Many of you reading this probably remember when cash-back credit cards were a fresh idea. In 1985, the retailer Sears launched the Discover card, which became among the first in the U.S. to offer a cash-back option, notes Richard Moroney, editor Dow Theory Forecasts.
Discover Financial Services (DFS) spun off into a stand-alone company in 2007 and is still best known for its cards. However, Discover provides a broad range of financial services for mostly middle-class customers, including student, personal, and home-equity loans, as well as payment processing.
This business diversity has helped the company deliver 27 consecutive quarters of higher revenue and positioned it to benefit from the expected rise in short-term interest rates over the next year or two.
Fundamentally, Discover has no serious weak points. Operating growth accelerated in the second half of 2017, with per share profits up 7% and sales up 11%. The loan portfolio reached $84.2 billion by the end of 2017, up 9% for the year and 28% since the end of 2013.
The company expects loan growth of 7% to 9% this year, with a slight increase in net interest margin. Analysts target sales growth of 8% and per-share-profit growth of 30% this year.
When a stock offers market-beating growth potential at a below-market valuation, we take notice. Discover trades at 13 times trailing earnings and 10 times the 2018 profit target, both at least 25% below the industry median.
Discover’s cash-back options extend to more than just its credit cards. Last year, the company spent $527 million on dividends and more than $2 billion on net share buybacks. Since cutting the dividend in 2009, Discover has boosted the payout by 1,800%.
The shares now yield 1.8%. In each of the last two years, the company announced a dividend hike in July, most recently a 17% increase. In addition, Discover has been repurchasing its shares aggressively ($8.5 billion over the last five years).
Outstanding shares declined 8% over the last year and 28% over the last fi ve years. Given the company’s recent history and growth outlook, we expect the buybacks and dividend increases to continue. Discover offers an appealing combination of growth and value.
