Bullish investors are hoping Discover bounce back from an underwhelming second quarter. The company, which was recently named consumers' favorite credit card in a J.D. Power study, is poised to benefit from its focus on attracting younger card users, who will continue to increase their buying power and overall transaction volume as they age. As consumers' favorite credit card, it seems likely that consumers will stick with Discover for longer, taking competition from other card issuers.
Last quarter, although Discover Financial Services posted a small year-over-year decline in profit, Discover still showed investors why they should stay with the company, as total loans continued to grow at an impressive pace, nearly 5% year over year, and personal loans increased more than 13%.
With this growth among young consumers comes risk, as younger cardholders typically tend to have higher delinquency rates than other card users. Concerns about this may be overblown, however. Despite Discover's relatively young user base, it has a credit card delinquency rate past 90 days due of only 0.77%.
Furthermore, because Discover Financial Services has not yet reached blue-chip status, investors can pick up shares of this stock at a discount and with a solid dividend yield, which is the higher than those of its competitors.
Discover and American Express pay higher dividends to compensate for the fact that they take on more risk than Visa (V) - Get Visa Inc. Class A Report and Mastercard (MA) - Get Mastercard Inc. (MA) Report by being one-stop locations for consumers' financial needs. That means they also feel compelled to offer better customer service, although judging from that J.D. Power study mentioned above, Discover seems to be winning.
This could be the reason that Discover outperforms in the future. Although Visa and Mastercard now are believed to be blue-chips, their job as intermediaries could be weakened with more competition and less focus on customers, whereas Discover will benefit from consumers' perceptions that Discover is necessary because it is actually originating loans. This puts Discover at an advantage right now as near field communication technology (think Apple's (AAPL) - Get Apple Inc. (AAPL) Report Apple Pay) threaten traditional credit cards.
Furthermore, Discover trades at a very low price-to-earnings ratio compared to the industry, leaving it with very little room to the downside.
Another important metric to use to compare the card companies is the price-to-cash-flow ratio, which will take into account the effect of delinquent accounts and changes in capital expenditures. Obviously, it will not affect Visa or Mastercard too much, but it still shows Discover with an advantage:
Discover remains poised to outperform, and this quarterly earnings call could be where Discover takes the next step. And if insider ownership is any indication, Discover will come out on top:
Investors should consider Discover Financial Services ahead of quarterly earnings.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.