Two of Morningstar’s favorite stocks are one you’ve undoubtedly heard of, and one you probably haven’t.
Without further ado …
Discover Financial Services
(DFS), the credit card/banking products company.
Morningstar moat rating (durable competitive advantage): narrow. Morningstar fair value estimate: $146. Recent price quote: $115.
Discover generates most of its revenue (about 70%) through interest income from its credit cards, notes Morningstar analyst Michael Miller.
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“While the company has substantial private student debt and personal loan portfolios in addition to operating its own payment network, its long-term health will be driven by its ability to build and maintain its portfolio of credit card receivables.”
Looking at that credit-card business for Discover, it “has historically been a strong performer, with receivable growth and credit results better than most of its peers,” Miller wrote in a commentary.
“With the majority of its credit cards and student loans charging variable interest rates, the bank is a beneficiary of rising interest rates, though this is limited by the firm's reliance on online and brokered deposits, which tend to be more interest rate-sensitive.”
Looking ahead, “Discover must continue to deal with the challenges that come with being smaller than many of its competitors in size and scope,” Miller said.
“Many of the traditional banks that the company competes with can offer their cardholders a broader selection of products and services.”
As for finances, “Discover reported solid [first-quarter] earnings, as strong loan growth and rising interest rates drove net interest income higher. That offset higher credit costs,” Miller said.
Tyler Technologies
(TYL), which provides software to local governments and schools.
Morningstar moat: wide. Morningstar fair value estimate: $475. Recent quote: $398.
Earlier this month, “Tyler hosted its first analyst day in more than four years. It emphasized its long-standing and deep relationships with government, its path to being cloud-first, and payments as a growth driver,” wrote Morningstar analyst Dan Romanoff.
Its financial targets are slightly stronger than his estimates, including revenue growing 10% to 12% annually through 2030, along with $1 billion in free cash flow.
“We see the investor day as reinforcing our thesis that Tyler maintains the largest portfolio of government-related software solutions and offers investors substantial expansion in free cash flow margins,” Miller said.
Tyler’s portfolio includes important solutions in public administration, courts and public safety, health and human services, and K-12 education, he said.
“The firm has more than 13,000 clients, many of whom have been a Tyler client for decades, with more than 40,000 software installations,” Miller said. “We believe this installed base is a strategic asset, as this represents the easiest path to growth.”
Reinforcing that idea, “management noted that multi-solution sales have grown by about 15% annually since 2020 and that Tyler could expand its revenue base by a factor of 10 simply by expanding relationships with existing customers,” he said.
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