* All data are as of the close of Friday, February 27, 2015. Emphasis is on company fundamentals and financial data rather than commentary.
Over the course of this six-year long economic recovery, the Credit Services industry has been absolutely on fire, with all five of the nation's largest credit card companies beating the broader market S&P index as well as the financial sector as a whole by as much as 2.5 to 5 times.
What has been going so well for them? Three things, really: Americans are heavily indebted, interest rates have been at their lowest levels in U.S. history, and credit card default rates are the lowest they have been in decades.
First, "The average US household credit card debt stands at $15,611, counting only those households carrying debt," informs NerdWallet. "Based on an analysis of Federal Reserve statistics and other government data... American consumers owe $11.74 trillion in debt, an increase of 3.3% from last year," which is broken down into "$882.6 billion in credit card debt, $8.14 trillion in mortgages, $1.13 trillion in student loans."
Second, the U.S. Federal Funds interest rate at near 0% for some six years has lowered borrowing costs for everyone, including banks and credit companies. And yet, credit card companies still charge their customers a hefty 13 to 20% on overdue balances, as graphed below. That is quite the spread. It's no wonder the nation's top five credit card companies' profit margins range from 18.25% to 43.31%, with an average of 30.21%, some of the best profit margins to be found anywhere.
Third, thanks to lower interest rates and a recovering jobs market, fewer Americans are defaulting on their debts. "Current credit card debt figures support the notion of an improving economy, both in terms of net growth and the current exceptionally low charge-off rate (bad debt)," reports ValueWalk. "The current credit card charge-off rate of 2.89% is lowest since 1985, suggesting that most consumers possess the financial resources to remain current on their obligations."
These three warm breezes blowing across the credit landscape - increasing personal debt, ultra-cheap money awash in the marketplace, and decreasing defaults - have combined to form a very powerful tailwind lifting the nation's five largest credit card company stocks to the stratosphere, as graphed below.
Since the economic recovery began in early March of 2009, where the broader market S&P 500 index [black] has risen 210% and the SPDR Financial Sector ETF (NYSE: XLF) [blue] has risen 290%, all five credit card companies have beaten both benchmarks by miles - with Visa (NYSE: V) [yellow] rising 450%, MasterCard (NYSE: MA) [gray] rising 540%, American Express (NYSE: AXP) [green] rising 675%, Capital One Financial Corporation (NYSE: COF) [beige] rising 800%, and Discover Financial Services (NYSE: DFS) [purple] rising 1,075%.
Having already compared America's 3 Largest Credit Services Companies - Visa, MasterCard, and American Express - we'll now look at the next 3 largest U.S. companies in the space: Capital One, Discover, and Equifax Inc. (NYSE: EFX). Though Equifax is not a credit card company, it still belongs to the Credit Services industry as a provider of credit services including credit information, credit scoring, credit modeling, fraud detection and prevention, identity verification, mortgage appraisal/title/closing services, consumer and commercial financial marketing services, and other credit consulting services.
Interestingly, today's two credit card companies Capital One and Discover - which are ranked 4th and 5th in size - have outperformed the three largest card companies Visa, MasterCard, and American Express.
But before we get too excited over credit card companies' stellar performances over the past few years, we must acknowledge that those three easy breezes blowing in their sails described above may not always be so pleasant. Interest rates are about to enter a steady rise back to normal historical averages of some 5 to 6%, possibly as quickly as over the next 5 to 6 years. Given how American households and individuals are steadily accumulating more and more debt, rising rates will equate to rising defaults.
What is more, the credit card companies have themselves accumulated enormous debt over the years as they have taken advantage of ultra low interest rates to borrow on the cheap. The five largest credit card companies' debt as a percentage of their market caps rank as follows: Capital One at 111.07%, Discover at 82.76%, American Express at 74.66%, MasterCard at 1.49%, and Visa at 0%. Though MasterCard and Visa will not be so adversely affected by rising rates, investors ought to take note that higher borrowing costs could impact the other three companies' performances over time.
Looking forward to future earnings growth, the Credit Services industry as a whole is expected to grow quite robustly near and long term, as tabled below where green indicates outperformance while yellow denotes underperformance relative to the broader market.
Over the immediate two quarters, the industry is seen growing its earnings at some 1.51 to 1.91 times the S&P's average growth rate. Though slowing to a slight underperformance next year, the industry is expected to resume its market outperformance at a growth rate of 1.48 times the market's average.
Zooming-in a little closer, however, the next three companies in the space are expected to split perform, with the credit cards beginning to show signs of strain, as tabled below.
Over the immediate term, while credit services provider Equifax is expected to outgrow the S&P's average earnings growth rate this quarter slightly under-grow next quarter, credit card companies Capital One and Discover as seen shrinking their earnings in both quarters. Equifax then continues to beat Capital One and Discover next year and beyond.
Yet there is more than earnings growth to consider when sizing up a company as a potential investment. How do the three compare against one another in other metrics, and which makes the best investment?
Let's answer that by comparing their company fundamentals using the following format: a) financial comparisons, b) estimates and analyst recommendations, and c) rankings with accompanying data table. As we compare each metric, the best performing company will be shaded green while the worst performing will be shaded yellow, which will later be tallied for the final ranking.
A) Financial Comparisons
• Market Capitalization: While company size does not necessarily imply an advantage and is thus not ranked, it is important as a denominator against which other financial data will be compared for ranking.
• Growth: Since revenues and expenses can vary greatly from one season to another, growth is measured on a year-over-year quarterly basis, where Q1 of this year is compared to Q1 of the previous year, for example.
