3 Things to Know About American Express Before You Buy the Stock

American Express (NYSE: AXP) is probably a business that you've at least heard of. Not only does the card giant carry a market cap of $171 billion, but it's also a top holding in Warren Buffett-led Berkshire Hathaway 's portfolio.

Given this financial stock trades near record territory, it's attracting the attention of investors. But before you scoop up shares, here are three important things to know about American Express.

Operating a unique business model

Like JPMorgan Chase or Capital One , for example, American Express is a card issuer. It advertises to consumers, approves cardholders, and takes on credit risk. The downside with this model is that it forces Amex to place capital aside in the case of defaults.

On the other hand, like Visa and Mastercard , Amex also runs a payments network. The business directly connects consumers and merchants to facilitate the processing of transactions. This is typically a very high-margin activity.

This unique setup means the company benefits in multiple ways nearly every time its cards are swiped. It earns annual fees ($2.1 billion in Q2) from cardholders, as well as interest income from consumers who maintain balances. And Amex collects what's known as discount revenue (accounting for 54% of its Q2 revenue, the most of any single source) from the merchants plugged into its system.

Key competitive strengths

Amex's unique business model has helped it develop some key competitive strengths that protect its industry positioning. When investors are looking for stocks to buy for the long term, identifying companies that possess an economic moat should be a top priority. I believe Amex has two primary moat sources.

The first one is the business's strong brand recognition. Amex is known as a premium card company in the industry, and this helps it target a more affluent customer base. Moreover, those cards exhibit pricing power in the form of higher annual fees over time.

The second major moat source that benefits Amex is network effects. I mentioned above that it operates its own two-sided payments platform. There are currently 144 million cards in circulation on one side and 80 million merchant acceptance locations on the other. As the number of either of these cohorts grows, everyone is better off. Consumers gain by being able to use their cards in more places, and merchants gain because there are more potential customers.

Investors can test the strength of a moat by asking if a company's advantage can be easily replicated. If a well-funded entrepreneur wanted to launch their own line of credit cards while creating a closed-loop payments network, I believe it would be a virtually impossible task. What Amex has built since its founding in 1850 is truly astounding.

Impressive financial performance

The uncertain macro climate, with ongoing inflationary pressures and high interest rates, hasn't prevented American Express from continuing to report strong financial results. The company's recent growth has been healthy.

For the second quarter (ended June 30), Amex reported an 8% increase in revenue year over year. This was driven by a 20% rise in net interest income, as well as 3.3 million new active cards.

Profits are soaring. Adjusted earnings per share (EPS) totaled $3.49 in Q2, up 21% versus the prior-year period. Management was so pleased with the momentum that it raised full-year EPS guidance, now expecting a year-over-year boost of 21% at the midpoint, which includes the gain of an asset sale. Executives had previously forecast a 15% jump.

American Express is a quality enterprise that should be on your radar. For those investors looking to buy the stock, you now have a better understanding of the business.

American Express is an advertising partner of The Ascent, a Motley Fool company. JPMorgan Chase is an advertising partner of The Ascent, a Motley Fool company. Neil Patel and his clients have no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Berkshire Hathaway, JPMorgan Chase, Mastercard, and Visa. The Motley Fool recommends the following options: long January 2025 $370 calls on Mastercard and short January 2025 $380 calls on Mastercard. The Motley Fool has a disclosure policy .