This Buffett Favorite Is Just Too Expensive to Buy Today

Warren Buffett's Berkshire Hathaway (NYSE: BRK.A)(NYSE: BRK.B) owns around $40 billion worth of American Express (NYSE: AXP) stock. American Express' market cap is around $220 billion, so Buffett is a very big shareholder.

Given these two facts, you might think that the Oracle of Omaha is expecting big gains from American Express. Probably not -- and that's a big reason why you probably shouldn't buy American Express just because he owns the financial giant.

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What does American Express do?

From a business standpoint, American Express is an attractive company. It operates in the payment processing space, collecting fees for connecting buyers that use cards emblazoned with the American Express logo with sellers of goods and services.

American Express competes with companies like Visa and Mastercard. However, there is a subtle difference: American Express focuses on higher-net worth customers.

Image source: Motley Fool.

Wealthier customers have more capacity to spend. And they tend to be more resilient during recessions and other economic hardships. Having built what is probably best seen as a "high-end" brand in payment processing helps American Express differentiate its business. And since there is status associated with using an American Express card, the company has a marketing advantage with the customers it most desires to attract.

Like all companies, American Express' fortunes wax and wane over time. But if you think in decades and not days, it is a very desirable business. This is why Buffett likely owns it -- and also why you probably shouldn't buy it right now.

Buffett doesn't like to overpay

One of Warren Buffett's most important teachers was Benjamin Graham, a die-hard value investor. Although Buffett's investment approach is more lenient than that of Graham, Buffett still doesn't like to overpay. In fact, he often steps in to buy companies when they are facing material difficulties.

That's what happened the first time around with American Express in the early 1960s. Buffett took a giant stake when American Express was dealing with a scandal that could have put it out of business. His investment basically helped save the company, and it gave Buffett a close look at its operations.

Years later, in the mid-1990s, Buffett jumped back into American Express, again taking a sizable position. The key fact, however, is that the price-to-earnings ratio back then was around 10x. Today, the P/E ratio is over 20x. The stock is currently trading near its all-time highs after a huge 50%-plus price gain over the last 12 months.

AXP PE Ratio data by YCharts

And it isn't just the P/E ratio that's elevated. The price-to-sales, price-to-cash flow, price-to-book value, and price-to-earnings ratios are all above their five-year averages right now. American Express looks expensive based on traditional valuation metrics. And the dividend yield is below 1%, which is even lower than the miserly 1.2% yield on offer from the S&P 500 (SNPINDEX: ^GSPC). It looks like Wall Street is well aware of how good a company American Express is right now.

Buffett owning this stock is more about his penchant to be a long-term investor in strong and growing companies, rather than his excitement about American Express as an investment today.

Great companies can be poor investments

One of the biggest lessons for investors to glean from Benjamin Graham is that value matters. It isn't the only factor to consider, as Buffett's more refined approach, which also considers a company's strength and growth potential, has highlighted.

But even a company with an attractive business and solid growth prospects like American Express can be a bad investment if you overpay. The fact that Buffett owns it isn't enough, in and of itself, to make this stock a buy. If you really want to invest like Buffett, you'll put American Express on your wish list and wait for a major price decline before adding it to your portfolio.

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American Express is an advertising partner of Motley Fool Money. Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Berkshire Hathaway, Mastercard, and Visa. The Motley Fool has a disclosure policy.