American Express Bull's Pen
by Paul Larson ([email protected])

I would venture that 99% of those reading this feature know exactly what American Express is. This speaks volumes about the brand strength the company has built over the years. In fact, it can be argued that American Express holds one of the highest-regarded brands in both travel and financial services. Not only is the brand a strong one that can be leveraged going forward, but the company is currently trading at a very reasonable valuation. For these reasons I find being anything but bullish on the company to be out of the question.

Let's take a peek at exactly where some of the company's strengths lie. Of course, the company is best known for "The Card" as well as its travel services. American Express pioneered the use of plastic as a way of paying for goods and services, and there's no reason to think the forward thinking at the company will not continue in the future. It's a great brand. End of story.

While clearly not holding the market share it once did, American Express' share of the credit card market is actually increasing for the first time in many moons. This is thanks largely to its Optima Card, which is geared towards the lower end of the credit card spectrum. The company's credit business is also an interesting play on the burgeoning e-commerce industry. All those purchases at Amazon.com have to be paid for in some fashion, and American Express is making its presence felt on the Internet more and more.

Meanwhile, the Department of Justice case against Visa and MasterCard is of extreme interest to those who own American Express. Justice has filed a civil lawsuit charging that both Visa and MasterCard have violated Section 1 of the Sherman Antitrust Act. The official complaint questions the "duality" of the credit card industry (read: lack of fair competition) and the bylaws of Visa and MasterCard that, according to the filing, "Prevent member banks from issuing competing cards, such as that offered by American Express." Essentially, banks that offer Visa cards are now prohibited by Visa from also offering American Express Cards.

Certainly I'm no lawyer, but it appears to me that Visa is more likely to be guilty than not. Speaking of which, similar lawsuits in Europe have not fallen Visa's way, and American Express can only stand to benefit from having the government in its corner. If the complaint is found to be legitimate down the road, you can bet that there will be literally hundreds of banks clamoring to offer their own version of The Card. And if that happens, those holding American Express are likely to be very happy.

Nevertheless, American Express is not just a credit card company; it is a complete travel and financial services powerhouse. The company does everything from 401(k) plans to student loans to booking corporate business trips. Having such a diverse (and well-branded) line of products and services does serve to mitigate some of the risk the company faces.

An investor buying American Express doesn't only get a true leader in the industry; right now the stock also isn't very expensive compared to some of the other blue chips in the market. One look at the company's historical financial results shows an amazing consistency in revenues and earnings. The profits have been steady in magnitude and in growth. Not many other companies can claim such a smooth path of expansion in their financial results.

Not only have the company's past profits been steady and consistent, but analysts are also expecting the growth to continue for the foreseeable future. The current earnings estimate calls for AMEX to earn $5.39 per share in 1999, which would put the stock at well under 20x forward earnings at the time this was written. Considering this is a below-average multiple for an above-average quality company, I certainly think American Express could be attractive here.

The company's executives must also think the stock is relatively cheap since they have been extremely active in repurchasing the company's shares. Share buybacks, when done properly, definitely increase shareholder value.

American Express's sustainable growth is also quite positive. The company's return on equity stands north of 20% (22% in the last twelve months), and its return on investment sits at a healthy 12%. With interest rates and therefore the company's cost of capital dropping recently, this means the spread between what the company pays for its assets and what it can return will get that much more positive.

Dropping interest rates not only helps stocks across the board, but lower rates especially help companies in the financial services arena. Banks and credit card companies are spread-management businesses. And when their "cost of goods" (interest rates) drop, their spreads tend to increase with little to no incremental cost.

Furthermore, users of American Express tend to be higher net-worth than those using other credit cards. If viewed as a bank, you could say that the company's "loan portfolio" is much healthier than its competition. That's to say that the average American Express customer is less likely to get hurt from a slowing economy than those of its competition are. The average charge is 44% higher on an American Express card than the average charge on other credit cards. Of further note is that 21% of all American Express customers only carry the American Express card. Additionally, 70% of all Fortune 500 companies use American Express for all their corporate expenses. I did mention the power of the American Express brand, didn't I?

Last but not least, it's worth mentioning that Warren Buffett owns a significant chunk of the company, about 10% at last tally, and I'm not one to second-guess THE MAN. As a Fool, I tend to be a very independent thinker, but I find it hard not to respect Buffett's position in owning the company. While I normally come to investment conclusions on my own, Buffett's de facto recommendation carries a lot of weight in my book.

I can't wait to read Bill's bearish argument. Maybe I'm missing something here, but American Express sure looks like a solid company and a good value at these levels.

Next: The Bear Argument