards. And like Visa and Mastercard, American Express also operates a payments network that connects all the various parties of a transaction. The result is a closed-loop network that captures a greater share of the economics every time a card is swiped. For what it's worth, Berkshire owns all four of these other stocks, so Buffett understands the details of their business models.

The company earned $8.5 billion in discount revenue in Q2, which represents the fees it charges to merchants to allow them to use the Amex network. By targeting a wealthier and more financially savvy customer, these merchants almost have no choice but to accept American Express cards at checkout.

Additionally, the company made $1.8 billion last quarter from net card fees, consisting of the annual dues that cardholders pay for the perks and benefits Amex offers. More affluent customers are drawn to these top-notch rewards, putting Amex in a favorable position.

3. Reasonable valuation

One important aspect of Buffett's analysis involves looking at the valuation. Currently, American Express trades at a trailing price-to-earnings (P/E) ratio of 16.2. That's a cheaper multiple than the stock's trailing three-, five-, and 10-year average valuations, as well as the S&P 500's P/E ratio of 20.2.

This means investors are being presented with a good opportunity to consider buying a wonderful and competitively advantaged company at an attractive price right now. I'm sure Buffett would agree with this.

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American Express is an advertising partner of The Ascent, a Motley Fool company. Bank of America is an advertising partner of The Ascent, a Motley Fool company. Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Bank of America, 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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