Editor's Choice

Discover The Greatness of This Financial Company

Joseph is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Discover Financial Services (NYSE: DFS) is known for their credit cards, top notch customer service, and insanely high cash back bonuses. As a college student with no credit, the experience of denial from Visa, Mastercard, and American Express left me with the feeling of being unwanted and lost. However, Discover came to the rescue and not only was I approved for a credit card, but my limits were raised quickly. I was able to build credit within a year to open other lines of credit. I fell in love with this company and will be a cardholder for life. Discover is not only great to their cardholders, but they have been incredibly strong for their shareholders. This stock has been performing well over the last 4 years and could continue this movement. Let's take a deeper look into Discover Financial Services. 

What They Do

This company operates in two segments--direct banking and payment solutions. Direct banking includes Discover Card, Discover Bank, and Discover Home Loans. Discover Card is a credit card offered to both individuals and businesses. There are cards that generate maximum cash back, earn bonus miles, and some that are designed for students or people new to credit. The Discover Card was the first card to introduce cash back rewards, as well as offering no annual fees and 24/7 customer service. 

Discover's various arms include:

  • The Discover Bank offers a full range of banking products such as online savings accounts, certificates of deposit, money market accounts, and student loans. 
  • Discover Home Loans are the newest addition, and offer competitive rates along with dedicated customer service. 
  • Discover Payment Solutions includes the Discover Network, PULSE, and the Diners Club International.
  • The Discover Network is a secure payments network for credit cards, debit cards, and prepaid cards. 
  • PULSE is one of the largest ATM and debit networks in the nation, with over 900,000 locations. 
  • The Diners Club International is a direct banking and payment services company. This card is accepted in over 185 countries, millions of merchant locations, and over 845,000 ATMs worldwide.

The expansion of these segments are crucial for Discover to continue growing.

Why a partnership with PayPal could pay off

Discover made a great move by teaming up with eBay's (NASDAQ: EBAY) Paypal to offer consumers another payment method in stores. PayPal is the global leader in online payments and has set up deals with several national merchants, including Home Depot, Abercrombie & Fitch, Dollar General, and Jos. A Bank. PayPal currently has over 123 million users in 190 markets who use 25 currencies, and the payment processor has been growing like a weed--it added over 5 million users in the 4th quarter of 2012. PayPal's revenues made up 39% of eBay's total for the quarter and 53% of eBay's total international revenue. PayPal has made up over 50% of eBay's total international revenue for 5 quarters straight, and this trend is sure to continue. Buying PayPal was the greatest move eBay ever made. 

This process of using PayPal in stores is very simple for consumers. At the register, customers will be able to access their PayPal accounts by entering their phone number and personal identification number. This will take funds directly from their PayPal accounts. PayPal is also issuing cards now that can be swiped at the register and not require a PIN. The cards are much easier and have more potential to be picked up by consumers. This is a great deal for both Discover and PayPal, and I am sure Visa, Mastercard, and American Express want in on it.

Google Wallet

Discover made another great deal when it entered into a partnership with Google (NASDAQ: GOOG) to allow users to access their cards through Google Wallet. Google Wallet lets users save all of their credit and debit card information on Google's highly secure servers. They can then access their cards and pay in-store using the Google Wallet app. Users just have to set their Discover Card as their preferred method of payment. Google uses Google Wallet much differently than eBay uses PayPal. Google Wallet is offered at no cost to issuers because Google is focused on collecting information about the transaction more than making a percentage. This transactional information is then used to create targeted ads for consumers. This direct approach to obtaining information makes Google even more desirable for advertisers than the company already was.

How this payment process works is the customer brings up the app on their phone and then swipes the back of the phone near the payment terminal. The terminal will be sent the payment information and the customer is then charged for the items. This means your smartphone basically becomes your wallet and you no longer have to dig for cash in your pocket or pull a card out of your old school wallet. If you lose your phone, you can lock the ability to make payments by logging on from a computer. This makes it both simple and safe. Google Wallet is also a major player in online payments. At the checkout portion of an online purchase, consumers can select to pay via Google Wallet, a process that is exactly like PayPal's. This deal with Google is great for Discover.

Financials & Stock Performance

At the close of trading on Feb. 21, shares Discover Financial Services are selling at $38.33. With 2012 earnings of $4.46, this means they are trading at just 8.59 times earnings. This is incredibly cheap compared to competitors. Mastercard trades at a multiple of 24, Visa trades at a multiple of 44, and American Express trades at a multiple of 16. The industry average price-to-earnings ratio is 30.90, which would put Discover at over $137 per share. This is not a likely move, but it shows that their multiple is much too low at these levels.

Currently, analysts project that Discover's earnings will fall by $0.08 to $4.38 in 2013, but then they will be back on the rise in 2014 and 2015. This predicted drop in 2013 could easily be wrong, as there is a high estimate of $4.59. Analysts expect Discover to earn $4.50 per share in 2013 and $4.64 in 2014. This is not the strongest growth you will find, but the low multiple makes Discover cheaper than other credit card companies.

On Dec. 20, 2012, Discover reported fourth quarter earnings. Their credit card sales volume increased 6% year-over-year to $26.5 billion. Credit card loans also grew by 6%. Direct banking income grew 7%, with personal loans increasing 24% and student loans increasing 6%. Payment services income decreased for the quarter, mainly due to increased marketing and employee expenses. Payment services overall grew by 13% to $49 billion for the quarter. These are all positive numbers for Discover's mission for growth.

Discover currently pays an annual dividend of $0.56, or 1.46%. This yield is much higher than Mastercard's 0.50% and Visa's 0.80%, and slightly higher than American Express' 1.3%. Discover has increased this dividend since 2010 and should continue raising it. 

Since the market lows in March of 2009, Discover is up an incredible 686%. They have a two year return of over 84% and a 31% gain over the last 52 weeks. Over the last three months, however, Discover is down 6%. This means that now may be a great entry point.

Bottom Line

Discover Financial Services is geared for growth over the next several years. The strategic partnerships with PayPal and Google Wallet should increase earnings with continued transaction growth. I am initiating an outperform call on CAPS, because this stock is a BUY.

JoeySolitro1 has no position in any stocks mentioned. The Motley Fool recommends eBay and Google. The Motley Fool owns shares of eBay and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

blog comments powered by Disqus