Why Should You Hold Discover Financial In Your Portfolio?

Discover Financial Services (NYSE:DFS) remains well-poised for growth, given its strong revenue momentum, solid Direct Banking business and a prudent capital management.

Its return on equity — a profitability measure — is 25.5%, better than the industry average of 12.9%. This reflects the company’s efficiency in utilizing its shareholders’ funds.

The company also retained investors' favorable sentiments by maintaining its positive surprise trend in all the last four reported quarters, the average being 1.30%. This definitely vouches for the company’s operational excellence.

Discover Financial has been witnessing a strong revenue momentum over the past several years, evident from its 5% CAGR during the 2012-2017 period. The trend also continued into the first nine months of 2018 with the same metric rising 8% year over year to $7.9 billion, driven by higher net interest incomes and other total income of the company.

Moreover, its strong Direct Banking Business has also been performing well from the past many years. Within this business, the private student loan portfolio has grown significantly from $1 billion in 2010 to nearly $9.2 billion in 2017. Total loans of $86.9 billion are up 8.6% year over year through the first three quarters. For the first nine months of 2018, direct Banking net interest income increased 6% year over year, primarily driven by loan growth.

Notably, the company’s rising card sales volume is also impressive. Discover Financial is one of the major card issuers in the United States and a leading innovator in the credit card industry. The company consistently launched products, tailored to suit specific customer needs for attracting new customers. It is also active in forging alliances and partnerships on the back of which, card sales volume expanded at an average rate of 4% in last four years (2013-2017), primarily owing to a rise in customer strength using Discover card. The same metric was up 12% during the first three quarters of 2018. The company’s constant collaborations, such as the one with PXP to boost the acceptance of Discover cards around the globe, poise it well for growth.

Investors are also impressed by its strategic capital management through share repurchases and dividend payouts. It has taken several initiatives to drive its capital base over the past few years. This further instills investor’s confidence in the stock.

However, the company has been suffering escalating expenses due to investments made to compete with other credit card issuers, attract and retain customers and also increase the card usage frequency from the past many quarters. Thus, higher expenditure remains a constant concern for the company. Also, its over dependence on debt induced a persistent deterioration in the leverage level. Its long-term debt increased at an average 8% rate over the last five years (2012-17). This rising debt load resulted in interest expenses that continue to weigh on the desired margin expansion.

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The Zacks Consensus Estimate for the company’s 2018 earnings is pegged at $7.83, representing a year-over-year surge of 30.9% on revenues of $10.72 billion.

For 2019, the Zacks Consensus Estimate for earnings stands at $8.67 on $11.4 billion revenues, translating into a respective 10.7% and 6.4% year-over-year increase.

Shares of this Zacks Rank #3 (Hold) company have lost 24.1% in a year’s time, slightly wider than the industry’s decline of 23%.