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Discover Financial Services (DFS) Earnings Preview: Closing The Valuation Gap

 March 14, 2013 12:20 PM

(By Rich Bieglmeier) Discover Financial Services (DFS) is expected to report earnings sometime next week. Yahoo Finance says it is Monday, and Zacks believes the announcement will be on Wednesday. Discover's investor's relations site says no events are scheduled.

If the credit services company does report earnings, let's talk about what to expect. Wall Street anticipates that DFS will earn $1.07 for the quarter. iStock expects credit card company to report earnings that will beat Wall Street's consensus number. The iEstimate is $1.10, a three cent upside surprise.

Discover is a direct banking and payment services company with one of the most recognized brands in U.S. financial services. Since its inception in 1986, the company has become one of the largest card issuers in the United States. The company operates the Discover card, America's cash rewards pioneer, and offers home loans, private student loans, personal loans, online savings accounts, certificates of deposit and money market accounts through its direct banking business.

[Related -Visa (V) Call Options Look For Rebound]

Usually, the orange card company delivers category 1 hurricane sized, bullish earnings surprises; topping the street consensus by an average of 84.42% 12 of the last 16 quarterly checkups. In fact, none of the 12 upside surprises were in excess of 28% with a 200% and 500% surprise topping the leaderboard.

Discover's stock gained ground seven times in the days surrounding bullish beats, moving higher by an average of 6.53%, remained flat once, and lost an average of -3.65% for the remaining four upside surprises.

[Related -Mastercard Inc (MA) Q3 Earnings Preview: What To Expect?]

Management failed to execute and meet the street's bottom line four times in the last four years. Bearish surprises were not met with the same mixed stock price performance as bullish beats. DFS investors watched their money shrink three times by an average of 6.3%. Only once did shares buck a negative EPS print, gaining a meager 2.10%.

Discover's stock is racing out to five-year highs on many levels as they prepare to turn in their earnings scorecard. As we type, DFS stock price is trading slightly below its 52-week and all-time high of $43.52.

The credit cards company's price-to-book (P/B) and price-to-sales ratios are hitting multi-year highs along with the stock price. At the moment, DFS trades at 2.358 times its book value, which is a smudge lower than the five-year high of 2.358 and well above the average of 1.476.

However, the financial P/B might not be too high when compared to American Express Company's (AXP) 3.82, Mastercard Incorporated's (MA) 9.40, and Visa Inc.'s (V) 3.82. In fact, DFS looks like a steal relative to these high fliers.

Price-to-sales are significantly less important for a financial company than P/B; it's a metric still worth watching. Once again, we find that Discover is trending slightly below its five-year high of 2.5 at 2.495. But again, with the exception of AXP's P/S ratio of 2.44, Discover is a bargain compared to MA's 8.76 and V's 9.83 price-to-sales ratios.

Overall: Discover Financial Services (DFS) shares are pricey relative to its history, but heavily discounted against its peers on a P/B and P/S basis. If the company can deliver another super-duper EPS surprise, and muscular guidance, perhaps, Discover's shares can continue to close the valuations gap.
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