💳 Business Overview

🎯Key Metrics

Total: 5/17

• +2 ✅✅ Projected Operating Margin: 26.67%
• +0 ⚠️ Projected 5-Year Revenue CAGR: 6.43%
• +0 ⚠️ Last 5-Year ROIC: 4.40%
• -2 ❌❌ Estimated Cost of Capital: 5.78% (greater than ROIC)
• +1 ✅ Last 5-Year Shares Outstanding CAGR: -3.36%
• +1 ✅ Projected 5-Year EPS CAGR: 13.19%
• +0 ⚠️ Projected 5-Year Dividend CAGR: 9.95%
• +1 ✅ Moody’s Rating: A2
• +2 ✅✅ Morningstar Moat: Wide
• +0 ⚠️ Morningstar Uncertainty: Medium

American Express is a company with a wide moat and its competitive advantages are reflected in its high operating margin. Its solid EPS growth along with the massive reduction of shares makes it a good investment, however the fact that the cost of capital is greater or at least in line with its average last 5 Years ROIC can be something to watch out for.

📈Business Valuation

To calculate the intrinsic value of the company I’ll use multiple methods:

• Discounted Cash Flows (DCF) – Intrinsic value is estimated by projecting its free cash flows over the next 10 years and discounting them to present value;
• EPS Growth – the fair value is estimated by projected the Earnings Per Share CAGR for the next 5 Years and then, given its current and historic values of PE, come up with a PE for the 5th Year. This will give us its price 5 Years from now using the formula: Price = EPS x PE that we then discount using the estimated cost of capital;
• DDM (Variable) – intrinsic value is calculated by how much the company can pay in dividends. It starts at a higher growth and later on transition to a stable growth at the rate of the economy (risk free rate);
• Historical Yield – we assume a mean reversion to the historical % the company pays in dividends;
• Historical P/E – we assume mean reversion to the historical PE values;
• Historical P/B – we assume mean reversion to the historical PB values;

I’ll give more weight to the DCF and EPS methods, and only then the historical and dividend ones. Giving the changing landscape of the world in general, is very difficult to believe that in 100% of the cases mean reversion to historical values is guaranteed.

Cost of Capital

I’ve used both the latest and annual financial statements of the company, the 10-Year US bonds as the risk free rate, the company Moody’s rating and revenue geographic exposure to come up with its cost of capital, cost of debt and cost of equity.

Cost of Capital: 5.78%.

This value will be used later as a discount rate in the valuation methods.

Discounted Cash Flows (Weight: 30%)

I’ve used the latest and annual financial statements of the company, the analyst estimates for both revenue and margins and the cost of capital calculated previously.

This gives us an estimated fair value of 463.14 dollars for American Express.

We can also do some Monte Carlo simulations to execute multiple DCF valuations. Each simulation will randomize the inputs between some pre-defined values. For this I also used analysts estimates.

As you can see from the above American Express seems to be undervalued, using DCF, because even on the lower end of the simulations its DCF estimated fair value is still high compared to the current company’s price.

EPS Growth (Weight: 20%)

For this valuation method, I’ve used the current EPS and the analysts estimates of EPS growth. I also assumed a 20 PE for American Express given its history.

Then again, I used the Monte Carlo simulations to check how the estimated fair value changed as my assumptions were modified.

Using this valuation method, American Express that is currently priced at 358.00 dollars, seems to be fairly valued or even a little undervalued, being currently valued around P20 that is 355.69. What this means is that given that it’s very near P20 or 20%, it exists 80% of probability for the real value of the stock to be above this. A good entry point if you are confident on the company fundamentals.

This output seems to be in line with the previous DCF. However let’s continue with the following valuation methods to get a clearer picture.

DDM – Variable Growth (Weight: 15%)

Now we look at a Dividend Discount Model (DDM). This will allow us to value the company, using its dividend payments and the overall growth of it. In this type of DDM we’ll set the dividend to grow at an initial rate that then over time moderates and declines to a given terminal stable growth that will be maintained “forever”.

For the stable growth, I normally use the growth rate of the economy the company is based on, namely the 10-Year bonds of the currency used by that economy country. Given that American Express is an American company, using dollars, we’ll use the 10-Year Bonds of United States.

As you can see below I started the dividend growth at 9.95% (analysts expectations) and then slowly the growth moderates to 4.19% (the risk free rate – 10-Yr bonds of US). Also note the use of the Cost of Equity, calculated previously when we also calculated the Cost of Capital.

Then, as always, we can also use a Monte Carlo simulation to dive deeper into the valuation 🤓

As you can see, by this method, American Express seems overvalued because its current market value is above the upper range of the simulations (P90).

This difference between the DCF and DDM output is closely related to how much the company pays in dividends (Payout Ratio). If most of the Free Cash Flows are to be paid in dividends, the DDM will more closely reflect the real value of the company. Given that currently American Express has a low payout ratio of ~20%, the DDM output will undervaluate the company real value.

Historical Yield (Weight: 15%)

The current Dividend Yield ratio is below its 7-8 Year average. This means that currently the company is paying less dividends, in relation with its market price, that historically has paid. This means the company may be overvalued. If we expect a mean reversion to the historical averages we can assume a fair value of 245.85 dollars.

Historical P/E (Weight: 10%)

The current P/E ratio is a little above its 7-8 Year average, this could mean the stock is overvalued. Using its historical average and comparing it to today’s price we reach a fair value of 246.67 dollars.

Historical P/B (Weight: 10%)

The current P/B ratio is very well above its 7-8 Year average, this could mean the stock is overvalued. Using its historical average and comparing it to today’s price we reach a fair value of 152.56 dollars.

✍️Summary

Now that we did all the heavy work, let’s take the above and come up with the company weighted average fair value.

I basically take each valuation method used and given my confidence on the company apply a 20% or 10% discount (when to buy) and addition (when to sell) or use the Monte Carlo P10, P20, P80 and P90 values:

Feel free to choose your own values, but for me I’ll take a fair value of 299.60 dollars for American Express given the wide moat and overall good metrics of the company.

Please remember that the fair value estimate is just a number and, probably, a very wrong number. However, overall, American Express seems to be overvalued (at least a little) at the moment.

Fair Value: 299.60 dollars