Friday, April 13, 2012

DFS: Credit cards

Discover Financial Services (DFS) is a third-tier credit card company. I say "third-tier" because credit cards are like the Solar System. You have the big gas giants -- Jupiter and Saturn (Visa and Mastercard) -- and after that it's just rocks and ice and other assorted space debris, such as Earth, Mars, and the Discover and Diners Club cards.

The latter two are mainstays of the Riverwoods, Illinois company's business. But Discover is more than cards. It has a direct banking segment and operates a global credit-card payments network, PULSE.

DFS had the most bullish chart of six stocks added today to the Zacks top-buy list. I should say "re-added", because Discover Financial has been a perennial favorite for months, slipping on and off the list like a comet in the galactic clouds. (And enough with the space metaphors, already!)

I last wrote about DFS in February in an analysis that reached a positive conclusion about the company. That was at $29.35. The price has since moved to a high of $34.43 on March 23 and then dropped back in lockstep with the broad weakness in the markets.

It is presently trading at around $33, having come off of a correction low of $32.17.

DFS has been in a clear uptrend since Jan. 10, and nothing about the present correction changes that assessment.

Discover Financial has an extremely high return on equity of 30%, but with heavy long-term debt amounting to more than double equity -- a situation not uncommon in the financial sector.

Institutions own 86% of the company's shares and have bid up the price to the point where it takes $2.46 in shares to control a dollar in sales.

Although DFS lacks a commanding position in its sector, it has clearly found a business model that works. Earnings have accelerated every quarter but one since the 2nd quarter of 2010.

The company has undertaken several share buy-back programs. The most recent began last month and is scheduled to run through march 2014.

DFS is highly liquid, trading 4.9 million shares a day on average. There is an adequate selection of options with high open interest and narrow bid/ask spreads.

Implied volatility is at the bottom of its six-month range, at 29%. Options traders are pricing in a 68.2% chance that DFS will close between $30.26 and $35.74 a month from now, an 8.3% gain or loss.

Discover Financial next publishes earnings on June 21. The stock will go ex-dividend in July for a quarterly payout of 1.21% annualized.

Decision for my account: I've owned DFS since February. I'm presently playing it as a diagonal spread, long the July 29 call and short the July 33 call.

I screened the stocks using a tourney bracket with a one-month daily chart and a three-day half-hour chart, and then turned to a five-year weekly chart for the broad context in analyzing the bracket winner. See my essay "10,000 Charts" for a discussion of my screening methods.
Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decision decisions for his or her own account, and take responsibility for the consequences.

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