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Is Discover Financial (DFS) a Good Pick for Value Investors?

Zacks Equity Research

Value investing is easily one of the most popular ways to find great stocks in any market environment. After all, who wouldn’t want to find stocks that are either flying under the radar and are compelling buys, or offer up tantalizing discounts when compared to fair value?

One way to find these companies is by looking at several key metrics and financial ratios, many of which are crucial in the value stock selection process. Let’s put Discover Financial Services DFS stock into this equation and find out if it is a good choice for value-oriented investors right now, or if investors subscribing to this methodology should look elsewhere for top picks:

PE Ratio

A key metric that value investors always look at is the Price to Earnings Ratio, or PE for short. This shows us how much investors are willing to pay for each dollar of earnings in a given stock, and is easily one of the most popular financial ratios in the world. The best use of the PE ratio is to compare the stock’s current PE ratio with: a) where this ratio has been in the past; b) how it compares to the average for the industry/sector; and c) how it compares to the market as a whole.

On this front, Discover Financial has a trailing twelve months PE ratio of 11.79. This level compares pretty favorably with the market at large, as the PE ratio for the S&P 500 comes in at about 19.51.

If we focus on the long-term trend of the stock the current level puts Discover Financial’s current PE among its highs. This suggests that the stock is overvalued compared to its own historical levels and thus it might not be a suitable entry point.

Further, the stock’s PE also compares slightly unfavorably with the Zacks classified Finance – Consumer Loans industry’s trailing twelve months PE ratio, which stands at 11.09. At the very least, this indicates that the stock is relatively overvalued right now, compared to its peers.

We should also point out that Discover Financial has a forward PE ratio (price relative to this year’s earnings) of 11.28 – which is faintly lower than the current figure. So it is fair to say that a slightly more value-oriented path may be ahead for Discover Financial stock in the near term.

PEG Ratio

While earnings are certainly important, it is essential to know how much you are paying for the growth of earnings as well. One can easily do that with the PEG ratio (ratio of the P/E to the expected future earnings growth rate).The PEG ratio gives a more complete picture of the valuation of a stock than the P/E ratio.

Discover Financial’s PEG ratio stands at 1.47, compared with the Zacks Finance – Consumer Loans industry average of 1.43. This suggests a somewhat similar level trading relative to its earnings growth potential right now.

Broad Value Outlook

In aggregate, Discover Financial currently has a Zacks Value Style Score of ‘A’, putting it into the top 20% of all stocks we cover from this look. This makes Discover Financial a solid choice for value investors, and some of its other key metrics make this pretty clear too.

For example, the EV/EBITDA for Discover Financial is just 9.56, a level that is lower than the industry average of 10.61. The EV/EBITDA multiple (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) is capital structure-neutral, as it takes into account the level of debt on a company’s balance sheet, not just its equity. Since the Finance – Consumer Loans industry is a debt-laden industry; it makes sense to compare based on this ratio too.

What About the Stock Overall?

Though Discover Financial might be a good choice for value investors, there are plenty of other factors to consider before investing in this name. In particular, it is worth noting that the company has a Growth grade of ‘C’ and a Momentum score of ‘A’. This gives DFS a Zacks VGM score—or its overarching fundamental grade—of ‘A’. (You can read more about the Zacks Style Scores here >>)

Meanwhile, the company’s recent earnings estimates have been mostly trending downwards. The current quarter has seen three estimates go higher in the past sixty days compared to three lower, while the full year estimate has seen three upward revisions and seven downward revisions in the same time period.

This has had just a small impact on the consensus estimate though as the current quarter consensus estimate has fallen by 2.7% in the past two months, while the full year estimate has inched lower by 1%. You can see the consensus estimate trend and recent price action for the stock in the chart below:

Discover Financial Services Price and Consensus

Discover Financial Services Price and Consensus | Discover Financial Services Quote

This negative trend is why the stock has just a Zacks Rank #3 (Hold) and why we are looking for in-line performance from the company in the near term.

Bottom Line

The Finance – Consumer Loans industry is characterized by stiff competition that weighs on the individual companies’ financials. The adverse impact of currency fluctuation has also been hurting the industry. Also, the future success of this space is dependent on the companies’ ability to adapt to technological changes and evolving industry standards, any failure in which might cause major decline in revenues.

Currently the industry carries a sluggish industry rank (Bottom 9% out of more than 250 industries), which dims the sparkle on Discover Financial stock too. As you can see below, the industry has also widely underperformed the broader market over the pat three years.

Thus, value investors might want to wait for analyst sentiment to turn bullish in this name first and for the price to correct downwards a bit, before investing in it.

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