Discover Financial Services (NYSE:DFS) shareholders have had their patience rewarded with a 25% share price jump in the last month. Looking further back, the 11% rise over the last twelve months isn't too bad notwithstanding the strength over the last 30 days.
In spite of the firm bounce in price, given about half the companies in the United States have price-to-earnings ratios (or "P/E's") above 17x, you may still consider Discover Financial Services as a highly attractive investment with its 7.8x P/E ratio. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's so limited.
With earnings that are retreating more than the market's of late, Discover Financial Services has been very sluggish. It seems that many are expecting the dismal earnings performance to persist, which has repressed the P/E. You'd much rather the company wasn't bleeding earnings if you still believe in the business. Or at the very least, you'd be hoping the earnings slide doesn't get any worse if your plan is to pick up some stock while it's out of favour.
View our latest analysis for Discover Financial Services
Does Growth Match The Low P/E?
In order to justify its P/E ratio, Discover Financial Services would need to produce anemic growth that's substantially trailing the market.
Taking a look back first, the company's earnings per share growth last year wasn't something to get excited about as it posted a disappointing decline of 12%. However, a few very strong years before that means that it was still able to grow EPS by an impressive 326% in total over the last three years. Although it's been a bumpy ride, it's still fair to say the earnings growth recently has been more than adequate for the company.
Turning to the outlook, the next three years should bring diminished returns, with earnings decreasing 1.1% per annum as estimated by the analysts watching the company. With the market predicted to deliver 12% growth per year, that's a disappointing outcome.
In light of this, it's understandable that Discover Financial Services' P/E would sit below the majority of other companies. Nonetheless, there's no guarantee the P/E has reached a floor yet with earnings going in reverse. Even just maintaining these prices could be difficult to achieve as the weak outlook is weighing down the shares.
The Final Word
Even after such a strong price move, Discover Financial Services' P/E still trails the rest of the market significantly. Generally, our preference is to limit the use of the price-to-earnings ratio to establishing what the market thinks about the overall health of a company.
We've established that Discover Financial Services maintains its low P/E on the weakness of its forecast for sliding earnings, as expected. Right now shareholders are accepting the low P/E as they concede future earnings probably won't provide any pleasant surprises. It's hard to see the share price rising strongly in the near future under these circumstances.
It is also worth noting that we have found 1 warning sign for Discover Financial Services that you need to take into consideration.
If you're unsure about the strength of Discover Financial Services' business, why not explore our interactive list of stocks with solid business fundamentals for some other companies you may have missed.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.