Key Points
American Express and Visa operate different business models, with the former capturing all the economics of a transaction.
Visa's capital-light setup supports substantial profits and capital returns, but its valuation is higher.
These companies each possess a powerful network effect that supports continuing success.
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Consumer spending represents a whopping 70% of U.S. gross domestic product. So it makes sense for investors to find ways of building portfolio exposure to companies that contribute to this key economic metric.
American Express (NYSE: AXP) and Visa (NYSE: V) are solid examples of businesses that benefit from consumer spending. During the past decade, both have outperformed the S&P 500 index (as of May 28), with the former doing much better than the latter.
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These financial stocks give investors two different ways to bet on premium consumer spending. Here's what you need to know.
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These are two different business models
First, it's worth taking the time to understand how these business models work. They aren't the same.
American Express is a closed-loop payment system. Only American Express cards can use the network. But the business captures all of the economics of a typical transaction, collecting fees from merchants and cardholders while earning interest on revolving balances.
This company is known to target an affluent clientele. It primarily leans on a spend-centric model that thrives when its customers use their cards.
On the other hand, Visa is an open-loop system. It doesn't actually extend credit, leaving this activity to its partner financial institutions, which act as lenders. Consequently, Visa operates as a toll booth, collecting tiny fees anytime payments run through its network.
There are Visa-branded cards that serve people across income categories. However, the payment network has a strong position at the premium end. JPMorgan Chase's Sapphire Reserve and Capital One's Venture X credit cards, for example, target wealthier customers and run on the Visa network.
Financial metrics and valuation
American Express resembles a traditional bank, as it has to manage its loan portfolio. This can make its financial performance more cyclical and more exposed to macroeconomic factors such as interest rates.
Because Visa doesn't lend, it operates with a capital-light approach since funds don't need to be held in reserve to cover potential losses. And it avoids credit risk, making it more stable.
Therefore, its profits are impressive. During the past five years, Visa's quarterly operating margin averaged a superb 67.3%.
This allows the business to return a lot of capital to shareholders. During the fiscal second quarter ended March 31, Visa paid $1.3 billion in dividends and repurchased $7.9 billion worth of stock.
American Express' quarterly operating margin averaged 20.6% during the trailing-five-year period. This is not remotely close to Visa's operating margin.
But the company also pays a dividend yield of 1.2% right now compared with Visa's 0.8%. And its share buybacks totaled $1.9 billion in Q1.
Investors should look at growth trends as well. During the past five years, American Express' diluted earnings per share (EPS) increased at a respectable compound annual rate of 9.3%. This is driven by new card sign-ups and greater payment volume.
Visa's diluted EPS rose at a yearly clip of 17.9% during the last five years. Better growth and margins, unsurprisingly, support its higher valuation multiple. Visa shares trade at a price-to-earnings (P/E) ratio of 28.8. American Express' P/E multiple sits at 19.9.
Which financial stock is right for you?
It's important for interested investors to understand that both of these are high-quality businesses. Each possesses a powerful network effect that supports its wide economic moat. I don't believe they face a threat of disruption, underscoring how critical they are to the smooth functioning of commerce.
Investors who are turned off by Visa's more expensive valuation will gravitate to American Express as a possible portfolio addition. But the cheaper price tag comes with credit risk, as mentioned, adding exposure to the economic cycle.
Investors who want to own a wildly profitable and steady business, which might justify the higher P/E ratio, will pick Visa.
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JPMorgan Chase is an advertising partner of Motley Fool Money. American Express is an advertising partner of Motley Fool Money. Neil Patel has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends American Express, JPMorgan Chase, and Visa. The Motley Fool recommends Capital One Financial. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
