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Why Should You Hold Discover Financial (DFS) in Your Portfolio?

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Discover Financial Services (DFS - Free Report) is well-poised for growth on the back of shift of payments to digital and cost-cutting measures.

Over the past 30 days, the stock has witnessed its 2021 and 2022 earnings estimates move 12.1% and 8.9% north, respectively.

As a direct banking and payment services company in the United States, the company is steadily gaining from its digital shift, primarily led by the COVID-19 pandemic.

Its fourth-quarter earnings of $2.59 per share beat the Zacks Consensus Estimate of $2.37 by 9.3% and also improved 15% year over year owing to contribution by its Direct Banking business.

Here we discuss the reasons for retaining this currently Zacks Rank #3 (Hold) company in your investment portfolio. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Discover Financial’s return-on-equity (ROE) reflects its growth potential. The company’s trailing 12-month ROE of 12.1% not only improved over the years but also compares favorably with the industry average of 5.6%.

The company’s organic growth contributed to its healthy revenue stream. This upside was mainly driven by higher net interest incomes and its other total income. Interest income of the company saw a CAGR of 8.1% from 2013 to 2019, which remains impressive to investors. Although in 2020, the company’s revenues — net of interest expenses — decreased around 3% year over year, we believe, the metric will recover in the upcoming quarters owing to its solid market position, expansion in the global payments business and an attractive core business.

Discover Financial’s cost-cutting measures also encourage us. It took various initiatives in response to the current environment, such as reducing account acquisition expense, cutting down on brand awareness and consideration activities, and lowering vendor and technology spend. The company made additional efforts in 2020 that enabled it to decrease $400 million from its planned expenses.

Its banking business provides significant diversification benefits and has been performing strongly over the past several years. Within this business, the private student loan portfolio grew significantly, evident from its eight-year (2010-2019) CAGR of 28.6%. In 2020, net interest income of this business slipped 2% year over year due to the pandemic. However, we expect this segment to continue performing well going forward.

Although the company witnessed pressure on its sales volumes due to lower spend on travel, retail, etc., it is bouncing back from the same. It saw an improvement in categories like grocery and retail.

However, the company’s provision for loan losses has been increasing over the last few quarters due to higher net charge-offs, rise in reserve build, seasoning of newer vintages and constant supply-driven normalization in the consumer credit line.

Shares of this company have rallied 27.3% in a year’s time, outperforming its industry’s growth of 14.7%.

Other companies in the same space, such as Synchrony Financial (SYF - Free Report) have gained 12.3% while Global Payments Inc. (GPN - Free Report) and Fiserv, Inc. (FISV - Free Report) have lost 4.5% and 9.9% each in the same time frame.

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