American Express (AXP) has long been a favorite holding of institutional investors such as Viking Global for its stability, long track record of success, and of course, its dividend growth. The company’s long-term track record of stable growth and regular dividend increases also make it an appealing stock for income investors.
The stock has underperformed in 2020, as the overwhelming majority of financials stocks have, but we see the current price as offering value for long-term holders and in particular, those looking for a safe, growing dividend.
American Express is a credit card issuer, primarily, but operates other smaller businesses as well. These include travel services, commercial services, and payments, but American Express is predominantly a credit card company.
It was founded in 1850, produces $36 billion in annual revenue, and trades today with a $93 billion market capitalization.
The company reported third quarter earnings on October 23rd, and while results showed material weakness year-over-year, revenue came in better than expected. Total revenue came to $8.7 billion, down 20% year-over-year, but slightly better than consensus. The decline was due to lower transaction volumes as consumers and businesses spent less in Q3 than the same period a year ago. However, this was a double-digit sequential improvement from Q2, so it appears American Express saw the bottom during that quarter.
Earnings were $1.30 per share in Q3, and again were down year-over-year, but up sequentially. American Express took $700 million in provisions for credit losses as well, building its reserves against what it believes may be significant losses in the coming quarters.
We expect $5.00 in earnings-per-share for this year, but in order to account for the coronavirus impact, we calculate fair value and valuation with earnings power of $8.00 per share.
American Express is exhibiting some of the same earnings traits as it did during the last recession, although this one is certainly shorter in duration. That bodes well for the company’s profits as it grew nicely coming out of the Great Recession. Indeed, American Express’ earnings growth rate from 2010 to 2019 was 10.5% annually, on average, which is quite strong for a large capitalization financial.
We expect consumer and business spending to drive revenue increases for American Express, which should drive deleveraging of operating costs, as it has in the past. This virtuous cycle of revenue growth and margin growth should see earnings-per-share expansion near our estimate of 7% annually in the coming years.
In addition, American Express has returned capital to shareholders in a big way in recent years, and we expect a meaningful level of share repurchases over time to reduce the float. While near-term visibility into share repurchases has been hampered by the transitory impacts of COVID-19, American Express has proven willing and able to boost earnings-per-share via a lower float over the years, and we don’t have reason to believe that will change.
American Express’ valuation has deteriorated significantly since late October, when shares traded for $90. Today, the stock is close to $116 after election results were made clear, and after a successful COVID-19 vaccine trial was announced.
Based upon our earnings power number of $8.00 per share, that puts American Express’ price-to-earnings ratio at 14.5, which is very close to our fair value estimate at 14 times earnings. We therefore see the valuation as having very little impact on total returns for buyers at today’s price.
The dividend payout ratio is just 22% of earnings power for this year, highlighting how safe the dividend is for American Express. This is a typical payout ratio for the company, as it chooses to use much of its capital returns on buybacks rather than a higher dividend. Still, over the last eight years, the company has boosted its dividend by an average of 10.5%, and we expect robust dividend growth for many years to come.
American Express has underperformed in 2020 due to external factors outside of its control, but for long-term holders, the stock looks fairly valued, its earnings have improved materially since the second quarter, and it appears to be back on its way to its pre-COVID-19 growth track.
In addition, we expect strong dividend growth in the years to come given earnings are holding up nicely during a very challenging period, and because the payout ratio is still quite low. With all of this, combined with our estimate of 7% annual earnings growth, we rate American Express a buy.
Bob Ciura has worked at Sure Dividend since October 2016. He oversees all content for Sure Dividend and its partner sites. Bob received a Bachelor’s degree in Finance from DePaul University, and an MBA with a concentration in Investments from the University of Notre Dame.
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