As mentioned before, Discover is the number four credit card in the U.S., behind Visa, MasterCard, and American Express Company (NYSE:AXP). However, of these competitors, American Express is the only “fair” comparison, as Visa and MasterCard are not direct issuer of cards; instead, their cards are issued by other financial institutions. I would also like to briefly take a look at Capital One Financial Corp. (NYSE:COF), whose business model is very close to what Discover Financial Services (NYSE:DFS) wants to be when the expansion of their banking services is complete.
American Express Company (NYSE:AXP) issues both charge and credit cards to consumers and businesses worldwide, as well as providing travel expense services (like their famous Travelers Cheques). The two major differences between their business model and Discover’s is their international exposure and the absence of traditional banking services, like student loans and mortgages, which investors could see as a positive or negative. American Express Company (NYSE:AXP) currently trades at a relatively high 16.1 times earnings, however analysts project a 12% forward growth rate, which would justify the higher valuation if accurate.
Capital One Financial has the business makeup that Discover wants, which makes them perhaps the best comparison. Capital One has about $206 billion in loans, with about 40% of those in the form of credit card outstanding balances. They are actually very similarly valued to Discover at 8.5 times earnings.
While there are higher-growth (American Express Company (NYSE:AXP)) alternatives, and similar companies with established banking divisions (Capital One), Discover offers a cheap valuation and the potential for high reward if their mortgage division picks up and their PayPal partnership plays out. I’ll admit that the outcome of the PayPal deal is a bit uncertain (who knows how many of PayPal’s customers will get the Discover-issued cards linked to their accounts?), but if it catches on, Discover could benefit in an enormous way.
The article Low Valuation And High Potential originally appeared on Fool.com and is written by Matthew Frankel.
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