Discover Financial Services is an american bank which owns the Discover Bank, who is serving its clients via online and Diner Club International, the biggest debit card issuer in US. Besides its famous Discover Card, the company offers several banking services to its more than 50 M clients such as personal loans, student loans and retirement plans.
| 2018 | 2019 | 2020 | 2021 | 2022 | |
|---|---|---|---|---|---|
| Revenue | 12848 | 13989 | 12953 | 13221 | 15202 |
| Sh. Equity | 11130 | 11859 | 10884 | 13408 | 14590 |
| ROE | 24,43% | 24,78% | 10,42% | 40,40% | 29,92% |
| Dividend | 1,5 | 1,68 | 1,76 | 1,88 | 2,3 |
| Div. yield% | 2,45 | 1,94 | 2,05 | 2,08 | 1,99 |
The company's revenue has been rising significantly (from 12,9 B to 15,2 B USD) which means a rise by 4,3% annually. The shareholder's equity has also been rising, which is a good sign. As for its return of equity ratio, the company reaches 24-30% every year, except for 2020. Taking these into consideration, we use an average of 26% in our calculations.
Dividends had also increased year by year and reached 2,6% dividend yield by 2023 at the price of 109 USD.
Debt capital is an important tool for banks and other financial institutions as it fuels growth. In our evaluation we have used shareholders equity, return of equity, the growth of the equity and the cost of equity. Free cash flow to equity is discounted by the cost of equity.
Our calculation is based on the yield of an American 10-year treasury bond (3,9%) as a risk free return and the average equity risk premium (4,4%) in the US market during the last 80 years. Getting 10,148% for the cost of equity we’ve calculated with the 26% average return of equity. We expect that net income will grow by 2% per annum on long term.
This analysis helps us estimate shareholder’s equity and net income in the next 5 years. All profit that was not payed out as dividend remains at the company to increase the shareholder equity in the following years. By deducting the cost of equity from the extra cash generation we get the additional cash flow which is the basis of our calculation.
| 2018 | 2019 | 2020 | 2021 | 2022 | 2023E | 2024E | 2025E | 2026E | 2027E | TV | |
|---|---|---|---|---|---|---|---|---|---|---|---|
| Net income | 2720 | 2939 | 1135 | 5420 | 4366 | 4745,69 | 5687,4 | 6816 | 8168,6 | 9789,6 | 9985,4 |
| Cost of equity | 1480,5 | 1852,3 | 2219,9 | 2660,4 | 3188,3 | 3821 | |||||
| Excess Return | 2885,4 | 2893,4 | 3467,5 | 4155,6 | 4980,3 | 5968,6 | 26944,83 | ||||
| PV | 2626,8 | 2858 | 3109,6 | 3383,3 | 3681,2 | 18085,61 | |||||
| Value of company | V= | 48334,7 | |||||||||
| Fair Shareprice | P= | 184,48 |
At the time of the analysis the value of the company is 48335 M USD, this means 184,48 USD per share. Using a safety margin, our proposed price is 121,77 USD which is higher than the current share price (108,96 USD). At this price level our offer is: buy.
According to current share prices and other data:
| Stock | Price | Shouts | NI | P/E | BV/sh | P/BV | Revenue | P/ Sales |
|---|---|---|---|---|---|---|---|---|
| Allly Finance | 34,75 | 299,32 | 1120 | 9,2869375 | 37,16 | 0,935145 | 7500 | 1,386849 |
| Synchrony | 38,23 | 438,22 | 2410 | 6,9515148 | 30,25 | 1,263802 | 7700 | 2,175734 |
| Navient | 19 | 130,21 | 387 | 6,392739 | 24,09 | 0,788709 | 1310 | 1,888542 |
| FirstCash | 110,39 | 46,29 | 231,95 | 22,030408 | 41,96 | 2,630839 | 2930 | 1,744011 |
| SLM | 18,67 | 240,68 | 367,38 | 12,231193 | 6,88 | 2,713663 | 1130 | 3,976545 |
| DFS | 87,55 | 262 | 4366 | 5,2538021 | 55,68 | 1,572378 | 15202 | 1,508887 |
| average | 8,715596 | 1,666432 | 2,234336 | |||||
| Pe= | 145,23776 | 92,78691 | 129,6427 |
Using averages, the value of Discover Financial Services shares are around 92-145 USD, while FCFE analysis shows 184,5 USD. All these results mean that Discover Financial Services shares are significantly undervalued at the price of 108,96USD.
The valuation analysis above shows that DFS's shareholder's equity and revenue have been increasing. Its dividend has increased year by year and the current dividend yield is 2,6%.
The ROE (26%) is much higher than the cost of equity (10,148%) meaning that it creates real additional value.
According to the FCFE analysis, the fair price is 184,5 USD / share. Using margin of safety our target price is 121,77 USD. This price is confirmed by the competitor analysis as well, meaning that the company is undervalued.
Compared to its competitors, its price should be 118-122 USD. The actual price (108,96 USD) is less than our proposed price (121,77), so our proposal is: buy.
