Discover Financial Services (DFS), Morgan Stanley (MS): Giving Credit Where Credit’s Due

In an environment where scores of varied financial companies are looking at sluggish–if any–growth, it’s rare to discover one that looks appealing. But Discover Financial Services (NYSE:DFS) looks absolutely alluring.

Discover logoDiscover Financial Services (NYSE:DFS) is a direct banking and payment-services company that offers credit cards, student and personal loans, and deposit products through its Discover Bank subsidiary and home loans through its Discover Home Loans. Spun off from Morgan Stanley (NYSE:MS) in 2007, roughly three quarters of credit card-accepting merchants took Discover cards. Today, nearly of them all do.

Since 2007, Discover shares are up some 150%. In the past year alone, shares have climbed 25%. Morgan Stanley, however, hasn’t fared as well since shedding Discover. The firm has lost half of its market value over the past decade. Many questioned if Morgan Stanley (NYSE:MS) would survive the 2008 financial crisis. Still standing, the financial institution and its investment-banking division remain on shaky ground.

Once a highly revered and prestigious brand, Morgan was a true innovator of a cache of products and strategies that define what it means to be a contemporary securities firm. But, its franchise value is now questionable.

Stock trading, which accounts for about 28% of Morgan Stanley (NYSE:MS)’s revenue, just isn’t what it used to be. Despite benchmarks reaching records on numerous occasions, volume has been light when compared to previous rallies– that will definitely weigh on Morgan’s bottom line.

The investment firm recently reported solid Q1 earnings. It has been aggressively cutting costs and reducing headcount. But return on equity, a measure of how efficiently shareholder money is being deployed, dropped from 9.2% to 7.6%.

Despite swinging to a $1 billion profit compared to a $79 million loss in the same period last year, market participants remain skeptical and sent Morgan Stanley (NYSE:MS) shares down about 4.6% following the report.

On the other hand, the Discover franchise is just starting to be recognized as a foe to be reckoned with.

Discover owns its payment network, allowing it to collect merchant fees. Through cleverly crafted deals, like the recent one with PayPal, Discover can increase its merchant reach and grow its fee-based revenue.

Since launching the first cash-reward credit card in 1986, the Illinois-based company continues to debut a bevy of cards, many featuring no fees. While Discover cards don’t carry the same kind of cachet as credit cards from rival American Express Company (NYSE:AXP), they present their own kind of perks.

In addition, Discover acquired the esteemed Diners Club International card in 2008. Diners Club, established in 1950, offered the world’s first multi-purpose charge card. It truly revolutionized the way consumers and companies pay for products and services. Diners Club was then, and remains today a “clubby” and elite card accepted in more than 185 countries and by millions of merchants.

A recent Barron’s article pointed out that Discover trades at just 2.1 times estimated tangible assets, compared to American Express at 4.2 times. And, trading at 9.5 estimated 2013 earnings of $4.53 a share versus 13.8 for American Express Company (NYSE:AXP), Discover shares look tempting indeed.