Up 14% YTD, What’s Next For Discover Financial Stock?

Discover Financial stock (NYSE: DFS) has gained roughly 14% YTD, as compared to the 24% rise in the S&P500 over the same period. Further, at its current price of $112 per share, it is trading at the same level as its fair value ($112) – Trefis’ estimate for Discover Financial’s valuation.

Amid the current financial backdrop, DFS stock has shown strong gains of 20% from levels of $90 in early January 2021 to around $110 now, vs. an increase of about 25% for the S&P 500 over this roughly 3-year period. However, the increase in DFS stock has been far from consistent. Returns for the stock were 28% in 2021, -15% in 2022, and 14% in 2023 (YTD). In comparison, returns for the S&P 500 have been 27% in 2021, -19% in 2022, and 24% in 2023 (YTD) – indicating that DFS underperformed the S&P in 2023. In fact, consistently beating the S&P 500 – in good times and bad – has been difficult over recent years for individual stocks; for heavyweights in the Financials sector including V, JPM, and MA, and even for the megacap stars GOOG, TSLA, and MSFT. In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Given the current uncertain macroeconomic environment with high oil prices and elevated interest rates, could DFS face a similar situation as it did in 2023 and underperform the S&P over the next 12 months – or will it see a strong jump?

The credit card giant posted mixed results in the third quarter of 2023, with revenues beating the consensus but earnings missing the mark. It reported net revenues of $4.04 billion, which is 17% y-o-y more than the year-ago period. It was primarily because of a 17% rise in the net interest income (NII), followed by a 13% increase in the discount & interchange revenues. Notably, the NII was up due to a 19% growth in the total interest-earning assets and a higher interest rate environment. On the cost front, provisions for credit losses witnessed an unfavorable increase from $773 million to $1.7 billion in the quarter. It led to a 34% decrease in the adjusted net income to $647 million.

The company’s net revenues grew 22% y-o-y to $11.66 billion in the first nine months of FY 2023. It was mainly driven by a 21% rise in the net interest income coupled with a 24% improvement in the noninterest revenues. Further, total card volume, a key metric, increased by 4% y-o-y over the same period. On the expense side, the provisions figure jumped from $1.48 billion to $4.1 billion, resulting in a 24% y-o-y decline in the adjusted net income to $2.47 billion.

Moving forward, we expect the Q4 results to be on similar lines. Overall, Discover Financial’s revenues are forecast to touch $15.61 billion in FY2023. Additionally, DFS’s adjusted net income margin is likely to drop in the year, leading to an annual EPS of $12.84. This coupled with a P/E multiple of just below 9x will lead to a valuation of $112.

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