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Smart Investing Newsletter Archive

Can Discover Financial Services (DFS) Loan Some Help to Your Portfolio?

 

Tuesday, May 9th, 2017

Discover Financial Services is in the financial sector and the credit services industry. The company operates through two segments: Direct Banking and Payment Services. The Direct Banking segment offers deposit products, credit cards, and other types of loans including private student and home equity. The Payment Services segment processes the credit card transactions and provides other payment transaction processing services. This is a positive as the company makes income from the net interest of the loans as well as discount revenue that occurs with credit card transactions. This company could be a big benefactor of an improving economy and increased credit card transactions.

The current price for DFS is $60.74 and the 52-week range is $50.32 - $74.33.

Looking at the valuation ratios, the current Price/Earnings ratio is 10.34, which is below the industry average of 12.36. This is a positive as we like to see valuation ratios below the industry average as it shows we are getting a good value for that given metric. Price/Sales of 2.49 is above the industry average of 1.77. Price/Tangible Book Value of 2.12 is above the industry average of 2.06. Price/Cash Flow of 8.49 is above the industry average of 4.97. One should do some additional research into the cash flow of the company as there is a substantial difference between Discover’s and the industry average.

Discover pays a small dividend of 1.99% and only uses 20.4% of its earnings to pay out that dividend. This is a positive as the company has the capability to increase the dividend, without using too much of its earnings.

Sales have grown by 9.31% quarter over quarter versus the industry average of 1.51% and has seen an increase of 8.77% year over year versus the industry average which has increased by 4.51%. Both figures are positives for Discover.

EPS growth also looks to be strong as it grew 5.92% quarter over quarter versus the industry average declining by 4.57%. Looking year over year EPS rose 12.55%, while the industry average increased 2.61%.

Turning to the balance sheet, the numbers do not appear to be strong as there is no Current Ratio and Total Debt/Equity is 238.11%. It is important to understand Financial Services companies typically have different accounting than traditional companies. This is due to loans being assets for the companies, deposits being liabilities, and a handful of other accounting practices. Before investing into this company, it would be important to spend time with the balance sheet and make sure there aren’t any liquidity risks present.

Looking forward to December 2018 and using a forward multiple of 16.5, estimated GAAP EPS of $6.68 gives us a target sell price of $110.22. While this is 81.5% away from the current price, there is further research that should be conducted before buying this company. The main concerns here would include the company’s elevated Price/Cash Flow and its complicated balance sheet.

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