Monday, September 18, 2017 3:22:10 AM
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Most Attractive Stocks Feature for September: Discover Financial Systems (NYSE:DFS)
Discover Financial Services, a payment service and credit card provider, is one of the additions to our Most Attractive stocks for September. DFS was also a featured Long Idea in December 2014 and highlighted as an underappreciated stock in July 2016.
"Since 2011, DFS has grown revenue by 5% compounded annually. Over the same time, the company has grown after-tax profit (NOPAT) by 57% compounded annually, per Figure 1. The impressive NOPAT growth can be credited to margin improvement from 3% in 2010 to 29% over the last twelve months. DFS also earns a top-quintile 19% return on invested capital (ROIC).
Figure 1: Discover’s NOPAT Growth Since 2010
Sources: New Constructs, LLC and company filings
DFS Presents an Attractive Risk/Reward Trade-Off
DFS is down 19% year-to-date while the S&P 500 is up 11%. This price depreciation amidst solid fundamentals provides an attractive buying opportunity. At its current price of $58/share, DFS has a price-to-economic book value (PEBV) ratio of 0.6. This ratio means the market expects DFS’ NOPAT to permanently decline 40% from current levels. This expectation seems rather pessimistic for a firm that has consistently grown NOPAT over the past decade.
If DFS were to never grow after-tax profits from current levels, the economic book value, or no growth value of the firm, is $101/share – a 74% upside. If DFS maintains TTM NOPAT margins (29%) and can grow NOPAT by 4% for the next decade, the stock is worth $125/share today – a 115% upside."
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