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Discover Financial’s stock offers high return on equity

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Greater than 20% ROE

Return on equity, or ROE, is one of the most important ratios that investors need to look at. It tells how effectively a company’s management uses shareholders’ money.

Discover Financial (DFS) has been consistently generating ROE greater than 20% over the last four years. The only other company matching its performance in this space is American Express. American Express also generated over 20% ROE consistently.

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Discover’s average ROE over the last five years was 19%—compared to the 5% average ROE for large banks that participated in the 2014 CCAR (Comprehensive Capital Analysis and Review). The ROE for Discover, American Express (AXP), Visa (V), and Capital One (COF) are shown in the above graph. Financial services account for ~25% of SPDR Dow Jones Industrial Average ETF (DIA).

Although the returns are greater than 20%, there’s a slight declining trend in Discover’s ROE. This is most likely due to the ongoing investments that the company is making for growth. The company is also facing challenges in the debit market. This is directly hitting the top line.

Factors contributing to high ROE

Discover’s revenue is growing consistently. Part of the revenue growth comes from higher interest income attributed to rapid loan growth. In addition to increasing revenue, one more factor supporting Discover’s ROE is its regular share buybacks. Discover has good capital levels. This allows it to execute its share repurchase plans.

What’s the company’s strategy going forward? What are its focus areas? We’ll discuss this in the next part of this series.

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