Financials are the biggest beneficiaries of rising interest rates. When interest rates are higher, banks make more money from higher spreads between their cost of borrowing versus the interest they pay on deposits, explains Sean Brodrick, editor of Weiss Ratings' Wealth Megatrends.
Discover Financial Services (DFS) offers an array of direct banking and payment services to clients. You probably know Discover as a credit card company. But it’s a lot more than that. DFS is a bank.
Yes, its most important product is its self-branded credit card. But the company also engages in traditional banking such as savings, checking, certificate of deposit, debit cards and personal and student loans. These are all areas that could see growth in an expanding economy.
Their banking services, including a variety of bank accounts, home loans, student loans and credit card offerings, make up 95% of their pre-tax income. The checking and savings deposits are also a source of cheap funding that DFS will utilize to push out lending products with higher rates.
Unlike a traditional credit card issuer, Discover offers credit cards directly to customers without the need for banking partners. It also collects a fee from merchants on every transaction. And it also gets extra fees from late payments. All of these factors contribute to the company’s ability to offer credit cards with no annual fees.
Instead of relying on high transaction volumes like a standard issuer, Discover relies more on the balances of their cards. As consumers look to spend as everything opens up again, this means higher balances.
Management reported fourth-quarter results that exceeded expectations for both earnings and revenue; earnings per share of $2.59 beat the consensus by 8%. This was a sharp turnaround from pandemic-related losses suffered in the second and third quarters last year.
Discover posted a net interest margin (NIM) of 10.63% in the fourth quarter. Indeed, Discover’s NIM is best in class. If interest rates go higher, Discover’s NIM will go even higher. The full-scale reopening of America’s economy and an increasing labor force will help even more.
As the economy continues reopening and vaccines are fully deployed, banks and credit card companies will be able to lower their loan-loss provisions as we’ve already seen.
Discover has an exceptionally strong balance sheet, with about $25.7 billion in cash and investments, which can easily cover their total long-term debt of $21.2 billion. Discover pays a dividend of 1.8%, and it has a history of raising it. The company’s dividend has grown an average of over 9% per year over the last five years.
While Discover took a break from raising their dividend in 2020 because of the pandemic, they’ll look to continue increasing it soon. Analysts expect Discover will increase its dividend by an average of 17% per year over the next three years!
The company is also buying back their stock. On Jan. 19, Discover’s board of directors approved a buyback initiative of up to $1.1 billion, which will help maximize shareholder value and inspire confidence in the stock.
Discover has been trending higher since its fall in January, and it’s approaching overhead resistance around $100 per share. The stock has been coiling up below early January highs, and it looks to have begun breaking out.
Once Discover is able to break through, it should move to $120 per share. The Force Index, my favorite momentum indicator, is also bullish.