* All data are as of the close of Tuesday, October 14, 2014.
As investors, we are accustomed to scouring through the hundreds of investment funds offered by large asset management firms the world over. But have we ever thought of investing in the management firms themselves? After all, they collect some pretty impressive management fees regardless of whether their funds make or lose money. We may stand a better chance of winning if we bet on the bookies rather than on the horses.
At look at their stocks' performance since the economic recovery began after the financial crisis of 2008-09 proves the point rather nicely, as noted in the graph below. Where the broader market S&P 500 index [black] has grown some 178% and the Financial Select Sector SPDR ETF (NYSE: XLF) [blue] has gained 256% since the start of the recovery in early March of 2009, the third-largest U.S. asset management company, Franklin Resources Inc. (NYSE: BEN) [orange] has beaten the broader market with a gain of 235%, while the largest firm, BlackRock Inc. (NYSE: BLK) [beige] has beaten both the broader market and the Financial sector with gains of 282%. The second-largest Bank of New York Mellon Corporation (NYSE: BK) [purple], however, has underperformed all, with gains of just 103%.
On an annualized basis, where the S&P broader market has averaged 31.9% per year and the Financials sector fund (NYSEARCA:XLF) has averaged 45.85% per year since March of '09, N.Y. Mellon has averaged a dismal 18.4%, Franklin has averaged a decent 42.1%, while BlackRock has averaged a stellar 50.5% per year.
Though the roaring good times in the Financial sector are not expected to be as robust over the next five years as they have been the last five, the sector is still seen outperforming the broader market S&P by about a percentage point in 2015 and beyond, as noted in the table below, where green indicates outperformance, while yellow denotes underperformance.
Within the Financial sector, the asset management industry as a whole is seen vastly outperforming this in Q3 and Q4, slipping behind in 2015, and then moving ahead modestly over the next five years.
The sector's and industry's growth in the years ahead will likely be slowed by rising interest rates which will reintroduce volatility in the financial markets, after having been virtually non-existent during the last several years with rates at all-time lows. The increasing volatility will make eking out profits from the markets a little tougher for asset management companies, with their expected lower performance reflected in their earnings outlooks.
Within the asset management industry, our three highlighted stocks of BlackRock, Mellon and Franklin are expected to lag behind their peers considerably this Q3 and Q4, finally catching up in 2015, and then forging ahead in the years beyond, as tabled below. Where BlackRock is seen growing at a faster clip than the others, Mellon seems to have the near-term advantage while Franklin has it over the longer term.
Compared to the broader market S&P 500 index, our three largest asset management firms are seen holding up nicely, and even meaningfully outperforming beyond 2015.
Though the three largest U.S. investment firms may not have the same explosive growth rates they recently enjoyed during this unprecedented bull market fuelled by near-zero interest rates and Federal Reserve stimuli, their large size should keep them from tumbling very deeply during periods of volatility, which are expected to increase in frequency as interest rates return to normal levels.
Hence, all three of our asset management giants will continue to hold a place in many portfolios as solid mature companies offering a profitable blend of stability and above-average growth for years to come. But how do they compare against one another, and which makes the best investment?
Let's answer that by comparing their company fundamentals using the following format: a) financial comparisons, b) estimates and analyst recommendations, and c) rankings with accompanying data table. As we compare each metric, the best-performing company will be shaded green, while the worst-performing will be shaded yellow, which will later be tallied for the final ranking.
This comparison may help investors plan ahead of BK's Q3 report due October 17th and BEN's Q3 report due October 27th.
A) Financial Comparisons
Market Capitalization: While company size does not necessarily imply an advantage and is thus not ranked, it is important as a denominator against which other financial data will be compared for ranking.
Growth: Since revenues and expenses can vary greatly from one season to another, growth is measured on a year-over-year quarterly basis, where Q1 of this year is compared to Q1 of the previous year, for example.
In the most recent reported quarter, BlackRock's revenues and earnings far outgrew those of the others, while Mellon shriveled in both.
Profitability: A company's margins are important in determining how much profit the company generates from its sales. Operating margin indicates the percentage earned after operating costs, such as labor, materials and overhead. Profit margin indicates the profit left over after operating costs plus all other costs, including debt, interest, taxes and depreciation.
Of our three contestants, BlackRock operated with the best margins, while Mellon had the narrowest, though still quite healthy.
