Credit cards are a
trillion dollar industry. In 2018, they were swiped nearly
45 billion times, paying for products and services worth just
under four trillion dollars. Americans owe around one point one
trillion dollars in credit card debt, about five thousand
seven hundred dollars each. The US consumer is
doing very, very well. Strong consumer sentiment, strong
retail spending, very low unemployment. All of those things are
great for the credit card industry. Giants like MasterCard, Visa
and Amex dominate the network market. Chase, Citi, Amex and Capital
One are the biggest issuers. A quiet but a steady and
perhaps lesser talked about competitor is Discover. We're not one of the
companies that's always out there talking about how great we are. The number one performing stock of all
financials in the S&P for a 10 year period is not
just an average company. Discover has the 10th largest credit
card portfolio in the world, despite a smaller footprint
outside of the U.S.. Still, there are 57 million
Discover cards out there. It's not really for the kind of
people that want to fly first class to the Maldives. Discover really is
kind of for the masses. When you think about the average
consumer and likely where they borrow and what their FICO scores
are, I think that they're right smack in the middle
of all these issuers. The Discover credit cards
topped the J.D. Power Customer Satisfaction
Survey in 2019. So how did they win
over the American middle class? To understand the credit card industry,
it's important to know the difference between a credit card
network and an issuer. The network is basically the digital
rails on which transactions are processed. A card issuer is the
company who actually takes on the credit risk. Discover and American Express
are both an issuer and a network. That gives them some
diversity in their business model. It also gives them a really stable
source of revenue, at least from the processing side. Very different from the credit side
of the equation where that could be a lot more profitable if they're
charging you 18, 20, 25 percent interest. But there's
also risk there. And it's also less predictable in
terms of the transactors and the revolvers. You know, people who are
paying their bills in full or people who carry debt
from month to month. Forty percent of
Americans are transactors. 60 percent carry debt
from month to month. We spoke with Discover CEO
Roger Hochschild over the phone. Our model is lend focused. We're looking for people and we make
most of our money from people who borrow money. American Express' model
is much more spend focused. For issuers American
Express and J.P. Morgan Chase interchange the top two
slots on purchase volume and outstanding debt. Citibank, Bank of America and Capital One
fill up slots 3 to 5. Discover is sixth. The Discover credit card was launched
in 1986 by Sears Roebuck, the largest retailer at the time. Back then it was part of Dean
Witter, which was part of Sears, and they launched during
Super Bowl Twenty. They had this commercial back
in early nineteen eighty six. They talked about the dawn of
Discover and they really pioneered two main categories cashback and
no annual fee. Sears wanted to expand into financial
services and decided to accept only this year's Discover
card at its stores. Many merchants actually viewed them as
a threat and they thought that accepting a Discover card meant they
were helping their rival Sears. So that actually really led to a
lot of hesitation and difficulty for Discover establishing itself. In 1993, Dean Witter Discovering
Company became a publicly traded company when it spun
off from Sears. Sears eventually filed for
bankruptcy in 2018. But that's another story. In 1997, Dean Witter Discovering
company merged with Morgan Stanley. The mid 2000s were eventful for
Discover and the barrier to entry didn't end at Sears front door. MasterCard and Visa were established
in the industry and Discover wanted in. In 2004, the Supreme
Court upheld a ruling in Discover's favor. Discover claimed that MasterCard
and Visa had harmed its business by preventing their member
banks from issuing credit cards from the Discover Network. They did everything they could,
including reaching out to merchants to tell them that taking
Discover would help S ears. After the Supreme Court ruling
Discover's business started taking off. G Consumer Finance Wal-Mart and
Sam's Club became card clients and pulls a debit card network was
acquired with more than 50 million cardholders, the company had
become a major player. In July 2007, only six months
before the Great Recession, Discover severed ties with Morgan Stanley and
started trading on the New York Stock Exchange as DFS. We just set up or our
finance department our treasury function. Luckily, we had a heritage that goes
all the way back, the Sears are being conservative lenders. In the midst of the downturn
t he company received welcoming news. Visa and MasterCard paid Discover nearly
$3 billion in damages after finally settling the lawsuit. Discover strategy remains simple charge
no annual fee, offer simple rewards like cashback, conduct all
business online 24/7 u.s.-based customer service and acquire and keep
the customers who will revolve a balance every month. There is a relentless focus here at
Discover on a limited set of businesses. You compare us to most other
banks that are big in credit cards the've got commercial real estate
, they have small business lending. We're focused
on consumers. That consumer is a prime borrower. 81 percent of Discover's customers have
a FICO score of 660 and above. Competitors like American Express
caters to a more affluent customer base with a higher average
FICO score and Capital One serves subprime borrowers with an average
score below that of Discover's customers. We might be more like
Toyota and American Express, maybe more like Mercedes. I would say the typical Discover
customer is probably a little bit more likely to be middle class or
even lower middle class, maybe more likely to be a parent, maybe more
likely to live in middle America. You know, we're not necessarily
talking about the affluent urban professionals that are more likely to
gravitate to, let's say, an Amex card or a chase card. According to the J.D. Power Customer Satisfaction Survey, Discover
has been voted number one every year since 2014,
except for in 2017. It's very difficult in this stage of
the game in the United States in a very mature market to grow
your business because so many people already have a card. But it's doing a really, really good
job of keeping the customers it has very satisfied with with
the value proposition that it's offering. I think sometimes these airline
mile cards get a lot more attention because that's just a
sexier kind of redemption, right? It's first class airport lounge,
all that fancy stuff. The fact is, though, we found that
about two thirds of credit card rewards chasers prefer cashback. Discover's balance sheet, reflects the
companies improving finances s ince the 2008 recession. The investors that are here looking
for, you know, high capital return, I mean, they've been roughly
around that 70 percent plus payout to investors through
dividends, share repurchases. And so it's about
having a high R.O.T.C.E. Having a very stable
but growing business model,. Maybe it's the Midwest heritage, we're
not one of those companies, that's always out there talking
about how great we are. And there are others who
do much more of that. But the last few years haven't stocked
up for the Discover stock in a one year and a
five year comparison. It underperformed that of the
S&P 500 and multiple competitors. On January 24, 2020, a day
after the company's earnings call the stock fell by 11 percent, the most
it had done in 10 years. It was announced that their share
of high risk customers, something called troubled debt restructurings, increased
by nearly 50 percent, something that has
worried investors. In an email to CNBC, the
Discover CEO Roger Hochschild said the market and individual stock prices can
be volatile from time to time. Our focus is on continuing to build
the long term value of the Discover franchise, which we believe will
be reflected in a stock's valuation over time. Data show that younger generations
aren't as enthused about credit cards, and though people as a whole
spend more and more on credit cards, revolving debt has declined nearly
every year in the past two decades, potentially hurting companies like
Discover, who depend on finance charges. If you want to continue to talk
to your shareholders and give them a successful story, you're gonna have to
come up with something that's going to look better than
just steady as it goes. It would not be surprising if in
time we see Discover either making an acquisition through merger with
another credit card issuer or being acquired by somebody bigger. In this day and age, it's hard to
know what's going to happen, but I would say, we have
a complete business model. We're strong on both sides of the
balance sheet, if you think about our lending products, but
also our deposit products. So I feel very good
about how Discover's positioned.
