Dividend stocks are everywhere, but many just downright stink. In some cases, the business model is in serious jeopardy, or the dividend itself isn’t sustainable. In others, the dividend is so low, it’s not even worth the paper your dividend check is printed on. A solid dividend strikes the right balance of growth, value, and sustainability.
Today, and one day each week for the rest of the year, we’re going to look at one dividend-paying company that you can put in your portfolio for the long term without too much concern. This isn’t to say that these stocks don’t share the same macro risks that other companies have, but they are a step above your common grade of dividend stock. Check out last week’s selection.
This week, we’re going to look at a dividend juggernaut of the future, Discover Financial Services (NYSE:DFS).
It’s all in the numbers
I know what you must be thinking, “But, the yield is only 1.4%! Why don’t I just go find a nice yielding CD instead?” The answer as to why you’re not going to do that is because Discover offers investors a chance to profit from significant price appreciation as well as dividend growth over the long term.
Discover’s fourth-quarter report tells you everything you need to know about where its business is headed. For the quarter, Discover’s total loans, credit card loans, and Discover card sales all grew by 6% as adjusted income rose to $1.07, return on equity hit a robust 23%, and credit card charge-offs hit a record low of 2.29%. Of course, things aren’t picture-perfect as credit card yields actually fell by 20 basis points to 12.16% from the year-ago period, but its overall net interest margin rose 34 basis points to 9.44%.
Record-low interest rates have spurred spending on multiple fronts and are serving to expand the credit services pie rather than pit expanding companies against each other. With multiple international markets largely untapped, and even numerous domestic channels still in their infancy, like mobile payments, processor/lenders like American Express Company (NYSE:AXP), and pure-play processors Visa Inc (NYSE:V) and Mastercard Inc (NYSE:MA) are no longer stepping on each other’s’ toes in order to grow their bottom line.
Credit, and debit, and partnerships, oh my!
One case in point that I’ve noted previously where Discover and American Express are at a distinct disadvantage relates to Visa and MasterCard acting strictly as payment facilitators and not lenders. This absolves Visa and MasterCard from any chance of payment default if the economy turns south. While that point does indeed have me favoring Visa and MasterCard, there’s a major counterpoint that demonstrates Discover can grow just as quickly. Because of its lending ability at an average rate of 12.16% in the most recent quarter and it’s considerably tougher lending practices since the downturn, even with the acceptance of what’s been a record low in net charge-offs, Discover’s return on equity can sometimes trounce that of Visa and MasterCard — or, at worst, run a very close second.
Domestically, processor/lenders like American Express and Discover are making waves by entering a market previously occupied by smaller credit service companies: prepaid debit cards. With the financial crisis a few years ago ruining many people’s credit, prepaid debit cards have become an instant hit and big moneymaker for credit service companies. American Express announced its intent to enter the prepaid debit card market in 2011 and announced a partnership with Wal-Mart Stores, Inc. (NYSE:WMT) last year. Discover, like AMEX, offers multiple prepaid debit card and gift cards, and with $37 billion being loaded on prepaid debit cards annually according to Bankrate Inc (NYSE:RATE), there’s a wide moat for everyone to take advantage.