Better Buy: Mastercard vs. Discover

Which of these financial giants looks like a smarter pick right now?

Dan Caplinger
Dan Caplinger
Feb 17, 2019 at 10:17AM
Financials

The credit card industry has come a long way over the long run, and both Mastercard (NYSE:MA) and Discover Financial Services (NYSE:DFS) have survived to become major players in the payments space. Mastercard's payment network spans the globe, with billions of cards issued and the company participating fully in international growth. Discover has a more limited audience, but it also profits from the interest and fees it collects by offering its own cards -- even though that also introduces an additional risk to its business model.

Favorable conditions in the payment space have helped players across the industry, but different companies have used different strategies and seen their results vary. Investors looking at the payments industry want to know if going with Mastercard's larger scope is the smart move, or whether Discover is poised to push higher with its more diverse offerings of financial products. Let's look at Mastercard and Discover to see which one might be a smarter pick for those looking to buy shares now.

Check out the latest earnings call transcript for Mastercard and Discover.

Four credit cards on a table.

Image source: Getty Images.

Valuation and stock performance

Mastercard and Discover have seen their shares move in different directions lately. Mastercard has jumped more than 30% over the past year, but Discover shares are down about 6% since February 2018.

It's logical, given the performance of the two stocks, that Discover would look like it has the cheaper valuation, but the extent of the difference between the two is striking. Mastercard trades at nearly 40 times trailing earnings, compared with a trailing multiple of just 9 for Discover. Even when you use forward earnings estimates, the spread remains wide, with Discover trading at a bargain price of 7 times forward earnings, while Mastercard has a much higher forward multiple of 25. Discover looks like the more attractive stock using these traditional valuation metrics.

Dividends and capital allocation

Discover also has an edge when it comes to dividends. The financial company has a current dividend yield of 2.3%, compared with just 0.6% for Mastercard.

Mastercard has never really emphasized dividends, but that doesn't mean it hasn't boosted its payouts over time. Yet because the stock has done so well, even multiple double-digit percentage dividend hikes haven't resulted in any significant increase in its yield. However, Discover has also rewarded investors handsomely with dividend growth, as its quarterly payout has doubled since 2014 and appears poised to keep rising in 2019. For income investors, Discover looks like the smarter play.


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Growth prospects and risks

Where Mastercard and Discover really differ is in their growth potential. In its most recent quarter, Mastercard continued its impressive string of strong quarters, posting revenue growth of 15% that pushed adjusted earnings higher by 33% from year-earlier levels. The company enjoyed success across its global footprint, with international financials taking a hit from the strong U.S. dollar but posting solid growth in local-currency terms. In addition to investing in internal growth initiatives, Mastercard has had enough money left over to do extensive stock buybacks. Even with spending of more than $1.6 billion between September 2018 and January 2019, the card giant has $6 billion left in authorized repurchase capacity to make further buybacks.

By contrast, Discover has seen some growth setbacks, but its most recent quarter helped to put at least some of its concerns to rest. The financial company saw a 7% rise in revenue, which helped push adjusted earnings per share up by more than 30% from year-earlier levels. Loan growth was strong, but Discover has continued to have to fight in order to get merchants to accept its cards as readily as they take Mastercard's products. Moreover, Discover has credit exposure to its customers, and principal charge-offs jumped 18%, suggesting a potential downward cycle in credit quality for the company. Yet with its efforts to expand more fully into banking and other financial services, Discover has some growth opportunities that Mastercard isn't even trying to match.

Going with the comeback kid

Despite my admiration for Mastercard's strategic success, Discover looks like the better buy for investors right now. Even admitting the challenges that Discover has to overcome, its rock-bottom valuation and higher dividend offer rewards that Mastercard can't. Mastercard isn't a bad pick, but Discover has more room to run higher in 2019.