Forget Earnings — For DFS, It’s All About the Fiscal Cliff

by Kyle Woodley | December 7, 2012 6:15 am

Forget Earnings — For DFS, It’s All About the Fiscal Cliff

ElevenBest Forget Earnings    For DFS, It's All About the Fiscal Cliff[1]

We’re coming into the home stretch for 2012, and Discover Financial Services (NYSE:DFS[2]) is beating the pants off of InvestorPlace’s hoity-toity Ten Best Stocks for 2012[3] club.

How bad is the carnage? At time of writing, DFS is up nearly 70% for the year-to-date, just about doubling the returns of first-place Capital One Financial (NYSE:COF[4]).

But it’s not time for bragging (yet). While there’s just less than a month to go in the contest, there’s one fat lady stretching the vocal chords for her potential aria: Discover’s fourth-quarter earnings report, due out Dec. 20.

Coincidentally, that’s the same day I begin my long winter retreat back to Ohio.

Normally, I needlessly worry about any loose ends when I step out of the office for more than a few hours, let alone several days, but now I’m headed on vacation with an extra monkey on my back because I’m fretting about Discover’s fate.

And funny enough, it has nothing to do with earnings.

What, Me Worry?

Before I get to what really has my boxers in a bunch, let’s talk about why we shouldn’t be sweating Discover’s upcoming report.

For one, the company is expected to finish out the fiscal year with fourth-quarter earnings growth of 16% on revenues expected to improve about 8%. If so, DFS will have grown earnings by 10% and sales by around 8% for FY 2012. There’s every reason to believe Discover will put up numbers close to that, if not above; DFS has been a master of expectation management, surpassing estimates in 10 straight quarters (including a host of double-digit beats).

Also, if the past three years are any indication, it will take some truly fantastic or pathetic news to really make Discover stock bolt on earnings day — in either direction. Here’s how DFS has performed post-earnings in the past 11 quarters:

Reporting Date Earnings Surprise DFS Change during
next trading session
9/27/12 +17% +7.3%
6/19/12 +1% +2.3%
3/21/12 +29% -0.7%
12/15/11 +4% -3.1%
9/22/11 +30% -0.3%
6/23/11 +45% +1.3%
3/22/11 +63% -1.7%
12/16/10 +48% -3.1%
9/20/10 +27% +3.8%
6/24/10 +200% +0.5%
3/16/10 -8% +0.6%

Granted, earnings aren’t the whole story — other report specifics helped accentuate or overshadow the reaction to some of those beats — but DFS has gotten really good at surprising to the upside, which always helps. And importantly to my stake in the contest, it hasn’t moved more than 4% in any direction on earnings since the beginning of 2010, with one exception.

Of course, that exception brings me to point No. 2 …

The Stupid, Stupid, Stupid Fiscal Cliff

As I said back in August[5], “Discover might shine on the market’s good days, but it can get downright pissy when the indices so much as sniffle,” and DFS has borne that out a bit more since then.

Since that Aug. 17 piece, DFS managed to gain about 8% vs. a slightly down S&P 500. But that return wasn’t without a couple big hiccups:

DFS2 Forget Earnings    For DFS, It's All About the Fiscal Cliff

#1: DFS lost 6.9% from Nov. 13-15, when the S&P 500 shed 1.5%.
#2: DFS lost 4.2% from Sept. 24-26, when the S&P 500 shed 4.2%.

The second hissy fit came right before DFS’ report on Sept. 27. Sure, there might have been some pre-report selling; but conversely, that downside move likely enticed the post-report buyers.

Because I think earnings will essentially be a non-event (if even positive), and because I doubt we’ll hear any other big news from Discover before the year is out, I expect any movement in DFS will go with the grain of the market.

And because the market is more or less being held hostage by the ongoing fiscal cliff negotiations, that’s a big, red stop sign for anyone toying with the idea of Discover right now.

For what it’s worth, I think Washington will come to an agreement or at least kick the can down the road … after all, stall-ball is what America does best. But what I think doesn’t matter. What a group of power-hungry, inept politicians might do with their backs against the wall is up to wholesale conjecture, and you and I have no business betting actual money on the cliff’s outcome — that’s the stuff of degenerate gamblers.

Yes, staying out deprives you of what I’d imagine will be a huge celebratory rally in DFS and most other stocks if a deal is struck (followed by a hangover once details are fleshed out). But you avoid the inevitable market waning if this is dragged out to the bitter end.

Bottom Line

I expect Discover Financial Services to come out ahead of these other Top Stocks picks by the time the contest is finished and college bowl games start mattering … but only because the lead was so great going into December.

If you’ve been in DFS for long enough that you’ve seen substantial gains, stick around — but start setting stop-losses to lock in most of your profits. And if you’re a long-term investor just now considering Discover, don’t even bother with it — or anything but the most market-resistant stocks, for that matter — until this mess has a solution.

Kyle Woodley[6] is the Deputy Managing Editor of InvestorPlace.com[7]. As of this writing, he did not hold a position in any of the aforementioned securities. Follow him on Twitter at @IPKyleWoodley[8].

Endnotes:
  1. [Image]: http://www.investorplace.com/best-stocks-for-2012/
  2. DFS: http://studio-5.financialcontent.com/investplace/quote?Symbol=DFS
  3. Ten Best Stocks for 2012: http://investorplace.com/best-stocks-for-2012/
  4. COF: http://studio-5.financialcontent.com/investplace/quote?Symbol=COF
  5. I said back in August: http://investorplace.com/2012/08/discover-financials-crazy-climb-cant-continue-can-it/
  6. Kyle Woodley: http://www.investorplace.com/author/kyle-woodley/
  7. InvestorPlace.com: http://investorplace.com
  8. @IPKyleWoodley: https://twitter.com/#!/ipkylewoodley

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