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Discover Keeps Cooking With 27% Return on Equity (Update 1)

Investors should also consider Discover's forward earnings multiple. The company's shares closed at $44.33 Tuesday, trading for 9.3 times the consensus 2014 earnings estimate of $4.77, among analysts polled by Thomson Reuters. That is a pretty cheap forward P/E, when considering the company's return on equity and continued growth.

KBW analyst Sanjay Sakhrani rates Discover "outperform," with a $48 price target, and said in a note to clients late on Tuesday that "following 1Q13 results, we came away incrementally positive on Discover given the solid underlying operating trends and multiple avenues of earnings upside."

"While probably not having the longest runway to the upside of our [outperform-rated] names to its shares, trading at less than 10x our 2014 EPS estimate, we believe that current levels discount the quality of the company/earnings as well as the multiple-enhancing traits of the network," Sakhrani wrote.

KBW estimates Discover will earn $4.66 a share this year, with EPS declining to $4.50 in 2014.

Discover's shares were down slightly in late morning trading, to $44.26. The broad indexes were all down slightly, after the U.S. Census Bureau reported that durable goods orders declined 5.7% in March after rising 4.3% in February. Orders excluding transportation were down 1.4%. The average estimate among economists polled by Thomson Reuters is for durable goods orders to fall by 2.8% in March, with core durable goods orders rising 0.5%.

FBR analyst Scott Valentin on Wednesday reiterated his "outperform," rating for Discover, with a $48 price target, saying in a note that the company's growth in card balances was mainly due to the success of the Discover "It" card, which, he writes, "was marketed heavily in 1Q13 and 4Q12."

"Discover is taking market share as evidence by stronger-than-peer average receivable growth," Valentin wrote, adding "we expect Discover to continue to gain share due to continued Discover "It" marketing." FBR estimates that for all of 2013, the company's card balances will grow by 4.5%.

Valentin expects Discover's net interest margin to remain "relatively stable," in a range of 9.3% to 9.4% through the end of the year, because of "general pricing discipline" and declining funding costs. When discussing the prospects for success of several growth initiatives, the analyst wrote "at present, payment services account for only 5% of income. If Discover were to grow these businesses, we believe it should trade above 10x earnings."

Discover repurchased 6 million common shares during the first quarter, for $238 million. The company said its share count was reduced by 1%. The company has a $2.4 billion buyback plan in place.

"We believe the combination of stable credit, high ROE (~20%), large return of capital (~100% of earnings in 2012), and increasing receivables market share makes Discover an attractive investment at current valuations," Valentin wrote.

JPM Chart JPM data by YCharts

Interested in more on Discover Financial Services? See TheStreet Ratings' report card for this stock.

-- Written by Philip van Doorn in Jupiter, Fla.

>Contact by Email.


Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.
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