Financial Planning is a great business
Financial planning and wealth management is a business that benefits from long-term demographic trends. Most financial planners make their money by charging a percentage of Assets Under Management (AUM). For example, if a money manager charges 1%, then for every $100,000 they manage they make $1,000/year. Planners take their cut whether the client’s portfolio is up, down, or flat. The beauty of this model is that since the stock market rises, on average, about 10%/year over the long-term, financial planners should see their earnings grow by 10% a year just from the rise in the general market. Assuming existing clients add additional money each year, and assuming the planner can bring a few new clients on board each year, it’s reasonable to expect AUM to grow in excess of 10%/year. If AUM grows by 15%/year then a planner’s income will rise by 15%/year. As I said, it’s a great business.
And of course costs don’t rise proportionally with AUM. After all, it doesn’t take 10x as much time to manage $1M as it takes to manage $100K. You’ll likely have the same asset allocation and the same investments – you’ll just purchase 10x as much of each investment. This means that as AUM increases you’d expect profits to increase even faster – the additional income from additional AUM will be almost pure profit.
As baby boomers retire we’d expect to see an even greater need for financial services. They’ll purchase annuities, ask for help managing their nest egg to ensure it lasts as long as they do, and, at the very least, want somebody to talk to about their retirement plans.
These demographic tailwinds should result in significant long-term opportunities for financial planners and financial planning companies.
Let’s take a look at a financial services company that I have invested in.
Ameriprise Financial
Ameriprise Financial (AMP) is a financial services firm that provides financial planning, brokerage services, investment advice, investment products, and various insurance products (life, casualty, etc.). Ameriprise was founded in 1894 as “Investors Syndicate”, and after various mergers, acquisitions, and name changes was acquired by American Express in 1984 and renamed American Express Financial Corporation. It was then spun back out as a separate company in 2005. Since then it has acquired H&R Block and a few other asset management companies.
In 2012 Ameriprise had sales of $10.259B and net income of $1.029B
In 2015 Ameriprise had sales of $12.200B and net income of $1.562B
That’s an annual sales growth of 5.95% but annual profit growth of 14.93%. Not a bad business, right?
It’s even more impressive when you take into account that Ameriprise has been on an absolute rampage of buying back their own shares. In just those 3 years the share count has gone from 222.8M to 184.2M, for an annual decrease of 6.14%/year. That’s easily one of the highest stock buybacks I’ve seen in a long time.
When you combine the buybacks and the growth in profits we see impressive EPS growth. In the 3 years from 2012 to 2015 earnings have grown from $4.73/share to $9.13/share. That’s a very impressive 24.51%/year. Things look good through the end of 2015.
So what’s happened in the last 12 months?
| 2015-09-30 | 2015-12-31 | 2016-03-31 | 2016-06-30 | 2016-09-30 | |
|---|---|---|---|---|---|
| Relevant Numbers (Quarterly) | |||||
| Revenues (mil) | 2851 | 3112 | 1630 | 2117 | 3010 |
| Revenue Growth (%YOY) | -6.03 | 2.94 | -46.96 | -33.2 | 5.58 |
| Earnings (mil) | 397 | 357 | 364 | 335 | 215 |
| Earnings Growth (%YOY) | -5.48 | -16.2 | -7.38 | -19.28 | -45.84 |
| Net Margin (%) | 13.92 | 11.47 | 22.33 | 15.82 | 7.14 |
| EPS | 2.17 | 2 | 2.09 | 1.97 | 1.3 |
| Return on Equity (%) | 17.83 | 16.58 | 18.79 | 18.9 | 12.39 |
| Return on Assets (%) | 1.08 | 0.98 | 1.02 | 0.95 | 0.6 |
These results are, in a word, terrible. Revenue growth is down. Earnings are down substantially. Margins are getting crushed. EPS has dropped by 40% from 2015 Q3 to 2016 Q3. ROE and ROA are both down.
