For the last several years, the long-term trend toward a cash free society has lead to tremendous capital gains for shareholders of credit card companies. The figure below shows the outperformance of American Express Company (NYSE:AXP), Discover Financial Services (NYSE:DFS), Mastercard Inc (NYSE:MA) and Visa Inc (NYSE:V). It is expected that this trend has room to run, particularly in many emerging markets. Thus identifying reasonably priced companies with exposure to emerging markets should make for an excellent long-term investment thesis.
Out of the four companies shown above, Discover appears to be the winner, balancing long-term revenue growth with a reasonable ttm p/e valuation, lower price/sales and price/book valuation and excellent gross profit margin. The business model of American Express and Discover is somewhat different from that of MasterCard and Visa. The former hold the underling loans on their books, while the latter have a payment based “toll-road” model in which they collect a fee on the transaction without exposure to the underlying loan. In this sense, MasterCard and Visa are lower risk, which is reflected in a lower beta. However, it is hard to argue that these companies are not fully valued at the present time with ttm p/e values of 30.2 and 71.3, respectively. Discover, on the other hand, has good 5-Year revenue growth and an excellent gross profit margin. While revenue growth trails that of MasterCard and Visa the lower valuation seems to more than discount somewhat lower revenue growth.
|Company||TTM P/E||Price to Sales||Price to Book||Gross Profit Margin||ROE||5 Year Revenue Growth||Beta|
Background on Discover Financial Services
Discover Financial Services was previously a business segment of Morgan Stanley and was spun off shortly before the worst of the 2008 financial crisis. Carrying consumer loans on its books makes Discover inherently more risky than MasterCard or Visa. However, industry trends could also turn this potential liability into an asset for the company. This logic holds true for two reasons: first, the boom in high yield credit has pushed down the net charge-off rate for the company. In other words, it is cheaper for Discover to finance loans, which may translate into faster than expected net income growth. Second, non-performing loans have been steadily declining since the credit crisis as consumers have been more scrupulous about their use of debt. Moving forward, it is expected that fewer write-offs of non-performing loans could translate into better than expected results.