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2 Words on Capital One: Keep Buying

- By Jonathan Poland

I'm not just saying investors should keep buying Capital One Financial Corp. (COF) because it's my bank and credit issuer, or because March Madness brings back all the funny basketball commercials with Charles Barkley, Samuel L. Jackson and Spike Lee. Since first discussing the bank in November, the stock has fallen close to 10%, only sweetening the long-term investment prospects.


Capital One Financial reported strong earnings gains for 2018, profiting from a sizable tax benefit and sales of the businesses it exited during the year, which included retail brokerage, mortgage portfolio and trust and asset management. It also repurchased $1.2 billion worth of stock, helping to further boost earnings per share. This divestiture should improve margins without dragging on profits as it rolls out a national banking strategy and new credit card products.

Capital One Cafes as well as a greater push toward technology will also boost profitability. Banking and credit services are only becoming more valuable to the market as society as a whole gains wealth and seeks growth. Remember that it signed an agreement to be the sole provider of Walmart's (WMT) private-labeled credit card program last July. The program's earnings will be coming in on the back half of this year.

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Capital One still looks highly undervalued when compared to other large credit providers and regional banks. Take SunTrust (STI), for example, which generates $2.7 billion in net profit on $9 billion in revenue and carries a market cap of $27 billion. It has a price-earnings ratio of 10, a price-sales ratio of 3.8 and price-book ratio of 1.20.

While it does operate on lower margins, Capital One generates $5.72 billion in net income on $27 billion in revenue and carries a market cap of $39 billion. It's priced at 7 times forward earnings, 1.5 times sales and 0.75 times book. Is SunTrust a better bank? No. If Capital One were valued on par in terms of price multiples, its stock would trade 30% to 100% higher, especially if it earns over $11 per share again in 2019.

The market will likely undervalue banks compared to direct-to-consumer credit providers like American Express (AXP) or lower tiered Discover Financial Services (DFS), but for industry leaders Mastercard (MA) and Visa (NYSE:V), banks are the distribution network. Capital One is better than most. The market will come to realize it again soon enough.

Disclosure: I am not long or short any stocks mentioned.

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This article first appeared on GuruFocus.