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Capital One: Should We Buy Before the Price Recovers?

GuruFocus.com
·7 mins read

- By Robert Abbott

Since January 2020, the share price of Capital One Financial Corporation (NYSE:COF) has taken a beating and then recovered somewhat:

Capital One: Should We Buy Before the Price Recovers?
Capital One: Should We Buy Before the Price Recovers?

Capital One is a credit card company that offers third-party versions of cards from Visa (NYSE:V) and Mastercard (NYSE:MA). In addition, it has added other lines of business, both organically and through acquisitions. It now has three main business segments:

  • Credit Cards: This branch serves customers and small businesses in the U.S., as well as in the United Kingdom and Canada. In the second quarter, this segment accounted for 64% of the company's revenue.

  • Consumer Banking: Branch-based operations gather deposits and make loans to consumers and small business customers.

  • Commercial Banking: Focused on companies with annual revenues between $20 million and $2 billion, this segment takes in deposits, makes loans and offers treasury management services to commercial real estate and industrial customers.




According to the infographic available on its Summary page at GuruFocus, it seems modestly undervalued now. That indicates the stock is available at a bargain price, but it that enough to make it a buy? Let's take a look.

Financial strength

Capital One: Should We Buy Before the Price Recovers?
Capital One: Should We Buy Before the Price Recovers?

Since the GuruFocus system gives Capital One just a 3 out of 10 rating for financial strength and a "Severe" warning label on its debt, we need to be cautious about it.

The first four lines on the financial strength table tell us that while the company does have debt, it is mostly on par with its competitors and peers in the credit services industry. The three light green bars under "Vs Industry" indicate it is mostly in the same ballpark.

Turning specifically to the first line, the cash-to-debt ratio is 1.26, where a ratio of 1.0 means the company could pay off all its debt with the cash, cash equivalents and marketable securities currently on the books. A ratio of 1.26 means it could pay off all its debt and still have cash available.

The one that could concern us is the equity-to-asset ratio, where more than 82% of its competitors have higher ratings.

Capital One has a Piotroski F-score of 5 out of 9, indicating the company's financial situation is typical for a stable company. Several of the other metrics normally included in this category are not relevant to financial stocks, such as the interest coverage ratio.

The company receives a low rating for financial strength, but as we can see, its financial strength metrics are not out of line with those of the industry.

Profitability

Capital One: Should We Buy Before the Price Recovers?
Capital One: Should We Buy Before the Price Recovers?

In the financial industry, the big driver of profitability is the difference between the amount a company pays for funds and the amount of income it earns from the funds it lends. For example, it might pay depositors 2% and lend out that money from depositors at 4%, providing a net interest margin of 2%.

This 10-year net interest margin chart shows that Capital One spiked its margin after the 2008 financial crisis, and has since settled down in the mid-single-digits:

Capital One: Should We Buy Before the Price Recovers?
Capital One: Should We Buy Before the Price Recovers?

The pandemic and associated economic slowdown have affected the company. Reporting on its second-quarter 2020 results, it stated its net interest margin declined by 100 basis points from the previous quarter and 102 basis points year-over year.

It has had to set aside extra funds to cover potential non-payments by credit card holders and other borrowers. For the second quarter, it reported, "Provision for credit losses of $4.2 billion for the second quarter of 2020." Overall, the company announced a loss for the recent quarter:


"Capital One Financial Corporation (NYSE: COF) today announced net loss for the second quarter of 2020 of $918 million, or $2.21 per diluted common share, compared with net loss of $1.3 billion, or $3.10 per diluted common share in the first quarter of 2020, and with net income of $1.6 billion, or $3.24 per diluted common share in the second quarter of 2019. Excluding adjusting items, net loss for the second quarter of 2020 was $1.61 per diluted common share."



This chart puts its earnings per share into context:

Capital One: Should We Buy Before the Price Recovers?
Capital One: Should We Buy Before the Price Recovers?

Valuation

Capital One: Should We Buy Before the Price Recovers?
Capital One: Should We Buy Before the Price Recovers?

The price-book ratio is often used to assess the value of a financial stock, and is calculated by dividing the current share price by a company's book value per share. This provides a metric by which different financial institutions can be compared by investors.

The lower the price-book ratio, the less an investor is paying. A ratio of less than 1.00 indicates a company's shares are undervalued, and that's the case for Capital One:

Capital One: Should We Buy Before the Price Recovers?
Capital One: Should We Buy Before the Price Recovers?

Note that the price-earnings ratio and the PEG ratio are not as relevent for a financial firm, while the discounted cash flow (DCF) calculator would be of little help because it is based on a GuruFocus predictability rating of just 1 out of 5 stars.

Dividend and share buybacks

Capital One: Should We Buy Before the Price Recovers?
Capital One: Should We Buy Before the Price Recovers?

The current dividend yield was not far off the average of the S&P 500 companies until the economic slowdown resulted in a cut. Note that the forward dividend yield, at 0.55%, is well below the trailing 12-months yield of 1.87%; that's because the company cut the dividend from $0.40 to $0.10 in the second quarter, helping the company stay in line with Federal Reserve and Basel III regulations.

The following chart shows how the board of directors built up the dividend, then let it level off:

Capital One: Should We Buy Before the Price Recovers?
Capital One: Should We Buy Before the Price Recovers?

The five-year yield on cost is up despite the dividend cut, because it is based on what has happened with the dividend over the past five years.

While Capital One has a history of share repurchases, it ceased the buybacks in March of this year, again in response to economic conditions.

Gurus

Fourteen of the investment gurus followed by GuruFocus have holdings in Capital One; that's a vote of confidence.

The largest position is that of Dodge & Cox, which held 47,473,473 shares at the end of the second quarter. That gave it a 10.40% stake in Capital One and represented 2.73% of its assets under management. During the quarter, it increased its holding by 7.73%.

Chris Davis (Trades, Portfolio) of Davis Selected Advisors added 1.03% to his holding in the quarter to end with 16,159,701 shares. Steve Mandel (Trades, Portfolio) of Lone Pine Capital was a newcomer to Capital One ownership, buying 10,278,292 shares.

Ooverall, gurus increased their holdings in the quarter:

Capital One: Should We Buy Before the Price Recovers?
Capital One: Should We Buy Before the Price Recovers?

Conclusion

Although Capital One Financial is more of a credit card company than a bank, its financial strength, profitability and valuation make it look more like a bank. That's unfortunate because the two big credit card companies, Visa and Mastercard, have a lot more green on their financial strength and profitability tables. However, they are also not available at bargain prices.

For those who want to own Capital One, or add to their current holding, I think this looks like a good time (subject to your own due diligence). The fundamentals are in line with those of the banking industry, so most shortcomings can be attributed to industry rather than Capital One's management.

For value investors willing to take on a company with some debt, the price could be right. Growth investors may see this as an opportunity to get in if they believe the economy will rebound in the near future. Income investors will likely look elsewhere for stocks with better initial yields and better prospects for ongoing increases.

Disclosure: I do not own shares in any companies named in this article.

Read more here:

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This article first appeared on GuruFocus.