3 Reasons Why American Express Is Warren Buffett’s Favorite Credit Card Paper

During the very first months of the pandemic in 2020, Warren Buffett’s company Berkshire Hathaway (BRK.A -0.81%) (BRK.B -0.62%) sold a good portion of its banking holdings, which included credit card companies. Buffett said Berkshire was concerned about its exposure to the sector, given the uncertainty at the time.

However, Berkshire hasn’t sold a penny of the big credit and charge card company American Express (AXP -0.11%), which has long been a favorite of Buffett and currently accounts for nearly 7% of Berkshire’s portfolio. Here are three reasons why American Express is Buffett’s favorite credit card paper.

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1. American Express has superior credit quality

Buffett knows the banking industry quite well, which is why Berkshire has invested in so many banking stocks over the years. In fact, Berkshire actually bought a bank decades ago called the Illinois National Bank and Trust Company, which the conglomerate ran quite well while it owned it.

Anyone who knows the industry that well knows that the first thing that can really sink a bank is bad debts. And in the credit card industry, loan losses can jump quickly in times of stress. At the end of the second quarter, American Express’ loss rate was lower than that of any of its major bank peers.

This is because American Express caters to a much more affluent customer base that is likely to be much more resilient during a recession or downturn. American Express has also been in the credit card business for some time and has a wealth of underwriting experience.

2. American Express has a strong brand

American Express has long had one of the most enviable brands in the industry. Buffett once told company CEO Stephen Squeri that “the most important thing about American Express is the brand and the customers who aspire to be associated with the brand.”

That’s a big compliment coming from Buffett, who invests in stocks for this very reason. Just look at the brand power of Berkshire’s largest stock portfolio, Apple.

The company’s brand is arguably the reason consumers will pay nearly $700 a year for the American Express Platinum card. Brand power isn’t always easy to quantify, but in the case of America Express, it’s a huge advantage that has added a ton of value to the company over the years.

3. American Express has various revenue streams

Many credit card companies rely solely on the net interest income they earn on credit card loans, which is essentially the difference between monthly interest payments earned on loans and what cost to the company to finance these assets. Interest on credit cards is high, so if you can avoid major losses, you can get away with it, but it’s harder than it looks.

In addition to credit card loans, American Express also operates an end-to-end payment network where it facilitates American Express payment transactions between consumers and merchants. Revenue from these transactions is actually the company’s biggest revenue generator. American Express also collects a good amount of revenue by charging subscription fees on several of its card programs, such as Platinum and AmEx Gold cards.

Over-reliance on interest income from loans can be a difficult business, which is why many bank investors like to see additional fee income business as well. American Express essentially flips this notion on its head by making the majority of its revenue come from fees. Payments businesses can also be very attractive once they reach scale.

American Express is an advertising partner of The Ascent, a Motley Fool Company. Bram Berkowitz has no position in the stocks mentioned. The Motley Fool holds positions and recommends Apple and Berkshire Hathaway (B shares). The Motley Fool recommends the following options: $200 long calls in January 2023 on Berkshire Hathaway (B shares), long $120 calls in March 2023 on Apple, short $200 calls in January 2023 on Berkshire Hathaway (B shares) , short calls of $265 in January 2023 on Berkshire Hathaway (B shares) and short calls of $130 in March 2023 on Apple. The Motley Fool has a disclosure policy.

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