Despite its lofty valuation, Discover Financial Services (DFS 0.87%) is a firm many investors should put on their radar, and there are three reasons to do so.
1. A diverse set of businesses
Discover is in an interesting place. Most people think of it in the same light as payment network peers Visa (V -0.59%) and MasterCard (MA 0.15%), but they also understand it has a diverse banking business like Capital One (COF 0.90%) and Wells Fargo (WFC 2.74%).
Some may argue as a result of this reality, Discover has too much going on to warrant an investment. After all it has its payments business, a sizable credit card arm, it provides direct consumer banking services, and even issues student loans and offers mortgages. However, the exact opposite position should be the correct stance.
Source: Flickr / 401(K) 2013.
Many people laud the diversity of firms like General Electric and Berkshire Hathaway, and even the broader value of the diverse range of businesses that encompass the S&P 500. While Discover isn't at the level of those firms thus far, the range of services it provides gives it access to a diverse set of revenue streams that helps insulate it against losses.
In addition, this diversity also allows it to move from just a credit card company into one that can provide each and every financial service to its loyal customers, which will ultimately translate directly to its bottom line.
2. Staggering returns
Discover also has delivered remarkably high returns. The company highlights from 2009 to 2013 it posted a 19% average return on equity, whereas its large bank peers only managed a 5% return. Even in 2013, which was the return to normalcy for the financial sector, it also delivered crushing results relative to its perceived peers mentioned earlier:
|
Company |
Return on Equity |
Return on Assets |
|---|---|---|
|
MasterCard |
43.2% |
21.5% |
|
Discover Financial Services |
24% |
3.2% |
|
Visa |
18.7% |
13.2% |
|
Wells Fargo |
13.5% |
1.5% |
|
Capital One |
10.7% |
1.4% |
Source: S&P CapIQ
Again, these are not exact apples to apples comparisons, as the banking business model is indeed very different from the payments industry, but it's further evidence to the remarkable profitability at Discover.
Many people laud Wells Fargo for its profitability in the banking industry. But it is absolutely a reality to consider Discover nearly doubles the returns Wells Fargo posts. Throw in the fact Discover trades narrowly ahead of Wells Fargo at a 2.6 price to tangible book value, versus the 2.4 of Wells Fargo, and it's also evident the market currently isn't demanding a premium valuation for the leading profitability.
3. Remarkable loyalty
The fact is, credit cards and other financial services provided by banks is becoming an increasingly competitive industry with each passing day. Thanks to growing technological capabilities new firms are entering into the landscape at a dizzying pace, and entrenched firms are offering new products in efforts to further tighten the grip on current customers.
While Discover has been actively expanding its suite of products, it hasn't hurt how much its customers appreciate it. The firm has been among the highest in customer loyalty for 18 years in a row according to Brand Keys, and it has also seen the average age of its active accounts grow from 11 years to 12 years from 2009 to 2013, well ahead of the 8 years seen by the broader industry in 2013.
When you also consider it narrowly trailed American Express in the ranking for customer satisfaction from J.D. Power -- 812 for Discover versus 816 for AmEx and 767 for the industry as a whole -- there is also the reality its customers truly appreciate the services it provides.
This all matters because in the increasingly competitive financial landscape where switching firms and products has never been easier, firms whose customers truly enjoy it will be those positioned for success.
Its diverse range of businesses, strong profits, and striking loyalty are three great reasons to consider Discover, and those even exclude discussions on its impressive loan growth, great efficiency, and leading positioning in specialty markets. While these are three reasons to consider an investment in Discover, it turns out there are many more.
