Business is good at Discover

The credit card business is a real mixed bag these days. American Express (NYSE: AXP) is struggling with a serious revenue decline, while Discover Financial (NYSE: DFS) reports steady revenue growth.

Discover added $153 million in revenues during fourth quarter 2016. Its revenues grew from $8.946 billion in September 2016, to $9.099 billion in December. Over the course of 2016, Discover accumulated $360 million in additional revenues. It started the year with $8.739 billion in revenues and ended with $9.099 billion.

This was the reverse of the situation at American Express which lost $700 million in revenue in 2016. Amex started the year with revenues of $32.82 billion in December 2015 that fell to $32.12 billion a year later.

 

Discover vs. American Express

It looks as if Discover has a far better business model than American Express. After all a lot of Amex’s revenue decline comes from the loss of one cash cow – its’ now defunct exclusive card arrangement with Costco Wholesale (NASDAQ: COST).

Discover’s strategy of providing basic credit-card services with good customer service is paying off. Amex’s methodology of branded cards and exclusive deals is not.

Naturally this brings us to the all-important question: is Discover making money? After all American Express is still a very profitable company and a value investment despite its troubles.

Is Discover Making Money?

Discover is making a lot of money it reported a net income of $2.393 billion (nearly one third of its revenue) and a profit margin of 23.88% on December 31, 2016, ycharts data indicates.

Value investors will also like the fact that Discover is generating a lot of cash and float. It reported a free cash flow of $1.271 billion on December 31. To that we can add cash and short-term investments of $13.77 billion, $3.332 billion in cash from financing and $4.177 billion in cash from operations.

This and $92.31 billion in assets make Discover Financial a definite value investment. It generates lot of cash and maintains that cash for the long haul.

Discover is a Great Dividend Stock

Discover investors will share in that cash with a 30¢ dividend scheduled for February 7, 2017. That dividend is up two cents from last year when shareholders received 28¢. More importantly Discover’s dividend has tripled since 2012 when it was just 10¢.

Beyond the dividend, Discover owners also enjoyed a return on equity of 21.99% on December 31, 2016. That makes Discover a triple threat of an equity, a growth stock that is also value investment and a dividend stock. So it definitely deserves consideration for a place in your portfolio.

Quick and Dirty SWOT Analysis of Discover Financial

Okay so Discover is a great stock right now but what about the future? Skeptics will point out that the financial industry is changing quickly and dramatically. The change is being driven by disruptive technologies such as payment apps, blockchains, cryptocurrencies and e-commerce.

The best way to assess Discover’s future prospects is with a quick and dirty SWOT (Strengths, Weaknesses, Opportunities and Threats) analysis. Here it is:

• Strengths: good customer service, popular products, great reputation strong brand. Wide adoption in home market of the United States. Highly profitable business model that generates large streams of cash. High cash flow and lots of float.

 

• Weaknesses: Limited market Discover is only available in one country the United States. Heavy dependence on traditional plastic credit cards, a technology that is slowly but surely dying. Not adopted or used by all retailers.

• Opportunities: Payment apps like Apple Pay, Android Pay and Walmart Pay can make Discover available to many more customers. New payment solutions like Braintree, Apple Pay and Square will enable Discover large numbers of retailers without expanding its network. Growing use of electronic payments of all sorts by almost all segments of the population. Improved financial technology can reduce costs of operation while making expansion of markets easier. Technologies like blockchain promise faster money transfer and greater security.

 

• Threats: Digital Wallets like PayPal and Apple Pay offer a more flexible and easier to use alternative to credit cards. Cryptocurrencies like bitcoin offer the potential to create a more flexible and cheaper means of electronic payment, particularly when they are combined with gift cards. Growing competition from alternative financial products like gift cards and hybrid fintech providers such as Capital One (NYSE: COF). Increasing wage stagnation and growing income inequality in the United States threatens Discover’s middle class customer base.

My take is that Discover’s strengths; particularly its high level of float and customer service capabilities balance out the threats and weaknesses. Discover’s ability to take advantage of payment apps in particular opens up new possibilities for growth and additional revenues with little added expenditure.

The future looks bright for Discover because of its expertise. Please note that this is simply my opinion, so do your own research before making any stock purchases. Despite that Discover is well worth investigating, particularly if you are seeking a fintech stock to add to your portfolio.