In the most recently reported quarter, Discover delivered the greatest trailing revenue growth year-over-year, where Equifax delivered the greatest trailing earnings growth. At the low end of the scale, Capital One and Discover split the slowest growth between them, with the latter in shrinkage.
• Profitability: A company's margins are important in determining how much profit the company generates from its sales. Operating margin indicates the percentage earned after operating costs, such as labor, materials, and overhead. Profit margin indicates the profit left over after operating costs plus all other costs, including debt, interest, taxes and depreciation.
Of our three contestants, Discover enjoyed the widest profit and operating margins, while Equifax contended with the narrowest.
• Management Effectiveness: Shareholders are keenly interested in management's ability to do more with what has been given to it. Management's effectiveness is measured by the returns generated from the assets under its control, and from the equity invested into the company by shareholders.
For their managerial performance, Equifax's management team delivered the greatest return on assets, Discover's team delivered the greatest return on equity, while Capital One's team delivered the least returns on both.
• Earnings Per Share: Of all the metrics measuring a company's income, earnings per share is probably the most meaningful to shareholders, as this represents the value that the company is adding to each share outstanding. Since the number of shares outstanding varies from company to company, I prefer to convert EPS into a percentage of the current stock price to better determine where an investment could gain the most value.
Of the three companies here compared, Capital One provides common stock holders with the greatest diluted earnings per share gain as a percentage of its current share price, while Equifax's DEPS over current stock price is lowest.
• Share Price Value: Even if a company outperforms its peers on all the above metrics, however, investors may still shy away from its stock if its price is already trading too high. This is where the stock price relative to forward earnings and company book value come under scrutiny, as well as the stock price relative to earnings relative to earnings growth, known as the PEG ratio. Lower ratios indicate the stock price is currently trading at a cheaper price than its peers, and might thus be a bargain.
Among our three combatants, Capital One's stock is cheapest relative to forward earnings and company book value, Discover's is cheapest relative to 5-year PEG, while Equifax's is the most expensive relative to all three ratios.
B) Estimates and Analyst Recommendations
Of course, no matter how skilled we perceive ourselves to be at gauging a stock's prospects as an investment, we'd be wise to at least consider what professional analysts and the companies themselves are projecting - including estimated future earnings per share and the growth rate of those earnings, stock price targets, and buy/sell recommendations.
• Earnings Estimates: To properly compare estimated future earnings per share across multiple companies, we would need to convert them into a percentage of their stocks' current prices.
Of our three specimens, Capital One offers the highest percentage of earnings over current stock price for all time periods, while Equifax offers the lowest percentages for all periods.
• Earnings Growth: For long-term investors this metric is one of the most important to consider, as it denotes the percentage by which earnings are expected to grow or shrink as compared to earnings from corresponding periods a year prior.
For earnings growth, Equifax's stock offers the greatest growth in all periods, while Capital One offers the slowest growth in all periods, with shrinkage over the near term along with Discover.
• Price Targets: Like earnings estimates above, a company's stock price targets must also be converted into a percentage of its current price to properly compare multiple companies.
For their high, mean and low price targets over the coming 12 months, analysts believe Capital One's stock offers the greatest upside potential and least downside risk, where Equifax's offers the least upside and greatest downside.
It must be noted, however, that Capital One's and Discover's stocks are already trading below their low targets. While this may mean increased potential for sharp moves upward, it may warrant reassessments of future expectations.
• Buy/Sell Recommendations: After all is said and done, perhaps the one gauge that sums it all up are analyst recommendations. These have been converted into the percentage of analysts recommending each level. However, I factor only the strong buy and buy recommendations into the ranking. Hold, underperform and sell recommendations are not ranked since they are determined after determining the winners of the strong buy and buy categories, and would only be negating those winners of their duly earned titles.
Of our three contenders, Discover is best recommended with 9 strong buys and 9 buys representing a combined 69.23% of its 26 analysts, followed by Capital One with 8 strong buy and 10 buy ratings representing a combined 66.67% of its 27 analysts, and lastly by Equifax with 2 strong buy and 5 buy recommendations representing 53.85% of its 13 analysts.
Having crunched all the numbers and compared all the projections, the time has come to tally up the wins and losses and rank our three competitors against one another.
In the table below you will find all of the data considered above plus a few others not reviewed. Here is where using a company's market cap as a denominator comes into play, as much of the data in the table has been converted into a percentage of market cap for a fair comparison.
The first and last placed companies are shaded. We then add together each company's finishes to determine its overall ranking, with first place finishes counting as merits while last place finishes count as demerits.
And the winner is… Discover by a number of credits, outperforming in 8 metrics and underperforming in 2 for a net score of +6, with Capital One coming in at a lower-case two, outperforming in 11 metrics and underperforming in 9 for a net score of +2, and Equifax in need of downgrading its own ratings, outperforming in 9 metrics and underperforming in 17 for a net score of -8.
Where the Credit Services industry is expected to outperform the S&P broader market significantly this and next quarters, underperform negligibly next year, then outperform modestly beyond, the next three American companies in the space are expected to split perform in earnings growth versus the broader market, with Equifax growing its earnings just a little better than credit card companies Capital One and Discover.
Yet after taking all company fundamentals into account, Discover Financial Services is discovered to have the more credit worthy financials, given its lowest stock price to 5-year PEG, highest cash over market cap, highest trailing revenue growth, widest profit and operating margins, highest return on equity, highest dividend yield, and highest strong buy analyst recommendation percentage - comfortably winning America's Next 3 Credit Services Companies competition.