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Credit Card Stocks: Are Discover & AmEx Being Overlooked?

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As we all know, when it comes to credit card payment networks, there are four major players; Visa (V), MasterCard (MA), American Express (AXP), and Discover (DFS). Ever since their IPOs a few years ago, the first two have been Wall Street darlings – and for good reason – considering that over the past 36 months, Visa has enjoyed a 120% gain and MasterCard, 150%.

The smaller guys – AmEx and Discover – have also experienced triple-digit gains since the lows of the recession. However, they presently sit at around the same prices they were at 5 years ago. Are they being given the credit (no pun intended) that they deserve?

Here are five long-term advantages that DFS and AXP have going for them:

Reason #1 - Smaller Marketshare

Because American Express has more affluent customers, their market share based on purchase volume is actually a close third (23.8% vs. MasterCard’s 27.1%). So AmEx really isn’t that much of an underdog, but Discover is, capturing only 5.7%.

I remember in late 90’s when Apple computers only had a 5% market share, my middle school teacher said to the class "Even if they double in size, that’s still only 10%. They have a lot of room to grow." If I only would have heeded to that advice, right?

Obviously I’m not saying Discover credit cards have the potential to be the next Apple, but it isn’t unthinkable that their market share could double from 5% to 10%, right?

Reason #2 - Acceptance is Growing

Some people have considered Discover to be the laughing stock of the credit card world, because they weren’t widely accepted. Well if you hold that mindset, you need to catch up with the times. Why? Because now Discover is accepted at over 90% of merchants who accept Visa/MasterCard (at least in the US).

So in the past, poor acceptance was a major deterrent in applying for their credit cards. But now, that’s no longer an issue. Most consumers don’t know this, but as they learn this fact, I would imagine more will continue to signup. Meanwhile, acceptance for American Express has also taken off over the past few years.

Reason #3 - Richer Rewards

Because AmEx/Discover act as both the payment network and the card issuer (they get the cut from both) they can often afford to dish out higher rewards.

During the recession, this was a disadvantage because it meant AmEx/Discover had to write off a lot of bad debt, since they also acted as the card’s issuing bank. However as the economy improves, the duel-model should prove to be a benefit… since [hopefully] more customers will pay their bills. It also means their richer reward programs may help lure consumers from other cards.

For example, with rising gas prices, Discover has a distinct advantage in that 2 out of their 4 credit cards offer the opportunity for earning fuel rebates of up to 2% to 5% cash back. That’s a lot better than what many gas station credit cards offer.

Reason #4 - Less Litigation

Perhaps the biggest obstacles facing Visa and MasterCard are the on the litigation front. Even though they already settled the antitrust suit with the Department of Justice in 2010, they’re still facing civil lawsuits from merchants regarding the processing fees they charge. On September 12th of this year, hearings will begin for a class-action case of some 5 million retailers versus Visa, MasterCard, and 13 banks which issue them.

Now that’s not to say American Express and Discover are immune from major lawsuits. In fact, AmEx is facing a similar suit, but it hasn’t progressed as far yet. But most of the litigation involving processing fees continues to center around the two dominant players, Visa and MasterCard.

Reason #5 - Customer Diversity

For decades, American Express was known as the card for the well-to-do. In fact up until the 90’s, all of their cards required payment to be made in full each month (so they weren’t “credit” cards). However that has since changed. The Blue cards (which are credit) have been a home run for the company and just last year, AmEx entered the lucrative prepaid card market. In short, they’re expanding into a lot of other areas of credit, which previously have been monopolized 100% by Visa and MasterCard.

Discover, albeit more slowly, is also diversifying their product offerings. Over the past couple years they’ve really ramped up the marketing of Discover student cards. Since they have no annual fees and rewards of up to 5% cash back, many college students are choosing them over the competitors. Even though student credit cards aren’t big moneymakers, they should help the company in the long run by building brand loyalty early on, by being the students’ first credit card.

When it comes to the prepaid market, Discover is also dipping their toe in the water with prepaid cards. Last year they launched a card with “Young Money” (a musician) to appeal to a younger audience. For a few years now they’ve also been offering prepaid cards which employers can use for payroll.

Conclusion?

Only time will tell whether or not Discover and AmEx will grow their market share. However one thing is for sure… Visa and MasterCard’s slice of the pie can’t get much bigger (percentage-wise) but it certainly might get smaller!

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