“Discover” New Value in Red-Hot Credit Card Stocks

Nicholas Vardy

Nicholas Vardy has a unique background that has proven his knack for making money in different markets around the world.

The stock market rendered its verdict on the reelection of President Obama — and it was devastating. Both your Bull Market Alert portfolio and the broader markets were hit very hard, in what was the worst week for stock markets in recent memory.

The Dow Jones was down 2.12% and the S&P 500 dropped 2.43%. The MSCI Emerging Markets Index was down a relatively modest 1.44%.

You did have one big gainer, Stratasys, Inc. (SSYS), which soared 11.00%, and moved back to a BUY.

Six of your positions moved to a HOLD, including Bank of Ireland (IRE)Seadrill Limited (SDRL)Michael Kors Holdings Ltd. (KORS)CVR Partners LP (UAN)United States Natural Gas Fund LP (UNG), and PowerShares Listed Private Equity (PSP).

You were stopped out of two of your bets on the pharmaceutical sector — Medivation Inc. (MDVN) at a loss, and Novo Nordisk A/S (NVO) for a 5.1% gain.

Credit card stocks have been on a roll in 2012. Former Bull Market Alert recommendation Mastercard Inc. (MA) and current Alpha Investor Letter recommendation Visa Inc. (V) have risen about 25% and 41%, respectively, so far this year. Both market leaders, however, lag the big gains racked up by this week’s Bull Market Alert recommendation, Discover Financial Services (DFS).

And here’s why I still like Discover looking ahead.

Discover, of course, operates the well-known Discover Card with more than 50 million card members, as well as the Goldfish credit card business here in the United Kingdom.

Now, there is no doubt that Visa and Mastercard have more attractive brands than Discover. And that is reflected in the current value of the companies. Discover’s market capitalization is around $20 billion. Mastercard boasts three times that figure and Visa stands at $95 billion. But the opportunity with Discover lies in the fact that it is simply much cheaper than either one.

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First, with a trailing and forward price-to-earnings (P/E) ratio of nine, Discover trades at a fraction of its higher-profile rivals. Visa has a trailing P/E of 45 and a forward P/E of 17, while these same numbers for Mastercard are 27 and 18, respectively.

Second, although Discover isn’t growing as fast as either Visa or Mastercard, it still boasts average annual earnings growth estimates of 10.67% over the next five years. That puts Discover’s five-year Price Earnings to Growth (PEG) ratio at 0.8. And anything below “1,” by this measure, is a “screaming buy.”

Third, like its rivals in the credit card business, Discover has been reporting better than expected results as U.S. consumer confidence rebounds. In Q3, revenue grew 9.8% year-over-year to nearly $2 billion, comfortably beating consensus estimates. Earnings grew 2.5% year-over-year to $1.21 per share — topping expectations by an impressive 18 cents. The real secret of Discover’s strong performance may lie in its improving margins which hit 41.1%, up sharply from the previous year’s 15.4%.

Given better-than-expected results at Visa (V), I expect Discover to deliver the same when it announces earnings on Dec. 10.

And when you buy Discover, you won’t be alone. Some of the smart money out there that has invested in the Discover value story includes billionaire Ken Griffin’s Citadel Investment Group and Cliff Asness’s AQR Capital Management.

So, buy Discover Financial Services (DFS) at market today, and set your initial stop at $36.70. If you want to play the options, I recommend the April $45 calls (DFS130420C00045000). Janney Capital has a price target of $47 on the stock — about 15% above its current level.

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Portfolio Update

Bank of Ireland (IRE) fell 5.54% over the past five trading days. Bank of Ireland’s balance sheet continues to improve as Standard & Poor’s raised its ratings last week on five of IRE’s subordinated debt issues. IRE is now a HOLD.

National Bank of Greece SA (NBG) fell 3.04% last week. The Greek stock market is beating the markets of many financially stronger countries — including China. In fact, the 2012 performance of the Greek stock market falls just shy of the S&P 500, and even beats the Dow Jones Industrial Average for the year. NBG is a HOLD.

Seadrill Limited (SDRL) gave back 3.27%. The continuing acquisition of Asia Offshore Drilling Limited (AOD) shares took an interesting turn last Friday as SDRL will now launch an “unconditional mandatory offer” to acquire all issued and outstanding AOD shares. SDRL is scheduled to report earnings on Nov. 30. SDRL fell below the 50-day moving average and is now a HOLD.

Michael Kors Holdings Ltd. (KORS) lost 10.27% last week. KORS took a hit as retail competitors issued weak guidance last week. However, KORS maintains its #2 spot on the Investor’s Business Daily 50 list of top-rated stocks. KORS is scheduled to report earnings on Nov. 13. KORS is now a HOLD.

CVR Partners LP (UAN) fell 7.90% for the week. UAN reported inline earnings last Monday, posting $0.43 earnings per share vs. a $0.424 per share estimate, on net sales of $75 million. UAN issued positive guidance, including an estimated $0.50 increase in next year’s distribution based upon increased output from manufacturing expansion. UAN paid a $0.496 per common unit distribution Monday to unit holders of record as of Nov. 7. UAN is now a HOLD.

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Stratasys, Inc. (SSYS) was the bright spot in your portfolio last week, apparently unperturbed by the Obama win as it jumped 11.00%. As suspected, last week’s sell-off, based upon company-issued conservative guidance, was somewhat overdone. This allowed SSYS to buck the trend and manage a hefty one-week gain. SSYS moved to a BUY.

United States Natural Gas Fund LP (UNG) lost 1.06%. Natural gas dipped last week, as most energy-related commodities were lower across the board. UNG ended slightly under the 50-day moving average on Friday and is a HOLD.

PowerShares Listed Private Equity (PSP) lost 2.89%. Your bet on a “Romney win” took a hard hit last week, as President Barack Obama won four more years in the White House. Although the judgment was harsh, this selling overreaction likely creates a buying opportunity — as no one, not even the U.S. president, can diminish the innovative spirit of the American entrepreneur and private equity investor. PSP is now a HOLD.

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