We recently compiled a list of the 10 Best Financial Stocks To Buy According to Hedge Funds. In this article, we are going to take a look at where Discover Financial Services (NYSE:DFS) stands against the other financial stocks.

The financial services industry in the US is poised for a dynamic and challenging year ahead, shaped by a confluence of economic, technological, and regulatory factors. The global economy is anticipated to grow modestly, with advanced economies like the US expecting around 1.4% growth. This is influenced by ongoing geopolitical tensions, climate-related disruptions, and persistently high inflation rates. These macroeconomic conditions are expected to significantly impact the operations and profitability of financial institutions. High interest rates have been a double-edged sword for the industry. While they have led to substantial increases in net interest income, particularly for larger banks, they have also driven up funding costs, especially for smaller and regional banks, squeezing their margins. According to Deloitte, the Federal Reserve’s monetary policy will be crucial, with expectations that rates will remain elevated initially but may decrease later in the year. This will necessitate careful management of the balance between deposit rates and lending rates to sustain profitability. Economic uncertainty and the potential for slower growth have prompted banks to increase their loan loss provisions as a precautionary measure to cover potential defaults. This trend is expected to persist, reflecting a cautious approach to managing credit risk amidst economic volatility and increased regulatory scrutiny.

Concurrently, the financial services sector is experiencing significant technological shifts. Advances in AI and generative AI are set to transform various aspects of the industry, from retail investing and fraud detection to insurance offerings. However, these advancements also introduce new risks, such as heightened fraud potential and the need for robust cybersecurity measures. On the regulatory front, changes are becoming more stringent, particularly around climate-related disclosures and sustainability. Financial institutions are required to adapt to these new regulations aimed at enhancing transparency and effectively managing climate risks. These regulatory changes, coupled with technological advancements, are forcing financial institutions to innovate and evolve their business models and strategies. Overall, banks and financial institutions must remain agile and proactive, navigating these multifaceted challenges to maintain profitability and drive growth in 2024. This will involve balancing the benefits and risks of high interest rates, managing loan loss provisions prudently, leveraging technological advancements, and complying with evolving regulatory requirements.

In a recent development, major U.S. banks withstood a hypothetical 40% decline in commercial real estate values in the U.S. Federal Reserve’s annual health test, which alleviated concerns about the banking sector amid rising interest rates. With increasing risks in the commercial real estate (CRE) sector, investors were keenly observing the Fed’s stress tests to gauge the exposure of American lenders at a time when pandemic-era work patterns have left office towers largely vacant, pushing vacancy rates to a historic high of 20%. Chris Marinac, head of research at Janney Montgomery Scott, commented, “In many ways, there should be a sense of relief that banks can endure a severe crisis. However, this doesn’t mean the Fed believes commercial real estate is in the clear. We are still in the early stages of this credit cycle”. The Fed’s stress tests evaluate banks’ balance sheets against a hypothetical severe economic downturn, including a 36% drop in U.S. home prices, a 55% plunge in equity prices, and an unemployment rate of 10%, reported Reuters.

Results of the stress test released recently showed that banks could continue lending to households and businesses in the event of a severe global recession and indicated the capital needed to be deemed healthy and to determine how much they can return to shareholders through dividends and buybacks. The 31 large banks tested demonstrated they had enough capital to absorb nearly $685 billion in losses. This test comes over a year after the collapse of mid-sized lenders like Silicon Valley Bank, Signature Bank, and First Republic, which sparked criticism that the Fed had underestimated banks’ vulnerabilities to rising interest rates, previously assuming rates would fall during a severe recession. Commercial office space is a significant concern, with $929 billion of the $4.7 trillion in outstanding commercial mortgages maturing in 2024, according to the Mortgage Bankers Association. This approaching maturity wall occurs amid declining property values and reduced rental income. Analysts foresee a challenging period for CRE, with banks still having “considerable concentration risks,” according to Moody’s Ratings. Of the banks tested, Goldman Sachs had the highest projected loan loss for commercial real estate at 15.9%, followed by RBC USA (15.8%), Capital One (14.6%), and Northern Trust (13%). One critique from analysts is that the Fed’s stress test did not include regional banks, which hold most of the CRE loans and are less regulated than their larger counterparts.

