There are many different types of finance stocks on the ASX. Banks such as Commonwealth Bank of Australia (ASX: CBA), fund managers like Magellan Financial Group Ltd (ASX: MFG) and diversified businesses like Macquarie Group Ltd (ASX: MQG) are all good options.
However, I think Challenger Ltd (ASX: CGF) is the best finance stock of all. Challenger is the leading annuity provider of Australia. Here are some reasons why I think it's a really good choice:
Generates strong funds under management
Challenger sells billions of dollars of annuities every year. Funds management isn't Challenger's main focus but it generates significant funds every year.
In FY17 the net flow of funds to Challenger was $6.2 billion and it had an average of $61.8 billion of funds under management during the year. This resulted in management fee earnings before interest and tax of $45 million, which is a decent percentage of the total earnings.
Long-term growth potential
Challenger has clear long-term tailwinds behind it.
Retirees are the biggest clients for taking up annuities because they are looking for guaranteed income for their capital.
The number of over-65s is expected to grow by 75% over the next two decades. I can't think of any other finance business that has such a clear growth trajectory.
Sustainable growth
There is a lot that could go wrong for Challenger in the short-term and the long-term, but I think Challenger is playing it safe by having a low dividend payout ratio of 50% of normalised net profit after tax.
Challenger also has a lot more capital than is required by regulatory capital. It had more than 1.5x the prescribed capital amount at the end of the financial year.
Foolish takeaway
Challenger is currently trading at 18x FY18's estimated earnings with a grossed-up dividend yield of 4.03%. I'd be a long-term buyer at the current price, but I'm holding out for a price in the low $11s or in the $10s before I buy again.
