One of Buffett's Favorite "Forever Stocks" Just Announced ANOTHER Dividend Increase...

Ryan Fuhrmann's picture

Thursday, April 12, 2012 - 1:00pm

by Ryan Fuhrmann

In the 1994 investment classic The Warren Buffett Way, author Robert Hagstrom delves into great detail on the stocks that catapulted Buffett's fortune into what it is today. In the chapter describing Berkshire Hathaway's primary holdings, he quotes Buffett as saying "I find that a long-term familiarity with a company and its products is often helpful in evaluating it."

Familiarity, coupled with a great business that does nothing but grow, are two of Buffett's most important investment philosophies.

A holding period that for all effective purposes is "forever," is another of his cornerstones. At StreetAuthority, we refer to such stock holdings as "Forever Stocks," and it's little coincidence that many of the Forever Stocks we recommend happen to be in Buffett's wheelhouse.

In Hagstrom's book, he discusses Berkshire holdings such as Coca Cola (NYSE: KO), GEICO, The Washington Post Co. (NYSE: WPO) and American Express (NYSE: AXP). Nearly 20 years after the writing of the book, it's little surprise that Buffett still holds all of these names. He details that Buffett first owned American Express back in the 1960s, when he ran Buffett Limited Partnership the precursor to Berkshire Hathaway (NYSE: BRK-B).

Today, Berkshire owns a staggering 13% of American Express. Its original cost basis on the 152 million shares is owns is about $1.3 billion. At the end of 2011, it sported a market value of $7.2 billion. It counts as the largest percentage ownership stake in Berkshire's investment portfolio of publicly-traded companies.

Clearly, Buffett has little intention of selling American Express. Its namesake credit cards continue to hold high brand recognition among wealthier consumers around the globe who spend freely and generally pay off their balance every month. This helps the firm avoid bad debt risk that most other rivals, such as Capital One Financial (NYSE: COF), must deal with.

Retailers will do nearly anything to accept the American Express card, which gives them access to a higher-end consumer base. This includes paying a higher fee to accept American Express Cards. Amex plastic charges were recently pegged in one study at a 34% premium to the 1.6% fee per transaction that market leader Visa (NYSE: V) charges retailers.

A well-respected brand such as Amex can be quite profitable. Last year, American Express logged profits of nearly $5 billion on sales of $30 billion. This is an impressive net profit margin of close to 17% that leads the industry average of less than 16%.

Returning to the growth equation, sales growth over the past decade has been more pedestrian at less than 4% annually (the credit crisis has a lot to do with this), but profit growth has been solid, at more than 15% annually. Bad debts did rise dramatically during the Great Recession, but snapped back even more dramatically since. Net write-offs per average loan are close to 5%, but rivals have much higher rates. For example, Citigroup wrote off more than 8% of its loans recently and saw a peak above 11% during the financial crisis. Amex's write-off rate remained in the single digits at the worst of the downturn.

The latest piece of good news out of American Express came in the form of moves to boost shareholder returns. In late March, it announced an 11% increase in its dividend as well as plans to repurchase 150 million shares. The dividend increase was the first since 2007, just before the credit crisis. It will boost the quarterly payout to $0.20 per share, up from $0.18 per share.

The dividend yield will now be 1.4%, or right around the industry average. Investors familiar with Buffett know he focuses on overall company growth, rather than solely on dividends. And as the world moves away from cash payments and adopts plastic, Amex's premium brand recognition is likely to attract more high-end customers from developing economies. This should lead to further growth in sales, profits and dividends over the long-run. Share buybacks help too, as they help boost per-share earnings over time.

Risks to Consider: Shares of American Express are currently bumping up against their highs over the past year. A quick run-up so far this year could mean the stock stops to take a breather, but future growth is what is most important for investors. In fact, Buffett has established several positions in stocks trading at their highs because he expects continued strong growth in the years to come.

Action to Take --> American Express currently trades at a forward P/E ratio of about 13.4. This is still quite reasonable in light of the recent run in the stock. And by reasonable, I mean that the multiple is still about 10% shy of its average valuation over the past five years. It is also well below the market average of 15.5 and the industry average of 14.8. Given American Express' easy-to-understand business model and stellar track record that has spanned many decades now, it should easily trade at a premium to the market and its key rivals. In other words, despite a strong recent run, it should still warrant consideration as a Forever Stock in many investor portfolios.

Ryan Fuhrmann does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.