Has Discover Financial Services (NYSE: DFS) Recovered From Its Bad Loans?

Discover Financial Services (NYSE: DFS) third quarter earnings report spooked investors given that the company reported a higher allocation for bad loans than most investors and analysts expected. The company’s allocation for charge-offs, which are loans that the company deems unrecoverable, increased by 42% to $517 million, which caused a major sell-off in its stock price.

Article Summary

Discover had a poor third quarter as it increased its provisions for bad loans.

The company faces stiff competition from American Express and others.

The company pays a good dividend, which is quite secure.

Here’s the trading report on DFS.

The company found itself in a major conundrum having to convince shareholders that the company’s loan business was performing well by highlighting the fact that its loan business was growing. This was especially difficult as the company’s provision for loan losses, which are loans whose payments are yet to be collected, increased by 51% on an annualized basis to reach $674 million.

Discover faces stiff competition from the American Express Company (NYSE: AXP), which has a similar business model, but has a lower percentage of charge-offs. However, the company’s CEO recently assured investors that Discover was fully focused on the prime credit market, which is more lucrative and has lower levels of loan defaults.

The company will have to compete aggressively with other lenders such as AmEx who also target the premium credit market in order to minimize the risk posed by loan losses and charge-offs. More diversified financial services companies such as JPMorgan Chase & Co. (NYSE: JPM) might be a better bet for investors who want to minimize the risk on their invested capital.  

The company has attracted many dividend growth investors who have benefited greatly from Discover increasing its dividend payout every year since 2010. The company’s quarterly dividend has grown by over 1,650% from $0.02 in 2010 to the current $0.35. However, the company’s dividend payout might be at risk in the event of a major financial downturn as it might be forced to write off 13% of its loan portfolio, according to the latest Fed stress tests.

Finally, it is not enough to know that a stock is likely to head higher, or lower this year. As an investor or trader, it is important to time your entry and exit points accurately in order to minimize risk and maximize your profit potential.

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