Management Effectiveness: Shareholders are keenly interested in management's ability to do more with what has been given to it. Management's effectiveness is measured by the returns generated from the assets under its control, and from the equity invested into the company by shareholders.
As regards returns on assets and on equity, Franklin's management team outperformed the others by a considerably margin, while Mellon's team fared the worst.
Earnings Per Share: Of all the metrics measuring a company's income, earnings per share is probably the most meaningful to shareholders, as this represents the value that the company is adding to each share outstanding. Since the number of shares outstanding varies from company to company, I prefer to convert EPS into a percentage of the current stock price to better determine where an investment could gain the most value.
Of the three companies here compared, Franklin provides common stockholders with the greatest diluted earnings per share gain as a percentage of its current share price, while BlackRock offers the worst, though all were quite close.
Share Price Value: Even if a company outperforms its peers on all the above metrics, however, investors may still shy away from its stock if its price is already trading too high. This is where the stock price relative to forward earnings and company book value come under scrutiny, as well as the stock price relative to earnings growth, known as the PEG ratio. Lower ratios indicate the stock price is currently trading at a cheaper price than its peers, and might thus be a bargain.
Among our three combatants, Franklin has the cheapest stock price relative to forward earnings and 5-year PEG, while Mellon's stock is best priced relative to company book. All three stocks ranked overvalued in one of the three metrics.
B) Estimates and Analyst Recommendations
Of course, no matter how skilled we perceive ourselves to be at gauging a stock's prospects as an investment, we'd be wise to at least consider what professional analysts and the companies themselves are projecting - including estimated future earnings per share and the growth rate of those earnings, stock price targets and buy/sell recommendations.
Earnings Estimates: To properly compare estimated future earnings per share across multiple companies, we would need to convert them into a percentage of their stocks' current prices.
Of our three specimens, Franklin offers the best earnings percentages across all four time periods, while BlackRock offers the worst EPS percentage over current stock price in three periods.
Earnings Growth: For long-term investors, this metric is one of the most important to consider, as it denotes the percentage by which earnings are expected to grow or shrink as compared to earnings from corresponding periods a year prior.
For earnings growth, all three firms split the first prizes for various time periods, with BlackRock having the advantage in Q3, Mellon having the advantage this Q4 and in 2015, while Franklin promises the best earnings growth over the next five years.
Price Targets: Like earnings estimates above, a company's stock price targets must also be converted into a percentage of its current price to properly compare multiple companies.
For their high and mean price targets over the coming 12 months, analysts prefer BlackRock's stock over the others, while Franklin's stock has the least downside risk. Mellon, however, is given the lowest stock price targets at all three levels.
Buy/Sell Recommendations: After all is said and done, perhaps the one gauge that sums it all up is analyst recommendations. These have been converted into the percentage of analysts recommending each level. However, I factor only the strong buy and buy recommendations into the ranking. Hold, underperform and sell recommendations are not ranked, since they are determined after determining the winners of the strong buy and buy categories, and would only be negating those winners of their duly earned titles.
Of our three contenders, BlackRock is best recommended overall, with 1 strong buy, 9 buy and 9 hold recommendations, followed by Franklin with 3 strong buys, 3 buys and 12 holds, and Mellon with 2 strong buy, 4 buy, 10 hold and 2 underperform ratings.
Having crunched all the numbers and compared all the projections, the time has come to tally up the wins and losses and rank our three competitors against one another.
In the table below, you will find all of the data considered above, plus a few others not reviewed. Here is where using a company's market cap as a denominator comes into play, as much of the data in the table has been converted into a percentage of market cap for a fair comparison.
The first and last placed companies are shaded. We then add together each company's finishes to determine its overall ranking, with first place finishes counting as merits and last place finishes counting as demerits.
And the winner is... Franklin Resources by a comfortable distance, outperforming in 13 metrics, while underperforming in 6, for a net score of +7. BlackRock places second, outperforming in 10 metrics and underperforming in 7, for a net score of +3. Crossing the finish line last a considerable way behind is N.Y. Mellon, outperforming in 5 metrics and underperforming in 15, for a net score of -10.
While the asset management industry is expected to outperform the S&P broader market overwhelmingly this Q3 and significantly this Q4, modestly underperform in 2015 and then modestly outperform in the years beyond, the largest three U.S. firms in the space seem poised to continue their split performance of the past few years. Mellon will likely continue lagging behind while the others advance ahead of both their industry and the broader market - with Franklin Resources likely proving the better investment choice overall.