We can’t speak for everyone but we’re going to go out on a limb and say approximately 90% of you make the majority of your purchases using a credit card.
Are we right or are we wrong?
Well, 2008 was the first year the dollar volume of payments with plastic cards exceeded those of cash and checks. Paper money is on its way out, and plastic is on its way in.
One Of The Easiest Businesses In The World
When we go to the counter to pay for our goods or services most consumers pay with a credit card. If you pay with an American Express credit card, then for every $1 you spend, the merchant keeps 97.5 cents and sends 2.5 cents to American Express. You would think because it’s a “fee” the 2.5% charge is added onto the cost of the problem but it is not. It’s discounted from the amount you spend.
Essentially, American express charges businesses 2.5% of their sales to be a part of their network. And AMEX has done a fantastic job of building their network!
Who is American Express’s network some of you may ask?
It’s you the cardholder!
Amex offers some of the most well-known and loved rewards programs. For the majority of their cards you receive one point for every dollar you spend. These points can be redeemed around the world in the form of hotel stays, flights, rental cards, and all kinds of other experiences.
And in exchange for these programs, cardholders gladly continue to use their credit cards when making transactions.
Without getting too technical, American express ultimately created an exclusive “paying” network and charges a fee to merchants for access. That’s their core business. It’s so simple that it seems a “too” simple but if you give us a few more moments we’ll prove to you it’s not!
Is It A Great Business To Own?
Sales, also known or considered as revenue are the life blood of a company. In order to do anything else you have to bring money through the doors. One of the first things we look at when evaluating a company are its sales, but more specifically its sales growth.
We want to know right away if this company is making more money, stabilizing, or declining. Sales are a great way to determine this quickly.
Long Term Debt
Just like you and I would have debt, companies also have debt. Long term debt for a company is debt with an obligation longer than 1 year.
Debt necessarily isn’t a bad thing, after all companies finance things just like the rest of us. However, we don’t like to see an explosion of long term debt without any significant reasoning from the company.
You can see from this graph American Express has stabilized its long term debt on the balance sheet.
Free Cash Flow
The number one thing we look for in a company is the amount the amount of free cash flow it generates. We want to see huge mountains of cash, literally! Free cash flow is the amount of money left over after a company pays its bills and makes the necessary investments in infrastructure and equipment. It’s essentially the money left over for owners and it’s nearly impossible to fake using standard accounting practices, another reason why we love this metric.
This certainly looks like a very shaky graph trending upwards. Typically, this would raise an eyebrow for us based on our criteria for dividend compounding companies. But after reading through a couple annual reports we were reassured in our analysis.
You must remember a stock is a “piece” of a business. That piece of business is called a share, it’s what you purchase and a company only has a finite number of shares. These shares are known as “outstanding shares.”
Think of a company as a pizza, the more slices it has the less pizza the owners have per slice. This is why we like to see the number of outstanding shares decreasing over time or at the very least stabilizing.
Looking at this photo it is abundantly clear American Express has its shareholder’s best interest at heart. They have steadily decreased the number of outstanding shares over the last 15 years. This has led to shareholders obtaining a larger portion of the company over time.
Companies who pay dividends typically pay them out every quarter, the company counts its earnings and pays out some portion to its owners (the shareholders). Essentially, your dividend check is your share of the profits. We look for companies that pay steady rising dividends on a consistent basis.
Amex passes this test with flying colors. The two best things for shareholders are great businesses that pay a dividend and buyback shares of their company on a consistent basis. We call this concept “Shareholder Appreciation.”
Will my grandchildren use this product?
And last but not least, we ask ourselves one final question. Will our grandchildren use this product? American Express has been in business for over 100 years and nothing at this time threatens the company’s existence.
Here’s The Million Dollar Question
Now that we know American Express is a great business, should we go out and buy it today?
The short answer is no, but let us explain why…
Let’s say my children turned their lemonade stand into a business and reported an annual net income (Revenue – expenses) of $100. If you were looking to acquire my children’s small business what price would you rather pay?
$250 – You will get your original investment back in 2.5 years
$800 – You will get your original investment back in 8 years
The answer is blatantly obvious right? Anyone in their right mind would much rather pay $250 and make their initial investment back in 2.5 years versus 8 years.
But investors do this all the time! Investors think they’re doing the right thing when buying great or iconic businesses but it doesn’t matter when they have a very minimal chance of getting their initial investment back.
Here we can even prove it!
The number one measurement we use to evaluate a company’s value is free cash flow. Remember, free cash flow is the money left over for owners.
In 2009, American express generated $4.79 per share of free cash flow. This means for every share you purchased generated $4.79 free cash flow. In March 2009, AXP was trading for $12.24. Approximately 2.5x free cash flow.
Fast forward to 2015, American Express currently generates $8.94 per share of free cash flow, almost double from six years earlier. As of September 28, 2015, AXP was trading for $73.34. Approximately 8x free cash flow.
Compared to other companies these are very low multiples of free cash flow. Typically an iconic company will trade for over 30x free cash flow. We could have valued the company by its book value but chose to go with cash value instead. Book value is how much a company has left over if they were to sell all their assets and pay off all of their liabilities. If you can purchase a great business for under its book value chances are you’re getting a steal!
Nonetheless, let’s see the difference in purchasing an iconic business after a market crash versus purchasing a great business after a huge bull market.
If you had purchased AXP for $12.24 in March of 2009 you would have received $.72 in dividend income over the next year. That’s a 5.8% yield on your money. Fast forward to today and AXP currently pays $1.33 in dividend income, remember this company has a history of steadily increasing their dividends. That’s a 10.8% yield on your money. Keep in mind this is just the income generated from you owning a stake in the business. Your original investment of $12.24 has now increased to $73.34 – approximately a 600% increase in value.
Let’s see how great of an investment AXP is after a bull market.
If you purchased AXP for $74.13 today you will receive $1.33 in dividend income over the next year. That’s a 1.79% yield on your money. Time will only tell how an investment in American Express will play out in the future, but we can all agree the investor who bought in 2009 will outperform the investor who buys today.