A knee-jerk reaction?
An analysis of Discover’s (DFS) fourth quarter earnings indicates that the non-recurring charges were the biggest factor that contributed to the decline in net income. The other major factor was the increased operating expenses—including additional reserves for the future.
Revenue increased—excluding the charge on rewards forfeiture reserve. Discover card sales volume and discount and interchange revenue increased. Total loans grew. This resulted in higher net interest income. There was a slight decline in margins due to the additional expenses.
The decline in the stock price was primarily due to lower-than-expected earnings. Visa (V), MasterCard (MA), and American Express (AXP) recorded an increased net income during the quarter. The earnings surprise brought Discover’s stock price down by 5.8% in the session after the earnings release. Discover forms ~0.9% of the Financial Select Sector SPDR ETF (XLF).
The stock continued to decline for the week after the release. It fell more than 10%. However, perhaps as the market realized that there isn’t much to worry about regarding the company’s fundamental operations, the stock price recovered. The above graph shows Discover’s stock price since January 21, 2015—the day the earnings were released.
Guidance for 2015
Discover expects the revenue margin to decline “modestly” from 12.9% in 2014. The revenue margin is the bank’s total revenue, net of interest expense, expressed as a percentage of average loan receivables. The factors contributing to this expectation are:
- A slight decline is expected in the net interest margin, or NIM—driven by increasing funding costs and a small decline in asset yields.
- There’s an anticipated decline in revenue from protection products. Protection products’ contribution to the company’s total revenue is relatively insignificant.
- There’s an anticipated rewards rate of ~105 basis points, or bps.
- Lower revenue is expected from the payments segment.
In the next part of this series, we’ll look at the longer-term matrices and future prospects for Discover Financial’s stock.