Is Capital One Financial the best bank stock for you?

Banks are vital financial institutions that facilitate commerce, but not all banks are created equal. Capital One Financial (COF -0.21%)for example, it has a unique operating model that may result in material fluctuations in its performance. Here’s why some investors will appreciate this big bank and others will want to avoid it.

What does a bank do?

From a simplistic perspective, banks take deposits (bank accounts and checking accounts) and then use that cash to make loans (mortgages). Banks differentiate between the interest they charge on loans and the interest they pay on deposits. Although the big banks have expanded far beyond this simple model today, it is still the core of many of the biggest names in the industry. Capital One does that too, and regular banking is generally a pretty consistent and maybe even boring business.

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What does Capital One do?

The thing is, Capital One’s consumer business accounted for only about a quarter of the net interest income it generated in the second quarter of 2024. A much larger 70% came from the bank’s credit card business . Credit cards are a big business for most banks, but it’s really “the business” for Capital One Financial.

To be fair, credit cards can be very profitable. And Capital One has quite a bit of exposure to lower-quality borrowers, who generally have to pay higher loan rates on their cards. So the bank’s card business can generate quite robust profits. While this is a fairly aggressive approach in the banking sector, it is also why more aggressive investors will appreciate the stock.

The problem with Capital One’s approach

Credit cards are a valuable payment tool for consumers. When the economy is strong, transaction fees and interest can generate strong returns. But cards are usually one of the first forms of debt to go down when finances get tight. And problems can arise quite quickly, especially when there are recessions. It should come as no surprise that Capital One’s stock price tends to fall significantly during economic downturns as investors try to shed riskier investments.

COF data by YCharts

To be fair, shares of other banks are also falling. But with more diversified and less risky businesses, economic uncertainty is not a headwind. For an idea of ​​how quickly things can change for Capital One, look no further than the second quarter of 2024. In the first quarter, the company’s card business generated $961 million in revenue. That fell to just $91 million in the second quarter. To be fair, there were a few one-off items during the quarter, but the big quarterly decline highlights how quickly things can change in Capital One’s business. Looking a little further, Capital One’s net income fell 54% between 2019 and 2020, hit by the pandemic.

Capital One continues to grow

That said, Capital One Financial has weathered the tough times and notably continued to grow its business over time. Most recently agreed to buy Find out financiallymaterially expanding his business (and doubling his credit cards). The company’s growth has driven the stock higher over time, despite sometimes stunning price declines along the way — which is why some long-term investors with strong stomachs will like the stock.

However, more conservative investors will probably be better off sticking with a more diversified and, frankly, boring bank to own. The positive potential may be less exciting, but that’s often the price to pay if you want to sleep well.