According to GuruFocus Real Time Picks, on Dec. 31 Brian Rogers (Trades, Portfolio) sold out his stake in Capital One Financial Corp. (COF). The Consumer Finance sector is dominated by three credit card companies: American Express (AXP), Discover Financial Services (DFS) and Capital One Financial. The business consists of charging small fees to consumer transactions. Although new legislation has arisen to protect consumers from credit card banks, I do not expect this to have a major impact on profitability. So what made Rogers cut back his position?
Two Strategic Acquisitions
We think in an expanding U.S. economy with improved credit conditions, this segment is very sensitive to economic downturns, and is a major risk despite the favorable economic trends. In order to expand its business, in May 2012, it acquired HSBC's U.S. credit card business. Another acquisition was ING Direct, also in 2012, which raised deposits by about 75% year over year. This acquisition made the company to become the sixth largest bank in the U.S. based on deposits.
Becoming the Fifth Largest Originator
In August 2013, the company announced plans to acquire Beech Street Capital (the sixth largest agency originator in the U.S.), a multifamily real estate lender that offers government-backed mortgage loans through government-sponsored companies and the Federal Housing Administration. The recent acquisition should help the firm to expand its commercial real estate business, benefitting from the recent housing market recovery.
In terms of valuation, the stock sells at a trailing P/E of 10.4x, trading at a discount compared to an average of 14.6x for the industry. For additional comparison, its price-to-book ratio of 1.01x indicates a discount versus the industry average of 1.37x and the price-to-sales ratio of 1.89x is below the industry average of 2.52x. The three ratios indicate that the stock is relatively undervalued.
Earnings per share (EPS) have increased in the most recent quarter compared to the same quarter a year ago. Also, it has demonstrated an upward trend over the past three years which is a good signal. We include in the next graph the stock price because EPS often lead the stock price movement.
As we can see, the share price has risen over the past years and it seems to still has good upside potential.
Finally, I always like to see one of the most important financial ratios applying to stockholders, the best measure of performance for a firm's management: the return on equity. Capital One´s ROE of 8.7% is below the industry mean of 11.3%. The ratio has increased when compared to the same quarter one year ago (10.39 vs 9.18). I have to emphasize this because it is a signal of strength within the company.
Let´s make a comparison in the next graph and see the evolution in the last 10 years:
Although the decline in revenue underperformed the industry average of 4.5%, it has not hurt the company's bottom line. In the past quarter, earnings per share (EPS) rose but still missed the Zacks Consensus Estimate. The firm is currently Zacks Rank #3 - Hold, and it also has a longer-term recommendation of “neutral.”
Other hedge fund managers that sold or reduced their position in the stock were Julian Robertson (Trades, Portfolio), Lee Ainslie (Trades, Portfolio) and Jim Simons (Trades, Portfolio). Although I do not have the track record of these gurus, I will not follow them this time.
Disclosure: Victor Selva holds no position in any stocks mentioned.