Is Capital One Stock a Buy?

Financial stocks have tumbled over the past year as hopes of interest rate cuts from the Federal Reserve boosted interest-sensitive businesses. Capital One (COF 1.79%) has been one of the beneficiaries, with its stock up 49% since last November.

However, investors’ attention has shifted to the weakening consumer. In a recent update to the jobs report, the unemployment rate rose for a fourth straight month and stocks sold off broadly. In second-quarter earnings calls, banks noted that consumer spending slowed in certain market segments. Not only that, but taxes continued to rise across the industry.

Capital One’s customer base could be particularly vulnerable in this environment, and in the second quarter, charge-offs on credit cards and auto loans increased. With that in mind, is Capital One stock a good buy today?

Credit card charge-offs have risen for several quarters in a row

Financial institutions today face an uncertain environment. Consumer values ​​weakened as banks increased their loan loss reserves and cashed in bad loans for several quarters in a row. As one of the nation’s largest consumer credit card companies, Capital One is particularly vulnerable to a shrinking consumer.

In the second quarter, the company saw its credit card net charge-off rate rise to 6%, up from 5.9% in Q1 and 4.4% a year ago. The company took out $2.6 billion in loans during the quarter, roughly in line with last quarter and up from $2.2 billion last year. It also recorded a $3.9 billion loan loss provision to account for potential future charge-offs.

According to The Fly, in a research note to investors in early July, an analyst from JPMorgan projects a seasonal decline in net settlements in the middle of this year, with a seasonal rebound in the fourth quarter beginning in the first quarter of next year. This development would be positive for Capital One and could allow it to release reserves, which would increase its net income.

During his earnings call, CEO Richard Fairbank noted that a new seasonal trend appears to have emerged over the past few years, driven by the timing of taxes and tax refunds due to changes made four years ago. As a result, losses appear to be seasonally lowest in the third quarter and highest in the first quarter. For that reason, Fairbank is a bit more cautious, saying: “We’re not really giving forward guidance on declaring a spike” in the company’s allowance for loan losses.

Capital One has a broader customer base and is exposed to more customers across the credit spectrum. For example, 31 percent of its credit card customers and 47 percent of its auto loan customers have FICO scores of 660 or lower, which is considered sub-prime. Consumers at the lower end of the spectrum could face more difficulties if there is an economic slowdown.

Image source: Getty Images.

Despite the caution, there are some positive takeaways. Capital One’s 30-day delinquency rate fell to 4.17 percent from 4.5 percent in the first quarter. Delinquency rates can be a leading indicator of net charge-offs, and seeing this decrease is a good sign.

Not only that, but taxes have risen gradually over the past two years since the Federal Reserve began raising interest rates. However, banks have not seen a sharp rise in delinquencies, suggesting consumers are holding up well so far.

What’s next for Capital One?

The stock is valued at a price-to-earnings ratio of 12.5 and a price-to-book value of 1.18, both of which are slightly higher than the 10-year average. The stock isn’t particularly cheap in that regard, so investors shouldn’t necessarily rush to buy Capital One right now.

COF PE report data by YCharts

You’ll want to pay attention to his credit scores for the third quarter. Fairbank said things should improve in Q3, but that it would pay particular attention to October, where there can sometimes be an “October surprise” in consumer credit values.

Looking ahead, a significant tailwind for Capital One would be its merger with Find out financially Services. Earlier this year, the two companies agreed to a merger valued at $35 billion. It would be one of the largest bank mergers in US history, and the deal has come under heavy scrutiny from lawmakers.

If passed, it would allow Capital One to create a closed-loop payment network, just like American Expressand allow him to compete against Visahis and MasterCardhis networks. For now, the merger is up in the air, and a decision is expected by the end of this year.

Is Capital One Stock a Buy?

Capital One faces near-term headwinds as questions about consumer strength persist, which could leave the stock vulnerable to near-term volatility. Hence, you should not rush to buy the shares today.

Still, I’m bullish on the company long-term, especially if its merger with Discover is approved, which I think it will be. For this reason, a smart strategy might be to build a small position while reserving additional capital to buy more shares if there is a short-term market sell-off.