HomeMost PopularInvestingDiscover Financial's Foul Play Warrants a Second Look

Discover Financial’s Foul Play Warrants a Second Look

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Discover Financial Services DFS has had a run of good fortune, with soaring receivables growth, record deposit inflows, and an expanding net interest margin. They also exhibit a commendable performance in enhancing shareholder value. However, these positive glimmers are insufficient to mask the dark shadows of concern that lurk behind the scenes.

Discover Financial is a major player in the digital banking and payment services arena in the United States, offering a wide array of financial products including credit cards, personal, student and home loans, as well as deposit products with acceptance in more than 185 countries and territories.

Zacks Rank & Price Performance

DFS currently carries a Zacks Rank #3 (Hold). In the past month, the stock rose 6.9%, matching the industry’s increase.

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Return on Equity (ROE)

The ROE of Discover Financial stands at an impressive 27.2%, dwarfing the industry average of 12.5%. Its prowess in utilizing shareholders’ funds is certainly praiseworthy.

Rising Estimates

The Zacks Consensus Estimate for DFS’s 2023 earnings per share is pegged at a healthy $12.32. The Zacks Consensus Estimate for 2023 revenues stands at $15.8 billion, forecasting an 18.2% surge from the year-ago reported figure.

Key Drivers

Discover Financial has consistently witnessed a significant uptick in revenue growth in recent years. In the first nine months of 2023, its total revenues soared by 22% to $11.7 billion, propelled by a surge in net interest income, sustained growth in receivables, and an improving non-interest income.

With the Fed continuing to uphold a high-interest rate environment to combat inflation, DFS’s top line is anticipated to continue its upward trajectory. The sustainability of its high net interest margin in the future, however, remains a looming question. Discover Financial envisions the net interest margin to remain steady at 11% in 2023, in line with the 2022 figure.

Non-interest income contributed 21.1% to total revenues in the first nine months of 2023. Apart from interest income, the company also derives earnings through net discounts, interchange and loan fees. This metric surged by 10% in the digital banking business owing to a higher volume of late payments and improved discount and interchange revenues. The figure is anticipated to soar further with loans expected to grow in the mid-teens for 2023. The launch of its Cashback Debit product is aimed at capturing interchange fees and being able to cross-sell other products in the future.

The company’s Digital Banking segment steered majority of the revenues in the first nine months of 2023 and is likely to witness an upward trajectory, accompanied by a moderation in payment rates. Non-card products in the Digital Banking segment include loans provided to individuals through organic student loans, personal loans and credit card loans. DFS’s enticing value proposition and disciplined marketing approach position it favorably for growth alongside burgeoning consumer demand.

Enhanced transaction processing revenues stemming from escalated PULSE and Diners Club volume should bolster the Payment Services segment. Furthermore, the company continues to expand its Discover Global Network through strategic partnerships.

DFS has also declared a quarterly dividend of 70 cents per share in 2023. Its dividend yield of 3.2% outshines the industry average of 2.7%. Hence, Discover Financial presents an ideal choice for investors eyeing returns in the form of dividends.

Key Concerns

Despite these triumphs, several factors have been thwarting the stock’s progress of late.

Soaring costs are posing a threat to its margins. DFS’s total expenses surged by 14% in the first nine months of 2023 owing to escalated employee compensation, benefits and marketing expenses. It expects total operating expenses to climb by a low-double digit percentage in 2023.

The mounting provision for loan losses at Discover Financial is undermining its growth potential. It swelled by nearly two-fold year over year, reflecting anticipated delinquent loans in the future. Nonetheless, we are hopeful that a meticulous and strategic action plan will underpin long-term growth.

Stocks to Consider

Several better-ranked stocks in the broader Finance space include Arch Capital Group ACGL, CNA Financial Corporation CNA and HCI Group, Inc. HCI. Each of these companies presently carries a Zacks Rank #1 (Strong Buy).

The Zacks Consensus Estimate for Arch Capital’s 2023 and 2024 earnings indicates year-over-year increases of 58.1% and 1%, respectively. ACGL yielded a four-quarter average earnings surprise of 35.2%. The consensus estimate for 2023 and 2024 earnings has ascended by 0.4% and 0.1%, respectively, in the past week.

CNA Financial delivered a four-quarter average earnings surprise of 9.2%. The Zacks Consensus Estimate for CNA’s 2023 and 2024 earnings indicates year-over-year increases of 14.8% and 7.4%, respectively. The consensus estimate for 2023 and 2024 earnings has climbed by 2.8% and 5.3%, respectively, in the past 30 days.

HCI Group delivered a four-quarter average earnings surprise of a whopping 519.6%. The Zacks Consensus Estimate for HCI’s 2023 and 2024 earnings indicates year-over-year increases of 194.9% and 51.4%, respectively. The Zacks Consensus Estimate for 2023 and 2024 revenues suggests year-over-year jumps of 5.5% and 19.5%, respectively.

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Discover Financial Services (DFS) : Free Stock Analysis Report

CNA Financial Corporation (CNA) : Free Stock Analysis Report

Arch Capital Group Ltd. (ACGL) : Free Stock Analysis Report

HCI Group, Inc. (HCI) : Free Stock Analysis Report

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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