By Adam Fischbaum
It's easy to overlook things . . . especially if you're not really looking for them.
It's the approach most investors have had with financial stocks. Since the crisis of 2008, the financial services business has changed radically. The "too big to fail" firms -- Bank of America
), JPMorgan Chase
), Wells Fargo
) and the like -- have enjoyed stock price rebounds but still suffer from constant regulatory scrutiny and risk.
Their earnings multiples are temptingly low, but for good reason: uncertainty. It's really hard to figure out how these firms make money and how much they're going to make going forward. So the market, which gets it right every now and then, doesn't have a whole lot of confidence in their ability.
It's even worse for super-regional and regional banks. Traditionally, they've had to lend money to make money. Since 2008, despite the Federal Reserve's best efforts to encourage them to do so, they just won't lend money. Most of their revenue is derived from existing business and "feeing" their current customers to death. That's a poor business model that no one should invest in.
So once past mega-cap financials and regional banks, other financials tend to get overlooked. However, I have found a group of financial stocks that are extremely attractive both as growers, dividend payers and potential consolidation candidates.
During a recent breakfast with a veteran money manager, the talk turned to his shop's parent company's acquisition plans. It seems that the consensus is that the best value in financial stocks lies within the asset manager stocks.
I agree. It's a simple, consistent business model: bring in assets, manage those assets for your clients, and charge a fee. Despite the challenges of financial markets, it's an incredibly predictable business for a well-established firm. Here are three that are worth a look.
Founded in 1970, Manning & Napier is an independent investment firm that currently manages nearly $50 billion. Through separately managed accounts, mutual funds, and collective investment trusts.
Two things impress me the most about this company. First, it was founded in 1970 -- and has survived a lot of bad markets between now and then. Clearly this is a firm that knows its stuff.
Second is its return on assets. Historically, the average ROA in the investment management business is somewhere around 50 basis points (bps), roughly half of a percent. Manning and Napier's is nearly 50 percent higher, coming in at around 75 bps.
The result is investment management revenue growth of 11 percent year over year, to $376 million in 2013. The 2014 projection is for $414 million and $476 million for 2015. That's revenue growth of 9 percent a year, leaving plenty of room for an upside surprise in MN. The company also boasts operating margins of 46 percent. The stock is a bargain at around $15 a share, a forward price-to-earnings (P/E) ratio of 12.4 and an attractive dividend yield of 4.2 percent.
Over the past decade, Invesco has evolved into to one of the world's largest and most diversified asset managers. Offering everything from traditional mutual fund products to boutique private equity investments tailored for institutions and high net worth individuals, the firm is currently most recognized for its rapidly growing exchange traded funds (ETF) business under the PowerShares brand.
At the end of February, Invesco reported total assets under management of $791 billion and fund inflows of over $1 billion for that month alone. Those results were coming off of the heels of an excellent 2013. Revenue for the year grew 11 percent to $4.6 billion, from 2012, and earnings per share (EPS) grew 30 percent to $1.95.
Analysts have boosted the company's 2014 EPS forecast to $2.48, a 27 percent increase. Now, that may be a stretch based on last year's huge stock market performance. However, Invesco is well-positioned thanks to its multi-asset profile, especially its ETF products.
IVZ currently trades around $35.50 with a 14.6 forward P/E and a 2.5 percent dividend yield. This is a reasonable price to pay for a company with the scale Invesco possesses.
3. Alliance Bernstein
Whenever I write about financial stocks, Alliance Bernstein usually ends up in the mix. I've been following this company in its different incarnations my entire career, and it's always worked out. (Since I discussed this stock in January
, for instance, it has gained 11 percent, compared with the S&P 500's 4 percent gain in the same period.)
My thesis for Alliance Bernstein is still in place. Currently, the firm manages over $450 billion. The main attraction has always been the company's master limited partnership (MLP) structure resulting in the handsome 7.2 percent annual distribution rate. But as the first-quarter advance in the stock price demonstrates, AB is a great growth vehicle as well.
Revenue grew at a staggering year-over-year pace of 161 percent, to $186 million last year. EPS jumped at an even more impressive rate with 235 percent growth, to $1.71 a share. Part of that growth is due mainly to resurgent equity markets resulting in positive inflows, which is the name of the game in the asset management business.
However, expectations are somewhat tempered for 2014 with analyst forecast calling for EPS of $1.90, representing an 11 percent increase over 2013. Still, AB represents an excellent value. Double-digit earnings growth at around $24.70 a share with a forward P/E of 13 and a 7 percent-plus yield is enticing.
Risks to consider: The biggest challenge facing all three, of course, would be choppy financial markets. Nervous fund investors always vote with their feet. Fund outflows mean shrinking management fees. Alliance and Invesco are probably best positioned to play defense.
Action to take: Grouping these stocks in a basket values them with an average forward P/E ratio of 13 and a blended yield of 4.7 percent. On a forward P/E basis, that's a 13 percent discount to the S&P 500 and over twice the yield of the index. On average, all three are delivering around 4 percent monthly growth in new assets under management. Based on those numbers -- and the fact that the basket delivers financial sector exposure with growth potential -- 25 percent upside is feasible. Allowing for dividends, that's a potential total return approaching 30 percent.
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