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.