3 Ways to Deal With American Express Stock

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During Monday’s trading session, shares of American Express (NYSE:AXP) hit an all-time high of just under $96 per share. As a provider of credit cards and credit to consumers and businesses, this isn’t surprising, as we learned recently that consumer spending in April soared. However, there are several other catalysts. as well.

First, there is a broader shift from the use of cash in transactions to using credit and debit cards. American Express has been a beneficiary of this shift. This is a very powerful trend, considering that it is recession-proof. In a recession consumers may spend less, but at the same time they will still spend more using credit and debit cards.

But note that American Express isn’t as recession-proof as its peers, Visa (NYSE:V) and Mastercard (NYSE:MA). The reason for this is that the latter two companies simply supply the credit and debit cards to consumers and businesses. These consumers and businesses borrow money from a bank if they are using credit cards, and the money is withdrawn from their bank accounts if they are using debit cards. American Express only offers credit cards, and it supplies the funds to consumers and businesses — in effect it, is itself a bank.

This means that American Express will benefit when consumers and businesses are spending more because fewer loans default in a growing economy. But it also means that in a recession, more loans default and American Express has to foot the bill.

Thus, if you are bullish on the economy, as many investors are, then American Express is a superior investment to Mastercard and Visa. In this market, this distinction is heightened by the fact that Visa and Mastercard are trading at much higher price-to-earnings multiples than American Express. Looking at 2015 earnings estimates, American Express trades at 15.2 times 2015 earnings, Visa trades at 20.4 times 2015 estimates, and Mastercard trades at 21.2 times 2015 estimates.

While the comparison is not exactly apples to apples, the fact remains that American Express remains relatively inexpensive. We should also note that an American Express card is more than simply a credit card. It is, in some ways, a fashion statement, as it is a marker of prestige and wealth: while banks simply issue Visa and Mastercard credit and debit cards, people need to apply and be approved for an American Express card. The company also has a well-known rewards program that enables American Express members to accumulate points in order to acquire things from trips to electronics. In short, people have an incentive to acquire and to use their American Express cards.

For these reasons, American Express appears to be a compelling investment at a reasonable valuation, and one can make this last point despite the fact that the stock trades at an all-time high.

However, there is one problem with simply putting your money into American Express. As I have already mentioned, the company isn’t nearly as recession-resistant as its peers because it has credit exposure, and in a recession, loan defaults rise and credit markets slow down. It follows that the company can face a serious funding problem during a recession.

We saw this potentiality realized during the 2008-2009 financial crisis: American Express shares collapsed nearly 90 percent in value! Even if we don’t face another crisis like the 2008-2009 collapse, I think it is clear that American Express shares can really take a nosedive in the event of a credit crisis. With this being the case, I think investors need to be tactful when investing in American Express shares. There are three strategies that you can take.

The first is to simply avoid American Express. As we saw above, you can get the same kind of exposure to the burgeoning electronic payment market through Visa and Mastercard. If you don’t mind some exposure to online retail, eBay (NASDAQ:EBAY), the owner of PayPal, is another compelling choice. You’ll pay more for these companies’ future earnings, but you won’t lose everything in a financial crisis.

The second is to buy American Express shares but use a stop order to limit your losses. The idea here would be to buy the stock at, say, $92 per share — which is the level the stock traded at just before the recent spike — and to place a stop order at, say $80 per share. This will limit your losses. Furthermore, as the stock continues to rise, you can raise your stop order in order to lock in gains. If there is a financial crisis you’ll lose a little money, but again, the loss will be limited.

Finally, you can hedge your banking risk by finding a weak bank and shorting it against your American Express position using put options. In short, you are buying insurance on your American Express position, but you are only insuring the credit side of the business. That way, you get the reasonably priced exposure to the aforementioned electronic payments trend while mitigating your exposure to credit losses. This will eat into your gains somewhat, as put options cost money, but you’ll be glad you bought them in the event of a financial crisis.

Disclosure: Ben Kramer-Miller is long Visa.

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