Shares of Capital One Financial (NYSE: COF) have lined investors' wallets with a fantastic 60% return during the past year. The banking giant, recognized for its major credit card business, has benefited from resilient macroeconomic conditions including solid consumer spending and borrowing.
Those themes will be in focus when the company reports its third-quarter results on Oct. 24. With the stock trading at a 52-week high, can the rally keep going, and should you buy Capital One shares before this key update? Here's what you need to know.
An improving outlook into 2025
Capital One stands out for its unique operating profile. Compared to larger banks that offer credit cards as one of their service offerings, issuing credit cards remains Capital One's core business. It's further diversified by its consumer and commercial banking arms.
This model lets Capital One leverage the highly profitable credit card franchise by cross-selling traditional banking products while securing a growing deposit base as a low-cost funding source. On the other hand, this side of revolving consumer lending is recognized as traditionally risky and exposed to shifting economic trends.
By this measure, the surprise in recent years has been the stronger-than-expected economic activity in the U.S. despite high inflation and elevated interest rates. From concerns that the economy may slip into a recession, Capital One has managed to grow while presenting relatively stable credit quality metrics.
In the second quarter, loans held for investment and total deposits increased by about 1%, which management described as "strong" results. Notably, the net interest margin at 6.7% climbed from 6.48% in the prior-year quarter.
Even as the bank increased its allowance for credit losses and saw the net charge-off rate tick up to 3.36% from 3.33% in Q1, the sense is that conditions are stabilizing. That was the message from Chief Executive Officer Richard D. Fairbank in the Q2 conference call:
The pace of year-over-year increases in both the charge-off rate and the delinquency rate have been steadily declining for several quarters and continued to shrink in the second quarter. ... I think what we see is something that's very stable. The U.S. consumer remains a source of strength in the overall economy.
The expectation is for those dynamics to continue. The 50-basis-point (0.5%) interest rate cut by the Federal Reserve in September should work to improve credit demand, potentially kick-starting a stronger growth cycle into 2025.
Image source: Getty Images.
What to expect from Capital One's Q3 earnings
According to the average of analyst estimates, Capital One is forecast to report third-quarter net revenue of $9.86 billion, up 5% year over year. Analysts also expect earnings per share (EPS) of $3.75, with that figure dependent on the size of the bank's adjustments to its allowance for credit losses, as a measure of the reserve to cover estimated bad debts.
A materially larger figure this quarter would imply some concern for underlying credit factors and the health of borrowers. On the other hand, a move by Capital One to release some of its reserves with a lower provision for credit losses would signal confidence toward improving conditions.
The market will also be looking to hear an update on Capital One's acquisition of Discover Financial Services announced earlier this year. The addition of Discovers' payments network is expected to diversify and expand Capital One's global scale, supporting a positive long-term growth outlook. Any indication the deal faces some regulatory hurdles or the timetable to close gets pushed back could be a catalyst for some near-term volatility in the stock; that's a risk to watch.
Ultimately, the tone set by management on the earnings conference call will dictate how the stock trades out of the report.
Is Capital One stock a buy?
I'm bullish on Capital One as an industry leader that is well positioned to consolidate its market share. I believe the stock deserves a buy rating within a favorable backdrop for consumer credit heading into 2025. Signs that earnings are set to strengthen could be a catalyst for the shares to rally higher. Investors with a long-term horizon can consider adding Capital One stock to a diversified portfolio.
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Discover Financial Services is an advertising partner of The Ascent, a Motley Fool company. Dan Victor has no position in any of the stocks mentioned. The Motley Fool recommends Discover Financial Services. The Motley Fool has a disclosure policy.
