American Express: Free Cash Flow Analysis

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Peter Mycroft Psaras submits:

The main thrust of this analysis is concentrated in three parts. The first two parts are based on free cash flow (current and historical) and the third is based on historical price action as a gauge of investor sentiment.

The three methods used in this analysis are:

1) Price to Owners Earnings ((OE)) = Current and future analysis.

2) Cumulative Owners Earnings ((COE)) = Historical analysis of owners earnings.

3) Statistical Indicator Analysis ((SIA)) = Historical price action.

For those new to this analysis please click on the above for an introduction. More here (CapFlow).

The main goal of my analysis is first to determine a sell price.

With that in mind, we attempt to buy the stock at half its sell price and then hold it for five years (provided that no macro- economic negative catalysts force us to sell). Due to the fact that we bought it at par, we can potentially achieve an average annualized return of 15% per year. This may enable us to double our money every five years. Occasionally we do find a stock that is not selling at par, but is actually selling at a discount. When this happens, gains are usually higher.

Analysis of American Express ( AXP )

Yesterday afternoon I was reading the news on Seeking Alpha and came across the following:

Monday 4:18 PM American Express ( AXP ): Q4 EPS of $0.94misses by $0.03 . Revenue of $7.3B (+13% Y/Y) in-line. Shares-1.1% AH. ((PR))

With American Express missing the streets estimates, I thought it would be interesting to test out the company using my Mycroft Research System (( MR )) and see how it stacked up to a free cash flow examination and then conclude this article by determining a final buy and sell price for AXP.

The following is an Owners Earnings ((OE)) table of American Express from 1969-2010:

(Click to enlarge)

From the table above you will notice that the credit card business is definitely a very lucrative one, and you can see why Berkshire Hathaway's (BRK.A) CEO Warren Buffett has been an investor in the company for decades.

Since 1969 American Express has only had two negative OE years. During those 42 years the company generated $56.18 per share in Cash Flow and spent only $15.55 per share in Capital Expenditures in order to generate it. Having generated our COE for AXP we can now determine our first of three sell prices. In 2010 COE for AXP is expected to be $40.63 and since we like to sell at two times our COE we get 2 X $40.63 = $81.26. The chart below gives you a good long term view of their COE:

As far as their CapFlow goes we definitely have a company that is extremely efficient in their cost controls as can be shown in the CapFlow chart below:

(Click to enlarge)

Over the last sixteen years management has been rock steady in their cost controls and are expected to have a wonderful 16% CapFlow for 2010. Having such a wonderful CapFlow usually equates to having a wonderful OE as well and this is definitely the case for AXP. For 2010 AXP is expected to have an OE of $3.50 a share. We like to sell at 30 times our OE, so American Express has a Price to OE sell price of 30 X $3.50 = $105.

Now that we have two of our three sell prices, let us determine our final SIA sell price. Below are the SIA price and SIA percentage charts for AXP.


(Click to enlarge)

(Click to enlarge)

Yesterday we introduced a new chart detailing all the available trading days that we have data for and today we are introducing our SIA Percentage Chart (starting on trading day 3651, not calendar days). We like to sell at two times SIA as we are not greedy investors and like to walk away from the table after we have a nice profit. I learned that trick from studying Benjamin Graham (the father of Security Analysis) who always tried to sell a holding when he made a 50% profit on it.He did so because he lost his fortune in the Great Depression not once, but twice.

I on the other hand use three sell prices to help me come up with a final sell price, with the third being that I like to sell at 2.0 times (200%) my current SIA. AXP's Price to SIA (P/SIA) hit that level multiple times over the last decade and following my system one would have gotten out in plenty of time in order to avoid the massive crash that occurred where AXP's stock went from $60 straight down to $9.78, just a few years back.

Investor Sentiment as measured by SIA went from extreme panic on the upside to extreme panic on the downside in a period of less than a year. Had you let the falling knife fall all the way down to its low of $9.78 on March 6, 2009, you could have made a killing buying AXP at almost a 66% discount to its SIA. (The closer you get to a stock's SIA the less risk you have as an investor, and the farther away from it the greater the risk.)

These events are very rare and are like devastating storms that show up once every 50 years. These storms come around once or twice in a lifetime with stocks of the caliber of American Express, so one should not expect for such an event to happen again anytime soon. With our historical perspective out of the way let us see how we should now handle the current sell price for SIA. Today's SIA for AXP is $34.90 and we like to sell at two times our SIA so $34.90 X 2 = $69.80.

So we have the three sell prices and can now determine our final sell and buy prices.

1) P/OE = $105.00 (30 times OE per Share)

2) COE = $81.26 (2 times COE)

3) SIA = $69.80 (2 times SIA)

Total = $256.06/3 = $85.35 = Sell Price

Buy Price = $85.35/2 = $42.675

Current Price $45.79

Conclusion = American Express is a very strong hold.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: Always remember that these are the results of our research based on the methodology that I have outlined above and in other articles previously published. This research is provided as an educational tool and should not be considered investment advice, but just the results of our research. There are many ways to analyze a stock and you should never blindly follow anyone's work without doing your own due diligence or by seeking the help of an investment advisor, if you so need one. As Registered Investment Advisors, we see it as our responsibility to advise the following: We take our research seriously, we do our best to get it right, and we "eat our own cooking," but we could be wrong. Please note, investments involve risk and unless otherwise stated, are not guaranteed. Past performance cannot be used as an indicator to determine future results. Strategies mentioned may not be suitable for everyone. We do not know your personal financial situation, so the information contained in this communiqué represents the opinions of Peter "Mycroft" Psaras, and should not be construed as personalized investment advice. Information expressed does not take into account your specific situation or objectives, and is not intended as recommendations appropriate for you. Before acting on any information mentioned, it is recommended to seek advice from a qualified tax or investment adviser to determine whether it is suitable for your specific situation.

See also Avon: Lack of Cost Cutting, Scattershot Growth Make It a Hold on seekingalpha.com



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Economy

Referenced Stocks: AXP , MR

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