Over the coming months, senior leaders in the financial services industry anticipate a challenging landscape marked by high interest rates, increased regulatory scrutiny, and persistent inflation concerns. While these trends are familiar to industry veterans, many younger employees have not encountered such conditions before. According to Deloitte, leaders will need to guide their teams through uncertainty, focusing on navigating near-term challenges and identifying potential opportunities. Looking ahead, rapid technological advancements—including generative AI, cloud migration, heightened fraud and cyber risks, and the convergence of industries through embedded finance—will demand unprecedented agility from financial services leaders. Adapting to these changes will require creating new strategic pathways to align with evolving market dynamics. Throughout history, the financial services sector has often driven progress by helping organizations and individuals navigate economic and societal shifts. By the end of this decade, 2024 may be recognized as a pivotal year when the future began to materialize in tangible ways. Investing now in innovative products and services that foster positive outcomes could position firms for sustained competitive advantage in the years ahead.

Our Methodology

We leveraged Insider Monkey’s comprehensive database of 920 prominent hedge funds to identify the top 10 financial stocks with the highest level of hedge fund investment as of Q1 2024. These stocks are listed in order of increasing hedge fund ownership, providing insight into the most popular financial stocks among elite investors.

Discover Financial Services (NYSE:DFS)

Number of Hedge Fund Holders: 71

Discover Financial Services (NYSE:DFS) is in the spotlight due to several developments. Its $10 billion U.S. student loan portfolio is for sale, with Carlyle Group and KKR & Co as final bidders. BTIG rated Discover Financial Services (NYSE:DFS) neutral amid potential merger talks with Capital One. Positive trends in credit metrics and receivables are noted, though loan growth slowdown raises revenue concerns. On June 25, Deutsche Bank made a notable adjustment to its outlook on Discover Financial Services (NYSE:DFS). The investment bank reduced the stock’s price target slightly from $137 to $136, while maintaining a Hold rating. This revision was prompted by an updated earnings model and valuation for the second quarter of 2024. The update to the model incorporated recent trust data from April and May, which offered new insights into Discover Financial Services (NYSE:DFS) performance. Specifically, the data indicated that the company has shown a positive credit performance during this period. Positive credit performance typically suggests that the company is managing its credit risks effectively, with fewer defaults and better overall credit health among its customers. However, alongside this positive credit performance, the data also revealed a slowdown in the growth of card loans. This could imply that while the existing credit is performing well, the company is not expanding its loan portfolio as quickly as before. A slowdown in card loan growth might raise questions about future revenue growth and market penetration. This dual observation of strong credit performance but slower loan growth influenced Deutsche Bank’s decision to slightly lower the price target.

Discover Financial Services reported its latest quarterly earnings on April 15, 2024, surpassing expectations across the board. The company posted a normalized EPS of $11.58, exceeding estimates by $2.94. Revenue for the quarter totaled $14.21 billion, significantly exceeding expectations by $1.28 billion, marking a robust performance for Discover Financial Services in the latest reporting period. The number of hedge funds in Insider Monkey’s database owning stakes in Discover Financial Services (NYSE:DFS) grew to 71 in Q1 2024, from 43 in the preceding quarter. The consolidated value of these stakes is nearly $3.54 billion. Among these hedge funds, Glenn Greenberg’s Brave Warrior Capital was the company’s leading stakeholder in Q1.

Overall DFS ranks 10th on our list of the best financial stocks to buy. You can visit 10 Best Financial Stocks To Buy According to Hedge Funds to see the other financial stocks that are on hedge funds’ radar. While we acknowledge the potential of DFS as an investment, our conviction lies in the belief that AI stocks hold greater promise for delivering higher returns and doing so within a shorter timeframe. If you are looking for an AI stock that is more promising than DFS but that trades at less than 5 times its earnings, check out our report about the cheapest AI stock.

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Disclosure: None. This article is originally published at Insider Monkey.