Discover Financial Services beats in Q2 -- buy the stock?

Wall Street doesn't seem to mind. As I write this, shares of Discover are up well over 6% in early afternoon trading (volume isn't overpowering at the moment, I should note; perhaps it will pick up later). Not only do we have the expectations issue driving the buying, but we may have the charge-off rate of 7.8% helping things along too. According to the news story I cited earlier, this percentage shouldn't seem too alarming (that was the opinion of one quoted portfolio manager, at least). The charge-off rate did see an increase, however.

If you read through the press release, you'll see that Discover is keeping its eye on expenses and has increased bad-loan provisions. The economy continues to exert pressure on the company. Another theme surrounding Discover is the issue of unemployment. If unemployment worsens, then unpaid credit balances theoretically should increase. This is a tough thing for Discover, because even if the recession begins to wane, we all know what the textbooks say about unemployment: it's a lagging indicator. So, job levels may continue to be unattractive once the contraction switches over to expansion.

How should you play Discover? Well, the stock might be a trade, but quite frankly, I prefer either Visa or MasterCard to Discover. The latter has risk to bad loans, while the former two don't really have that risk; instead, they generate their value from transactions. Whenever a Visa or MasterCard product is used, the relevant company collects a fee for the processing. The financial institution attached to the plastic takes on the risk for the loan. Discover did okay during the quarter, and the market is bidding shares higher, but the alternatives are better.

Disclosure: I don't own any company mentioned; positions can change without notice.