Capital One Financial (NYSE: COF) is not your typical bank. This is probably the most important thing to keep in mind when deciding whether to purchase. But what exactly is Capital One Financial? It’s a combination of credit card issuer and auto loan manufacturer. Both of these tend to be high-risk areas of the banking industry. Here we take a closer look at the issues you’ll face if you purchase Capital One Financial.
I’m excited about owning Capital One Financial
Careful risk-taking on Wall Street can lead to very large returns. For example, Capital One Financial’s stock price has risen about 60% over the past five years, while the banking sector’s stock price as a whole has risen 20%. It’s clear that everything Capital One’s management has been doing has worked well over the past five years.
COF chart
The nuance here is that while Capital One is a bank, it has a very focused business. The company’s credit card business is its largest segment, accounting for approximately 48% of outstanding loans. This is a huge number for banks. The next largest part of the loan pie is auto loans, accounting for about 23% of the total. These are both high-risk types of loans. Capital One also tends to issue cards and auto loans to customers with bad credit.
Overall, high-risk businesses account for just over 70% of Capital One’s outstanding loans. Traditional loans made by banks, such as home loans, make up the remainder of the loan portfolio. The advantage of focusing on high-risk loans is quite simple. Capital One will be able to charge higher interest rates. Therefore, these loans are usually more profitable than loans that are considered to be less risky.
Capital One Manages Risk Well, But Be Prepared for Downdrafts
Overall, Capital One has done a very good job of building its business and rewarding its investors. But before buying this bank, you should keep in mind the inherently risky nature of this bank. History suggests that it is likely to be a profitable investment in the long run. However, business can be a little scary in the short term.
COF chart
The reason is simple. When an economy faces financial hardship, the greatest pain often falls on the weakest consumers and riskiest loans, and that’s where Capital One essentially focuses. At the moment, the economy looks relatively strong, even though the Federal Reserve has been raising interest rates for the past few years. Remarkably, it has just reversed course and started lowering interest rates.
This could be a signal for investors to become a little more concerned about Capital One’s business. For example, the amount of charge-offs in the company’s credit card business has been on the rise over the past year. It’s now up 36% compared to a year ago. To be fair, this represents an increase from 4.41% to 6%, so there is no Armageddon impact on banks’ credit card portfolios. But the trend suggests that Capital One’s customers are becoming increasingly stressed. For reference, the auto loan business’ depreciation rate increased from 1.4% to 1.81% over the past year.
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Assuming the planned acquisition of Discover Financial (NYSE:DFS) goes as planned, there will be notable changes to Capital One’s business model. The move will add a payment processor to the company’s business model, likely leading to more stable revenue. However, the impact on Capital One is likely to be positive, as Discover does not have the scale of competitors Visa and Mastercard, but may be less likely to lend to some of its highest-risk customer bases. May not be significant enough to offset the inherent risks. Until this deal is completed and the combined entity has some history, it’s best not to get too excited about how it will affect Capital One’s business.
Should you buy Capital One Financial?
Historically, and from a big-picture perspective, Capital One has managed to run its business successfully in a way that rewards investors while taking on extra risk. So it looks like an investment worth considering, but perhaps best suited for more aggressive investors. If the economy goes into recession, Capital One’s business will likely perform worse than other conservative banks, and Wall Street will react accordingly. That’s normal for this credit card lender. If you want to buy, make sure you can handle the drawdown. Otherwise, you may end up selling out at the worst possible time.
From a short-term perspective, Capital One’s price-to-book multiple is above the average over the past five years, suggesting that the stock is currently modestly valued. And, as mentioned above, the company’s customers appear to be facing increasing financial burdens. Investors may want to hold off for a while until the economic environment becomes a little clearer.
That said, if there is a downturn, aggressive investors who understand the company’s approach and long-term success may want to jump in, while other Wall Street investors could retreat. is high.
Should you invest $1,000 in Capital One Financial right now?
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Discover Financial Services is an advertising partner of The Motley Fool’s Ascent. Reuben Greg Brewer has no position in any stocks mentioned. The Motley Fool has positions in and recommends Mastercard and Visa. The Motley Fool recommends Discover Financial Services and recommends the following options: A long January 2025 $370 call on Mastercard and a short January 2025 $380 call on Mastercard. The Motley Fool has a disclosure policy.
Is Capital One Financial Stock a Buy? Originally published by The Motley Fool
