Title: Parsing Warren Buffett's Preference: Visa vs. American Express
Witnessing Warren Buffett's investment ventures, it's no secret that he holds a soft spot for American Express (AXP -0.40%). This stock has been a staple in the Berkshire Hathaway portfolio for an impressive 30 years, and today, it occupies the second-largest position behind Apple, representing 15.2% of the portfolio. In truth, Berkshire Hathaway possesses an enormous 21.5% stake in American Express' outstanding shares, showcasing Buffett's unwavering faith in the company.
Buffett has always had a penchant for financial stocks. He's an ardent advocate of companies with a substantial influence on the economy, and financial infrastructure certainly fits that criteria. More specifically, he's a fan of bank stocks, as they boast considerable cash reserves, ensuring the economy works smoothly, and they frequently provide dividends, which is a testament to their commitment to shareholders.
On the other hand, despite Visa's status as the global leader in credit card networks, it makes up just 0.9% of Berkshire Hathaway's portfolio. Nonetheless, it's important to note that Berkshire Hathaway owns 8.6% of Visa stock.
So there you have it – a dilemma, pitting Visa against American Express, each solid choices in their own right.
Dissecting the Differences
To the untrained eye, Visa and American Express might as well be the same entity, both being prominent entities in the world of credit cards. However, their unique business models set them apart in meaningful ways. Visa operates as a credit card network, brokering the financial transactions between customers, financial institutions, and merchants. The banking partners are responsible for supplying the credit, which is then moved through Visa's system.
American Express however, takes a different route entirely. Instead of relying on credit partners, the company operates as its own bank, employing a "closed loop" model. This means it offers credit directly to customers and holds deposits, giving it a broad range of services that extend beyond the credit card sector, including personal accounts and robust business offerings.
These variances are reflected in their market shares, with American Express owning a significantly smaller cardmember base compared to Visa, with only about 150 million cards in circulation.
Profitability Paradox
Although American Express has a smaller cardmember base, it excels in other areas to generate almost double Visa's total sales. The trick lies in American Express' targeted clientele, primarily affluent and resilient customers who have the financial means to spend more than the average consumer. Moreover, American Express generates additional revenue by charging annual fees for many of its cards and offering a rich rewards program for members paying these fees.
On the other hand, Visa boasts unmatched profit margins because it doesn't carry the same level of credit risk as American Express, as it only serves as a conduit for financial transactions, incurring no additional expenses with each transaction. As a result, Visa generates incremental profits with minimal cost escalations.
Wins in the Past and Future
Historically speaking, Visa has been the more lucrative investment, although American Express has gained significant traction over the years, particularly in recent times. American Express now boasts a younger and more resilient customer base, allowing it to thrive in the face of economic volatility.
Weighing the Buffett Pick
Without a doubt, both American Express and Visa have compelling cases to make as investment opportunities. However, it's clear that Buffett strongly favors American Express, frequently expressing his admiration for the company. As a shareholder of American Express, I'm inclined to agree with him. American Express' broader business focus, coupled with its premium customer base and attractive product offerings, makes it an appealing long-term investment choice, as evidenced by Buffett's unwavering support.
Insights (15%):
- Revenue and Earnings Growth: American Express demonstrated strong revenue growth of 9% and EPS growth of 28% for the nine months ending September 30, 2024, compared to the prior year. This was achieved through the company's focus on premium products, effective risk management, and low write-off rates, which maintained strong credit quality even during challenging economic periods.
- Operational Efficiency and Leverage: American Express benefits from operating leverage, enabling it to generate significant earnings growth with relatively small increases in revenue due to fixed expenses being spread across a larger revenue base. The company's ability to maintain strong margins despite slower revenue growth contributed to its profitability.
- Credit Performance and Fee Revenue: American Express reported an 18% increase in card fee revenue and a 17% leap in net interest income in the third quarter of 2024, fueling its earnings growth. Its solid credit performance with low write-off rates further boosted its profitability.
- Valuation and Growth Momentum: American Express shares had a current P/E ratio of 22 and a forward P/E of 20 in Q3 2024, lower than the market index's average P/E ratio of about 25. This indicated that the stock was reasonably priced given its growth momentum, making it an attractive long-term investment.
- Strategic Focus on Premium Products and Younger Consumers: American Express targets premium customers and has seen robust growth among younger demographics, such as Millennials and Gen-Z. The company's product refresh strategy and expansion into the dining sector have contributed to its financial success.
These factors explain why American Express has outperformed Visa in profitability, despite having a smaller cardmember base. Buffett's investment strategy and continued confidence in American Express reflect his belief in the company's growth potential, making it an enticing choice for long-term investors.
Buffett's investment decisions often lean towards companies with a strong influence on the economy, and he views financial infrastructure as a crucial component. Given his affinity for bank stocks, it's not surprising that he's also keen on investing in money management or financial services companies, like American Express.
Having a diversified investment portfolio is key to achieving stable returns. With this in mind, investors might consider diversifying their money by exploring various investment avenues, including companies that specialize in finance, investing, and managing money, like American Express.
