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Increasing the Exposure in the Consumer Finance sector: Capital One Financial

August 26, 2014 | About:
ovenerio

ovenerio

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In this article, let's take a look at Capital One Financial Corporation (COF), a $46.06 billion market cap company, which is a diversified financial services holding company which offers a broad spectrum of financial products and services to consumers, small businesses and commercial clients.

Expanding the business

Due to strategic acquisitions the company has changed from a simple credit card company to a diversified holding company, which offers a broad spectrum of financial products.

It can be divided into three segments: credit cards, consumer banking and commercial banking. The credit card´s segment is the principal one. This segment is very sensitive to economic downturns and constitutes a major risk despite the fact that we believe the U.S. economy will continue expanding.

A bit of history, in 2012 there were two acquisitions with good sense. The firm acquired HSBC´s U.S. credit card business and the ING Direct, which helped to raise deposits by about 75% year over year. As a consequence, Capital One became the sixth-largest bank in the U.S. based on deposits. Further, it helps liquidity and cost structure because it doesn’t need expensive branches.

More recently, in 2013, it announced plans to acquire Beech Street Capital, a multifamily real estate lender which offers government-backed mortgage loans through government-sponsored companies and the Federal Housing Administration. The recent acquisition will expand its commercial real estate business benefitting from the housing market recovery.

Shareholder´s value

The company has been successful in building national scale in both traditional and online banking. Once that scale was done, the management is focused shareholder´s value. We see with good eyes strategies like diversifying the businesses while maintaining expense controls and trying to generate good returns.

Revenues, Margins and Profitability

Looking at profitability, revenue declined by 3.78% and reported flat earnings per share in the most recent quarter compared to the same quarter a year ago ($2.06). During the past fiscal year, the company increased its bottom line by earning $7.31 vs $6.70 in the prior year. This year, Wall Street expects an improvement in earnings ($7.63 versus $7.31).

Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.

Ticker

Company

ROE (%)

COF

Capital One

9.96

AXP

American Express Company

27.49

BAC

Bank of America Corporation

4.91

DFS

Discover Financial Services

22.85

 

Industry Median

13.17

The company has a ROE of 9.96% which is higher than the one exhibited by Bank of America (BAC). In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. So for investors looking those levels or more, American Express (AXP) and Discover Financial (DFS) could be better options. It is very important to understand this metric before investing and it is important to look at the trend in ROE over time.

1409014659020.png

Relative valuation

In terms of valuation, the stock sells at a trailing P/E of 11.5x, trading at a discount compared to an average of 14.5x for the industry. To use another metric, its price-to-book ratio of 1.1x indicates a discount versus the industry average of 1.6x while the price-to-sales ratio of 2.2x is below the industry average of 2.6x.

As we can see in the next chart, the stock price has an upward trend in the five-year period. If you had invested $10,000 five years ago, today you could have $24,088, which represents a 19.2% compound annual growth rate (CAGR).

1409014619068.png

Final comment

As outlined in the article, Capital One has been successful at integrating new businesses into its model. I think the stock still has good upside potential despite the fact that it has already risen in the past year. So I would recommend the stock for investor´s long-term portfolios. Further, the PE relative valuation makes me feel bullish on this stock.

Hedge fund gurus like Paul Tudor Jones (Trades, Portfolio), David Dreman (Trades, Portfolio), Bill Nygren (Trades, Portfolio), John Buckingham (Trades, Portfolio) and James Barrow (Trades, Portfolio) added this stock to their portfolios in the second quarter of 2014.

Disclosure: Omar Venerio holds no position in any stocks mentioned

About the author:

ovenerio
We provide independent fundamental research and hedge fund and insider trading focused investigation.

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