The pace of innovation in the payments industry has been extremely rapid, and the movement from card-based payment solutions to purer electronic commerce has made it essential for players in the industry to keep up. Discover Financial Services (NYSE:DFS) is no stranger to innovation, having been the first credit card provider to emphasize cashback rewards as a business model to attract cardholders, and it has worked hard to gain acceptance in expanding its network to rival those of its main competitors. PayPal Holdings (NASDAQ:PYPL) has used a different approach, beginning as a payment facilitator for online auctions but now taking full advantage of e-commerce opportunities and moving into in-person alternatives as well. For stock investors, which company is the better investment? Let's compare PayPal Holdings and Discover on a number of metrics to see which deserves your attention.
Valuation and stock performance
Both PayPal and Discover have struggled in their recent stock performance. PayPal shares have lost about 3% of their value since the first-day close following the e-commerce company's IPO roughly a year ago. Similarly, Discover stock is down about 6% since June 2015.
Even though the two stocks have performed roughly in line with each other, their valuations don't compare closely at all. PayPal takes on the characteristics of a high-growth stock, trading at about 32 times trailing earnings. Discover, on the other hand, resembles a beaten-down value stock, with a trailing earnings multiple of just 10.
Taking near-term future growth into account doesn't change the picture markedly. PayPal's forward earnings multiple is much lower than its trailing P/E, and the stock currently fetches about 20 times forward earnings estimates. However, Discover's forward P/E is less than 9. Based on valuation and performance, Discover looks more attractive than PayPal.
Another area where Discover tops PayPal is in dividends. Like many companies that are still in high-growth mode, PayPal hasn't yet started to pay a dividend to its shareholders. Instead, it reinvests most of its free cash flow back into growing its business, and it also uses stock repurchases from time to time to return capital to shareholders in an arguably more tax-efficient way for investors.
Discover, on the other hand, has a solid dividend history and pays a current yield of 2.1%. That's not stellar, but it's far more than what most of its credit card peers pay. Moreover, Discover has room to increase its dividend further if it wants, because it currently pays out only about a fifth of its earnings in the form of dividends. Particularly impressive is the fact that Discover has boosted its quarterly payout from $0.02 per share as recently as late 2010 to $0.28 per share currently. Investors also expect another dividend increase in the next couple of months, as the summer has historically been the time that Discover gives shareholders good news on the dividend front. In terms of dividends, Discover is an obvious winner.
Where PayPal shines is in the growth arena. Its efforts to expand have been exemplary, and although Discover has made progress, the nature of its future prospects will require more creative thinking in order to keep up with PayPal.
PayPal's growth rates have kept investors mostly satisfied. In its most recent quarter, PayPal grew its top line by almost a fifth, and that helped boost the bottom line by upwards of 40%. Mobile-device adoption has been a huge part of PayPal's success, with the company processing about $21 billion in total payments volume in mobile-facilitated transactions. Overall, growth in total payments volume amounted to about a third year over year, and the 184 million users it has in its payment network was 4.5 million more than PayPal boasted previously. International expansion plans and the prospect for entry into new markets are encouraging for PayPal.
Discover's performance hasn't been quite as optimistic. In the first quarter, loan growth of 4% was encouraging, but payment-services transaction dollar volume fell 10% from previous-year levels. Gains in net interest margin and card yield had a positive impact on profitability, but Discover faced challenges from the discontinuation of its mortgage origination operation. Still, Discover enjoyed a 4% rise in credit card loans, which make up almost 80% of the company's total loans outstanding. Investors were generally pleased with the progress Discover has made to become more relevant worldwide.
PayPal and Discover are very different stocks, and investors have to know their own preferences to make a smart choice. Value investors might prefer Discover, but PayPal's better growth prospects could be enough to persuade some growth-oriented investors to choose PayPal over Discover. Regardless, a growing pie in the payments industry could help both stocks rise over the next several years.
Dan Caplinger has no position in any stocks mentioned. The Motley Fool owns shares of and recommends PayPal Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.