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Jonathan Poland
Jonathan Poland
Articles (453)  | Author's Website |

Discover Financial Services Is a Buy

Company has a bright future and should trade with a higher multiple

August 07, 2018 | About:

Discover Financial Services (NYSE:DFS) is a credit issuer and bank. It has a forward price multiple of 9.3, it pays a solid 2% dividend and it has steadily grown earnings per share and book value over the last five years. Companies that grow their earnings per share and book value typically see stock prices increase as well. Through share buybacks, Discover should be worth significantly more compared to the other brands supplying logos to credit cards.

Forward P/E
Visa (NYSE:V) - 26.1
Mastercard (NYSE:MA) - 31.6
American Express (NYSE:AXP) - 13.9
Discover Financial (NYSE:DFS) - 9.3

For what its worth, Discover also pays a better dividend than the others, even hiking it to 40 cents per quarter. It’s also in a very good financial position with the equity at a healthy 12% of total liabilities, comparable to the best banks and better than American Express.

Being one of the big four in the credit services business is a durable competitive advantage. The company generates over $2.3 billion a year in net income on $10.3 billion in revenue. It continues to buy back stock, with $2.75 billion worth approved until this November. The company is doing all it can with its cash, and that will increase value for shareholders.

It has had a great 2018 thanks to surging demand for student loan products and better advertising campaigns that fueled new card holder signups and boosted existing customer usage rates. The company is on pace to document a record earnings per share this year of $7.75. Even under Discover’s historical multiple (11.6), the price should rise to $90 a share, a 23% jump.

Discover Financial Services has been likened to a "poor man's American Express,” and it's true the company targets middle-class users, which may spell trouble during the next economic downturn. Discover is also a bank, with credit card loans make up roughly two-thirds of the company's assets, and deposits fund over half of the bank's balance sheet. Without the need of a branch network increasing the costs, Discover’s direct consumer banking model could take off. The company should have the ability to increase deposits and make loans online without the added layer of costs physical branches bring into play.

Customers are gravitating to its newly remodeled rewards program, as evidenced by lower attrition rates and higher customer satisfaction scores. This will go a long way in growing sales and profit organically, making those share buybacks even more interesting. If the company gets the share count down to 300 million with the same financial aspects, it would be earning close to $10 per share. At 12x, that’s a $120 number. I don’t expect the market to place as much value on Discover as it does Visa or MasterCard, but even at half the multiple Discover would be a $150 stock.

Disclosure: I am not long/short any stock mentioned in this article.

About the author:

Jonathan Poland
I used to manage money. I still publish my thoughts on stocks here on GuruFocus, mainly on big cap companies. I rarely write about stocks that I own. Thank you for reading.

Visit Jonathan Poland's Website

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