Given the Magellan Financial Group Ltd (ASX: MFG) share price is up 1,026% over the past five years many investors will ask themselves whether this stock is a good bet for the five years ahead?
This afternoon it changes hands for $27.24 and has climbed 20% over the past year while paying 76.4 cents in fully franked dividends.
I have previously covered the main attractions of Magellan as a long-term investment prospect. The most important is its founder-led nature that means it is able to retain a tight control on operational costs (that commonly balloon out at other mid-sized fund managers) such as staffing. The means as revenues grow in line with funds under management its already low cost-to-income ratio (26.5%) falls as operating leverage and profitability blow out.
The group directly employs middle and front office staff functions, with back office functions largely outsourced to funds administrator Mainstream BPO Ltd (ASX: MAI). This is important as it allows senior management to concentrate on running the fee-earning side of the business effectively, while administrative operations and costs are outsourced and largely fixed up front.
The group's investment performance has also been consistent enough to attract high-margin retail FUM thanks to a wide and growing distribution network developed under former Colonial First State manger Frank Casarotti.
It also appears to win enough institutional business due to a good five-year investment track record, star fund managers that help sales pitches, and a sales message that appeals to consultants and their insto clients. The message being long term and blue chip (defensive), with a leaning to large and mega-cap US tech businesses that follows the investing zeitgeist.
All this together explains the stock's meteoric rise and paints an attractive investment picture, however, no stock is a buy at any price and Magellan is now trading on expensive earnings multiples while facing the short-term appreciation of the Australian dollar.
I sold half my holdings in the group for $28.45 per share at the end of June, although committed more funds at an average price of $26.99 around two weeks ago and would be reluctant to pay more than $27 per share.
For the trailing 12-month period over calendar year 2016 the company earned $1.02 per share, with analysts forecasts for it to earn around 65 cents per share for the six-month period ending June 30 2017.
That would place it on around 23x FY17's estimated earnings at $27 per share with expectations it could pay out at least $1 per share in dividends over the 12 months ahead on a yield around 3.7% plus franking.
This is an attractive business that will be cycling off ever-growing funds under management (FUM) over the year ahead, especially with the opportunity to earn larger performance fees if the outperformance of the mega-cap tech sector continues, alongside strong US equity markets.
In other words it should comfortably beat FY17's earnings in FY18 just by virtue of it cycling off larger FUM with the opportunity to improve on the $18 million in performance fees for the six-month period ending June 30 2017.
Analyst consensus is for it to earn $1.33 per share in FY18, which would represent growth around 15% and put it on an FY18 earnings multiple around 20x. This looks about right to me, although given Magellan's leverage to equity markets, performance fees, and the Australian dollar forecasting 12 months out is an unreliable business, with potential for up or downside surprises.
The company also has no debt and some $229 million in principal investments as at the end of 2016.
However, if the Australian dollar keeps climbing the stock is likely overvalued as it will face a big headwind in growing Australian dollar translated FUM. Other risks include a general malaise in equity markets, the rise of exchange traded funds, or poor investment performance.
Patient investors may get a better entry price for the stock after it goes ex-dividend in just a couple of weeks' time.
Magellan is not going to shoot the lights out over the five years ahead unfortunately, but investors looking to take on more risk in this space could consider fund manager Australian Ethical Investments Limited (ASX: AEF). It has just over $2 billion in FUM currently, but is growing nicely, now winning institutional business, and coming off a small base that offers the potential for big returns.
