Rising Household Net Worth
Discover Financial is benefiting from the rising net worth of households. According to the Federal Reserves’ financial accounts, the nation’s household net worth figure now stands at $144.7 trillion after a $2.4 trillion spike in Q3.
Most credit-providing entities are currently benefiting from the increases in net worth, with year-over-years consumer loans growing by 6.2% and home mortgages by 7.8%.
Rising disposable income provides better interest coverage ratios across the spectrum, meaning that debt repayments are more consistent, in turn instilling confidence among lenders to amplify their outstanding loans; Discover is benefitting from this on a firm-wide basis.
The bullish macroeconomic factors are reflected in Discover’s latest earnings report, which got released in October.
During its third quarter, the firm experienced a 2.1% increase in its total quarterly loans versus the same time last year. Furthermore, credit card volume increased by $2.4 billion quarter-over-quarter, and payment services increased by $7.84 billion year-over-year.
Although expansionary monetary policy has ended, for now, I do believe Discover will benefit from widening yields in 2022. I’m concerned about growing delinquency rates and a 2.2x year-over-year increase in loan provisions. Still, I think this comes with higher demand, and the company has high-quality internal controls to ensure these matters won’t get out of hand.
Valuation & Liquidity Analysis
Discover is a deep value play at the moment as the stock is trading at a significant discount relative to its 5-year average. Discover stock is trading at a price-to-earnings ratio just below 7x, which is a discount of 34% from its five-year average. In addition, its PEG ratio of 0.02 means that the stock’s earnings growth is 50 times greater than its price-to-earnings ratio.
Furthermore, Discover’s price-to-sales and price-to-cash-flow ratios are in great shape. The firm’s price-to-sales ratio is trading at an 11.6% discount to its five-year average, while its price-to-cash-flow ratio is at a 35.8% discount to the sector.
A final matter I’d like to outline here is the firm’s liquidity. Discover has excellent liquidity with its current assets exceeding current liabilities by 1.26x. It’s critical for financial services companies to have strong liquidity metrics because their stock price tends to be very market-driven, and the market strongly dislikes a financial company with lousy liquidity.
Wall Street’s Take
Turning to Wall Street, Discover has a Moderate Buy consensus rating, based on four Buys and six Holds assigned in the past three months. The average Discover price target of $136.40 implies 19.6% upside potential.
Investors shouldn’t be worried about rising delinquency rates and the end of expansionary monetary policy because a rising yield environment will guide loan portfolio profits higher.
Furthermore, with record household net worth, we may still see rising demand and transactions in 2022, subsequently giving rise to Discover’s earnings.
Disclosure: At the time of publication, Steve Gray Booyens did not have a position in any of the securities mentioned in this article.
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