Market Mad House

In individuals, insanity is rare; but in groups, parties, nations and epochs, it is the rule. Friedrich Nietzsche

Long Ideas

Capital One and the Value in Finance

Capital One (NYSE: COF) has become one of the most interesting value investments in banking and finance, because of its technological capabilities and customer service.

I have had a Capital One 360 savings account and a Capital One investment account for many years, and a Capital One 360 checking account for over a year. Guess what, they’re great and getting better largely because the technology actually works.

Best of all is the new Capital One App for my phone, which really works as advertised. I can actually see my account balances in real time on it, so I know how much money I have. More importantly, it has a fingerprint lock that makes the app secure but easy to open.

Checking my balance and making transfers has never been easier. The account also works pretty well, for example, I’ve only had one or two overdrafts and the fee was low around $10. More importantly, the few times I have called Capital One for customer service, I’ve gotten through to an actual human being and had my demands met.

The only Capital One feature that does not work is Zelle, the peer to peer (P2P) money-transfer app. To be fair; Zelle is not the work of Capital One, but of a network of financial institutions called Xchange. I have to wonder why Capital One did not build its own P2P from scratch or tap an existing proven technology such as PayPal’s Venmo.

Is Capital One Making Money?

It was this ease of use and satisfaction that convinced me to look into Capital One as an investment and I was not disappointed there either. Capital One offers growing revenue, lots of cash, and a respectable dividend and a nice return on equity.

The best part of Capital One’s 3rd Quarter Financial report was the revenue, which keeps growing and growing. Capital One reported revenues of $23.03 billion in September 2015; that expanded to $25.13 billion in September 2016 and $26.79 billion in September 2017.

That means Capital One added $3.76 billion in the last two years and $1.66 billion in the last year. Those numbers justify Capital One’s decision to buy Ing’s online banking business and all the investments in credit cards. The financial services business at Capital One is growing and generating more cash.

Capital One reported a free cash flow of $2.775 billion, $8.484 billion in cash and short-term investments, and $12.09 billion in cash from operations on September 30, 2017. The cash from operations was up from $10.61 billion in September 2015, and $10.98 billion in September 2016.

Although all is not well in the world of Capital One, the net income has been shrinking for the last two years. Capital One reported a net income of $4.129 billion in September 2015, that fell to $3.88 billion in September 2016, and $3.744 billion on September 30, 2017.

Capital One’s Business is Growing but Less Lucrative

This demonstrates that Capital One’s business is growing but becoming less lucrative.

The company needs to do more to control expense and increase the more profitable aspects of its business. An obvious solution might be to find better ways to market credit cards; perhaps Samuel L. Jackson and Jennifer Garner’s salaries might be better spent elsewhere.

One obvious strategy would be increased investment in social media and more modern marketing. A potential solution might be sentiment based-social media marketing driven or directed by artificial intelligence.

Another potential solution would be more investment in next-generation financial technologies such as mobile-payment apps and cryptocurrency. Ethereum and debit cards that convert altcoins into fiat currencies are two technologies that might be lead to lucrative streams of revenue.

New Sources of Revenue Capital One can Tap

A strategy for Capital One would be to expand its international business into new markets. Extensive investment in phone-based apps, peer to peer (P2P) money transfer, prepaid debit cards might give Capital One the vehicles it needs to enter developing markets like India.

FILE – In this July 18, 2013, file photo, a woman uses a Capital One Bank automated teller machine in New York. Capital One reports quarterly financial results on Thursday, July 17, 2014. (AP Photo/Mark Lennihan, File)

Beyond that, Capital One should develop alliances with tech companies such as Alphabet (NASDAQ: GOOG), Apple (NASDAQ: AAPL), and PayPal (NASDAQ: PYPL). Offering PayPal or Venmo-enabled credit and debit cards, and working with Alphabet’s Android Pay and TEZ, PayPal’s Venmo P2P app, and Apple Pay might help Capital One expand its business especially among millennials (people under 35) that prefer using phones to plastic cards for payment.

A major opportunity for Capital One would be to replace Zelle with TEZ; the P2P app and mobile wallet combination, Alphabet (NASDAQ: GOOG) is testing in India. An advantage to TEZ is that it works with QR Code; which would enable its use at more than 5,000 Walmart (NYSE: WMT) and Sam’s Club stores in the United States.

Another opportunity would be to add QR code capability to the Capital One App so it can be used at Walmart stores. Walmart’s quick-read (QR) code based solution Walmart Pay is one of the fastest growing digital wallets in America.

Finally, Capital One should seriously consider developing or buying a combination prepaid Visa and MasterCard/digital wallet that converts cryptocurrency to fiat currencies. Excellent candidates would be Centra, Uquid, Shake Pay, and TenX all of which have working products. Another excellent idea would be to create an Ethereum-based marketplace for blockchain investments.

The Value of Capital One

Despite its problems, there is still a lot of value at Capital One; including $361.40 billion worth of assets on 30 September 2017, and an enterprise value of $95.17 billion on 7 December 2017.

Investors enjoyed a modest return on equity of 7.7% on 30 September and a dividend of 40¢ at Capital One on 10 November 2017. The dividend has not increased since May 2015 when it rose from 30¢ to 40¢.

The lack of dividend growth is a good sign because it means Capital One’s management is using the extra cash for other purposes such as better technology. It also means this company might be poised for dividend growth in the near future.

Capital One is a good solid company and a value investment. It makes money and is well-positioned to take advantage of the ongoing revolution in consumer finance. That makes Capital One a slight value buy right now, and a good contrarian play for those betting against companies like PayPal.


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