What’s behind these terrible numbers?
First, the company is feeling the effects of low interest rates. These low interest rates are hurting the insurance and annuities businesses (lower interest rates mean lower returns on premiums that are collected). Second, the company had a few one-time charges, including a revaluation of the value of their insurance business due, in part, to low interest rates. Finally, the insurance arms of the business had higher than expected losses during the year.
That’s the bad news.
The good news is that the losses are primarily accounting losses (due to revaluation of assets, etc) and don’t really reflect the strength of the business. They have been aggressively growing the dividend and buying back stock, but unlike a lot of companies, they have managed to do so without taking on lots of debt.
Cash flow has remained strong. Net operating cash flow for the last 4 quarters (Q3 2015 through Q2 2016) has been $640M, $371M, $1.06B, and $1.02B. Client assets hit an all-time high and revenue rose 3.9% in Q3 2016.
Overall, I’d characterize the business as solid, but with a worrisome recent hiccup. This is why the stock price is down about 25% over the last year, including an almost 7% drop on Oct 26, 2016. Has the market overreacted and is the stock too cheap now?
Related: Avoid companies that borrow to pay a dividend
Valuation
The valuation is very interesting, especially after missing earnings estimates for 2 quarters in a row. The current PE ratio is 12.1 and the stock carries a 3.36% yield.
Over the last 5 years Ameriprise has had an average PE of 14, with a high of 18.o9 and a low of 8.96, with an average of 14. That valuation makes sense to me. Ameriprise is a combination of an insurance company and a brokerage company. The overall PE ratio of the financial services industry is just under 19, with brokerages at just over 20 and insurance companies at just under 10.
So we see that Ameriprise is a bit under its average and somewhere between the market average for insurance and brokerage companies. That seems about right. Insurance is a great business in a lot of ways, but it’s the ultimate commodity business. The terms of insurance contracts are fixed by state regulators, so a $500k life insurance policy from company A is identical to a $500k insurance policy from company B. The only factor that provides any differentiation whatsoever is the financial strength of the company (incidentally, this was Warren Buffett’s realization when he moved into the financial industry in 1967 – he realized he could use his stock picking prowess to increase the value of an insurance company’s investments and thereby create a financial stronger insurance company). The commodity nature of insurance is why the industry PE is lower than the market average.
The consensus EPS growth for the next few years is about 10%/year. That’s the kind of solid but unspectacular growth that is repeatable for many years into the future.
The company held up pretty well during the Great Recession (the only downturn the company has encountered since being spun off from AmEx). Earnings went from $3.39/share for FY 2007 to -$.16/share for FY 2008, then rebounded to $2.95 in 2009. That’s very solid performance during a period when most financial companies showed enormous losses. It’s not a recession proof company like McDonald’s, Walmart, or Altria, but a single year of small losses isn’t too bad.
Conclusion
I think Ameriprise is reasonably priced today at around $88. It’s not a screaming deal, but it’s not particularly overvalued either (unlike the rest of the market). The earnings quality is not as high as with a business like Coke or Johnson & Johnson, but you appear to be well compensated for that by the well-below-market PE ratio.
A quick conservative estimate of the total return over the next 10 years would be a 3% dividend, 3% buybacks, 5% profit growth, and another 1% for an increase in the PE to return to the long-term average. Adding those up we get a 12% total return, and that’s assuming half the buyback rate and profit growth the company has had over the last few years.
A more aggressive estimate would use the analyst projections of 10% yearly profit growth and a higher buyback of 5-6%/year. Adding those numbers to the dividend and PE expansion would give us 19-20% return per year.
Ameriprise offers a pretty compelling investment here – low valuation, solid growth, and a clear management emphasis on shareholder returns through growing dividends and aggressive stock buybacks. It’s diversified across a couple of different financial services sectors, so it’s not overly reliant on any one type of income stream, and the business performance held up pretty well in the last recession.