Originally published on Nov 20, 2014.
The Baton stock-picking system is a quantitative model that determines when a stock is undervalued and worthy of investment. The following analysis is based upon that methodology and should only be used in conjunction with a similar system for identifying when to sell.
Summary: After dropping sharply in the 2008 financial crisis, BlackRock's (NYSE: BLK) earnings per share have tripled. Today it's a financial juggernaut. In the latest quarter, EPS jumped 18% on a 12% gain in revenues. Wall Street analysts project full-year EPS of $19.22, 16% over the 2013 level. BlackRock shares trade at 18 times that number, roughly in line with the valuation of the Standard & Poor's 500-stock index, but with double the benchmark's profit-growth rate. BlackRock's diversified products, revenue mix and global footprint should enable it to adapt to changing client needs and market conditions while generating solid profit growth and investment returns.
Analysis: Our methodology for evaluating stocks is based on formulas that follow specific investment strategies that have a proven track record of long term success. BlackRock earns a near-perfect score of 91% according to our mathematical model designed to mimic the investment style of Peter Lynch, the legendary former manager of the Fidelity Magellan fund. Our formula examines 8 ratios designed to determine the extent to which a company can be classified as a "fast grower", as follows:
P/E/GROWTH RATIO: BLK has been growing its earnings at a higher rate than its P/E ratio over the past five years, meaning its "PEG ratio" is less than 1.0 and is therefore attractive. BLK has been able to grow its earnings at a 23% rate over the past 5 years, much greater than its P/E ratio of 18. In fact, BLK's PEG ratio of 0.78 implies that its stock price could appreciate by almost a third before its PEG ratio exceeded 1.0.
SALES AND P/E RATIO: Lynch believes that for companies with sales greater than $1 billion the P/E ratio must remain below 40 to avoid becoming overvalued. Although BLK has sales in excess of $11 billion, it is trading at P/E ratio of 18 is well below that limit.
EPS GROWTH RATE: Lynch likes to see earnings growth in the range of 20% to 50%, as earnings growth over 50% may be unsustainable. The EPS growth rate for BLK is 23.2%, based on the average of the 3, 4 and 5 year historical eps growth rates, which is considered very good.
TOTAL DEBT/EQUITY RATIO: BLK is a financial company so Lynch's debt-to-equity rules are not applied to determine the company's financial soundness.
EQUITY/ASSETS RATIO: Lynch uses the Equity/Assets Ratio as a way to determine a financial intermediary's health, as it is a better measure in his opinion than the Debt/Equity Ratio. BLK's Equity/Assets ratio of 12% is healthy and well above the minimum 5% this methodology looks for, thus easily passing the criterion.
RETURN ON ASSETS: This methodology uses Return on Assets as a way to measure a financial intermediary's profitability. BLK's ROA of 1.52% is above the minimum 1% that this methodology looks for, thus passing the criterion.
FREE CASH FLOW: Lynch assigns a bonus point if a company's Free Cash Flow/Price ratio is above 35%, as in his opinion a positive Cash Flow (the higher the better) separates a wonderfully reliable investment from a shaky one. This methodology does not favor companies that rely heavily on capital spending, so this ratio for BLK is only (3.93%) and therefore too low to add to the attractiveness of the stock.
NET CASH POSITION: Lynch assigns another bonus point for a company that has a Net Cash/Price ratio above 30% (Lynch defines net cash as cash and marketable securities minus long term debt). According to this methodology, a high value for this ratio dramatically cuts down on the risk of the security. The Net Cash/Price ratio for BLK of -2.33% is too low to add to the attractiveness of this company.
Conclusion: BlackRock meets or exceeds all of Lynch's required measurements, and only fails the "bonus point" metrics that are not as important. In addition, on November 19th it declared a quarterly dividend of $1.93 per share, which results in a dividend yield of approximately 2.2%, slightly less than the 10-year Treasury Note. It's rare to find a company of its size that possesses so many favorable traits and is so fairly valued compared to the rest of the stock market.
Recommendation: Buy BlackRock up to $375.
Disclosure: The author is long BLK.
Additional disclosure: BlackRock is a portfolio holding of the BatonInvesting.com stock portfolio, which the author owns.