Find out that financial stocks have 11% upside potential

[Updated 01/05/2022] Check out the Financial Stock update

Discover the financial action (NYSE: DFS) has gained around 28% in 2021 and is currently trading around $119. By comparison, the S&P500 is up 27% over the same period. That said, the stock has lost 3% in value since the third quarter results. Trefis estimates Discover the valuation of Financial at around $134 per share, or around 11% above the current market price. The company posted better-than-expected results in the third quarter, with revenue up slightly year-over-year. Although net interest income and discount and interchange fees showed some growth, this was partially offset by unrealized gains/(losses) on equity investments. Revenue improved in the first nine months of 2021 and we expect the trend to continue in the fourth quarter. Notably, the consensus estimates for fourth-quarter revenue and profit are around $2.99 ​​billion and $3.52, respectively.

The company’s revenue suffered a 3% year-over-year decline in 2020 due to lower NII and non-interest income. This development was driven by headwinds on interest rates, lower levels of consumer spending and lower outstanding loans. That said, the economy has seen some recovery in the first three quarters of 2021. The company reported an 11% year-over-year increase in nine-month cumulative revenue to $9.15 billion. We expect the same trend to continue in the fourth quarter, allowing Discover the earnings of Financial to touch $12.1 billion in fiscal 2021. In addition, the adjusted net profit margin is expected to increase from 10% to nearly 43% in fiscal year, primarily due to a favorable decrease in provisions for credit losses. It should result in an adjusted net profit of $5.2 billion and an EPS figure of $18.01. This, coupled with a P/E multiple just above 7x, will lead to a valuation of $134.

Below is our previous Discover Financial stock coverage where you can follow our view over time.

[Updated 11/11/2021] Is the price of Discover Financial Stock reasonable?

Discover the financial action (NYSE: DFS), the credit card giant, has gained 30% year-to-date, rising from its value of $91 at the start of 2020 to around $117 currently, outperforming the S&P500, which has risen by 24% over the same period. Additionally, the company’s net interest income and discount and interchange fees for the first nine months of 2021 improved 3% and 27% year-over-year, respectively.

There were two clear reasons for this: First, the easing of travel bans and Covid-19 restrictions benefited consumer spending levels. Second, favorable financing costs.

But we believe there are more benefits to come over the next few months.

Trefis estimates Discover the valuation of Financial at around $134 per share – around 14% above the current market price – based on a key opportunity and risk factor.

The opportunity we see is Discover Financial’s revenue growth in subsequent quarters. The company generates more than 90% of its total revenue from the direct banking segment. Nearly 85% of the share comes from NII. The NII suffered a decline of 2% year-on-year in 2020, due to lower outstanding loans and interest rate headwinds. In addition, non-interest revenue decreased 7% year-on-year due to lower discounts and interchange fees. That limited the company’s revenue to $11.1 billion in 2020, down 3% year-over-year. That said, the pattern has changed in fiscal 2021. The company recently released its third quarter results, beating consensus estimates for revenue and profit. It posted total revenue of $2.8 billion, up 2% year-on-year, driven by 6% growth in NII and a 26% increase in discount and interchange fees. Notably, turnover was partially offset by -$167 million of unrealized gains/(losses) on equity investments. Overall, the NII and discount and interchange fees both saw some improvement in the first three quarters of fiscal 2021. The cumulative NII for the first nine months improved by 3 % year-on-year, mainly due to favorable financing costs due to lower market rates and lower interest charges. Additionally, discount and interchange fees increased 27% year-on-year over the same period, primarily due to higher transaction volumes.

Going forward, we expect the same trend to continue in the final quarter of fiscal 2021. Overall, this will likely drive Discover Financial’s revenue to $12.1 billion over the course of the year. fiscal year 2021. Our dashboard on Discover Financial Revenues offers more detail on company segments.

Discover Financial’s profitability numbers suffered in 2020 due to large provisions for credit losses and higher expenses as a % of revenue. However, the company reduced its provisions figure in 2021, due to the improvement in the repayment capacity of its customers’ loans. Overall, the adjusted net profit margin is expected to increase from 10% to approximately 43% over the course of the year, generating net income of $5.2 billion. This will likely translate to EPS of $18.01, which, coupled with the P/E multiple just below 8x, will lead to a valuation of around $134.

Finally, how much should the market pay for every dollar of profit from Discover Financial? Well, to earn nearly $18.01 a year from a bank, you would need to deposit about $1,801 in a savings account today, or about 100 times your desired earnings. At the current Discover Financial stock price of around $117, we are talking about a P/E multiple of just below 7x. And we think a figure closer to 8x is appropriate.

That said, credit card issuance and electronic payment solutions currently appear to be a risky business. Growth looks less promising and the short-term outlook is far from rosy. What’s behind that?

Discover Financial is highly dependent on net interest income and consumer spending levels. While the NII has seen some recovery due to lower funding costs, the company has seen stagnant growth in outstanding loan balances. This has limited NII’s growth potential in the near term. Additionally, consumer spending levels have improved in recent quarters. However, any sudden increase in the number of Covid cases or worsening economic conditions may adversely affect the current trend. In summary, we think Discover Financial stock is undervalued.

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Return Jan 2022

MTD [1] 2022

YTD [1] 2017-22

Total [2] Yield DSF 3% 3% 54% Return of the S&P 500 0% 0% 79% Return of the MS Trefis portfolio 0% 0% 292% [1] Monthly and year-to-date cumulative as of 4/1/2022

[2] Cumulative total returns since 2017

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