3 Reasons Why You Should Buy Discover Financial Stock

Discover is one of the largest credit card services in the country, and investors have many reasons to check out its stock. Here are our top three.
By Chiradeep BasuMallick ,

There are several great reasons why you should pick up shares of direct banking and payment services company Discover Financial Services (DFS) - Get Report stock today.

The $23.49 billion company is one of the top players in the credit services space, going head-to-head with the likes of Visa, American Express, and MasterCard. The 30-year-old Discover is one of the largest card issuers in the country and also owns a leading ATM/debit network and global payments network, Diners Club International.

Discover's stock, up 6.27% year-to-date, looks to be in fine form and could deliver double-digit total returns over the next 12 months.

These details are intriguing, but here are the top three reasons that make Discover a great play for investors.

No. 1: The safe dividend haven

The company has grown its dividend for five straight years (since 2011), with a payout ratio of 2.11%.

This yield is way higher than the dividends of rivals Visa (0.71%), MasterCard (0.82%), and American Express (1.81%). The $515 million (2015) dividends in Discover are backed by an annual free cash flow of $3.6 billion (which has more than doubled in 10 years).

Earlier this month, Discover declared a 30-cent-per-share quarterly dividend, marking 7.1% growth from the prior dividend of 28 cents.

Additionally, the company's board also approved a new $2.5 billion share repurchase program. Share buybacks should help the company reduce its shares, allowing it to reward the shareholders who stick on. Remember, from 2010, DFS has reduced its share-count by 20%.

No. 2: The steady earnings curve

Annual profit growth of over 100% over the past decade is among the reasons why we believe Discover Financial is one of the best plays in the credit services sector.

With credit card industry trends turning favorable and brand loyalty staying strong (Discover ranks right up there in the top spot for the 20th straight year), Discover's strategy of riskier credits should continue to drive positive results.

Visa, MasterCard, and American tend to concentrate on top-tier clients, but Discover has consciously targeted lower-quality but solid borrowers.

Analysts are suggesting Discover will clock 7.62% per annum earnings per share (EPS) growth for the next five years, better than the 4.5% run-rate in the previous period.

Discover is also pulling out all the stops to come out on its own, beyond the shadows of the larger card networks.

What's helping the company is its steady commitment to cashbackrewards, earning it a good reputation. This, we believe, should help the company locate new ways to attract both merchants and cardholders.

No. 3: The cheap valuations metric

If we look at forward price-to-earnings, MasterCard is at a valuation of 22.37 times. Visa trades at a premium valuation of 23.8 times, while American Express trades at a discount of 11.5 times.

However, Discover Financial Services' valuation of only 9.3 times reflects a large gap.

We believe the opportunity of multiple expansions is clearer when you look at price-to-earnings-to-growth ratios. DFS trades at a PEG ratio of 1.31, compared to 1.7-1.8 times for MasterCard and Visa. This should soon change in favor of Discover.

Already this year, DFS has seen a stock rise of more than 6%, even as MasterCard shares dropped by 5% and American Express slipped by 7.7%.

This slow but sure trend toward DFS should continue.

Analysts project the stock will appreciate by nearly 9% in one year. Add the 2%-plus dividend yield to that, and you can well expect steady double-digit total returns.

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This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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