American Express is one of Berkshire Hathaway's top holdings.
It's clear Warren Buffett and his team at Berkshire Hathaway (BRK.A -0.69%) (BRK.B -0.49%) love credit card companies. Their business model is strong, as they take a slice of each transaction processed. This toll booth model is sustainable if you provide a vital product, which credit cards have become.
Of the four major credit card issuers in the U.S., Berkshire owns shares of three of them. But which is his favorite?
American Express has several qualities Berkshire looks for in an investment
While Berkshire owns shares of Visa (V 0.50%) and Mastercard (MA 0.80%), its positions are relatively small at 0.6% and 0.4% of its assets, respectively. It doesn't own any shares of Discover Financial (DFS 0.45%), which leaves American Express (AXP 0.38%) as the last remaining company.
But oh, does Berkshire love American Express. American Express is Berkshire's third-largest holding, constituting 6.7% of total portfolio assets. The size of its stake also means it owns nearly 21% of American Express, making Berkshire a principal shareholder (because it owns more than 10% of the company).
So why do Buffett and Berkshire prefer American Express over much larger rivals Visa and Mastercard? It has to do with the fundamental makeup of the business.
Unlike Visa and Mastercard, which issue cards and provide payment infrastructure to clients, American Express is also a bank and holds onto the debt behind its cards. This gives it a different revenue stream than just processing transactions, which, if done properly, can also be more profitable. Buffett also is a big fan of American Express's brand power, which he considers a vital part of investing in a company.
But if American Express didn't execute at a high level, Berkshire wouldn't consider owning it. And after American Express's latest quarterly results, I wouldn't be surprised if the company purchases more shares.
American Express's Q3 was one of its best ever
In Q3, American Express's revenue rose a respectable 13%, but its net income soared 30% to $2.45 billion. With American Express also buying back a fair amount of shares year over year (2%), this helped its earnings per share (EPS) increase at a rate of 34%. Both revenue and EPS were quarterly records for the company, which means the company has never been executing at this level before.
It's also seeing strong momentum in younger generations, with Millennial and Gen Z customers making up its fastest-growing consumer groups. This group's U.S. spending was up 18% year over year, compared to a 9% spending increase across all U.S. members. This trend is critical, as American Express must continue to do well with the younger generation to stay relevant.
Because American Express manages its own lending services, credit losses are another item to watch. But with write-offs and delinquency rates below pre-pandemic levels, American Express isn't seeing outsized losses. Still, it's increasing its loan loss reserves just in case this trend reverses.
It's those conservative qualities with strong execution that make American Express a Buffett pick. But its cheap valuation is another consideration. Despite the company's success, American Express still trades near its recent low valuation.
Data source: YCharts
With the S&P 500 trading at 25 times earnings, it's cheaper than the market as a whole.
American Express stock looks like a fantastic value with a bright future ahead. Its execution has been top notch, and the stock can be purchased for well below the market average. To sweeten the deal even more, American Express has a 1.6% dividend yield.
While American Express may be Buffett's favorite credit card stock, I don't own any shares. However, because of American Express's execution, I could see myself becoming a shareholder soon.
American Express is an advertising partner of The Ascent, a Motley Fool company. Discover Financial Services is an advertising partner of The Ascent, a Motley Fool company. Keithen Drury has positions in Mastercard and Visa. The Motley Fool has positions in and recommends Berkshire Hathaway, Mastercard, and Visa. The Motley Fool recommends Discover Financial Services and 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.
