Why did Blackrock Advisors Bet Big on These Financial Companies?

Aubrey is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In the latest quarter, Blackrock Advisors went shopping for financial stocks. Three of its four big buys are financial stocks of varying types. In general, the financial sector has a positive outlook in 2013 for the simple reason that a recovering economy, along with the boom of the energy sector, are in need of huge amount of capital. I try to briefly analyze each. Although the transactions contained in the 13F of Blackrock may have been made way before the period filing, we can find out if a stock is still worth buying at present by analyzing its current metrics and the latest market trends and outlook.

AIG is progressing financially, but is this enough?

The fund manager increased its stake in American International Group (NYSE: AIG) by 75%. AIG has been surpassing EPS estimates in at least the last 4 quarters by wide margins. In fact, AIG exceeded analysts’ estimates by 52% in the latest quarter. In terms of profitability, the company was able to recover from a negative margin in the last quarter in 2012 to 13.88% in the first quarter of the current year. And the outlook is positive, as analysts estimated that its EPS will grow by roughly 12% each year in the next 5 years.

In terms of pricing, the P/E ratio (ttm) based on Finviz data is at a low 11.59. However, over at Yahoo! the ratio of 29.22 is above the industry’s 22, which indicates that AIG is relatively overvalued compared to its peers. Moreover, taking growth into the equation, AIG has a PEG ratio of 0.95, above its peer’s average at 0.31. The PEG ratio is an indication of valuation that incorporates future growth; a higher value implies a relatively overvalued stock. Meanwhile, AIG is more prone to fluctuations relative to the market than its competitors. Its beta of 1.77 according to Macroaxis is above its peer’s average beta of 0.32.

What is worth noticing, though, is its debt level. The debt-to-equity ratio is on a consistent downward trend, from 0.7356 during the first quarter last year to 0.4548 in the same period this year. This shows the increasingly improving financial stance of the company. While this and its recent EPS performance are quite admirable, I need to see more momentum in terms of profitability and earnings with less volatility to consider AIG for a long term investment.

Take advantage of the high growth expectations in this company.

Bank of America (NYSE: BAC) is another financial company that Blackrock favored in the first quarter. The fund manager purchased 72% over what it bought in the previous quarter. The bank’s profit margin is in single-digits, but has increased notably from 2.93% in the first quarter of 2012 to 6.39% in the same period of the current year. I must say, however, that the bank’s revenue is quite volatile. During the last two quarters of 2012, the quarterly revenue went down year-over-year by 28% and 25%, respectively. Prior to that, during the quarter ending June 30, 2010, the bank saw an impressive rally of roughly 66%. Overall, it suffered a negative operating cash flow of $13.86 billion last year. Fortunately, the cash flow statement has quickly recovered during this year's first quarter.

Bank of America is considered a volatile investment. Its beta, now calculated at 1.92, indicates that it offers greater fluctuations relative to the market and is way past its peer’s average at 0.32. Notwithstanding the high fluctuations and dwindling cash flow statement, analysts expect its EPS to robustly grow by 23% annually in the next 5 years.

In terms of dividends, Bank of America may be consistent but is lacking in dividend growth. Moreover, the current pricing is at the higher end relative to the industry. Its P/E ratio of 40.19 based on Yahoo! data is way above the industry’s 11.00. But if one takes into account growth, this bank looks cheaper based on a Yahoo! compilation with a PEG ratio (5-year expected) of 0.59, as opposed to Citibank’s 0.70, JP Morgan’s 1.44, and Wells Fargo’s 1.60.

Despite this, Blackrock seemed to have seen a great cycle coming from the bank as shown by consistently high analysts' expectations on its EPS in the coming quarters. If you wish to take part in this, you may need to wait for a better timing of entry. Bank of America has had quite a rally, and investors may be thinking of profiting from this--that is when you might want to move. Indeed, you can take advantage of its low forward P/E ratio of 9.95 (based on finviz.com data)--just be ready to swallow the risks that come with significant fluctuations.

Mastercard and its consistently strong performance

Blackrock Advisors increased its stake in Mastercard (NYSE: MA) by $235 million. This company is indeed a favorite of many, and is a gem in everyone’s long term investment portfolio.

Mastercard's business operation is solid, no doubt about that. Its net operating cash flow based on a Marketwatch compilation grew each year by 30% on the average within the last 3 years. Since 2008, the net operating cash flow never contracted and instead grew at a whopping 81% annually on average. The free cash flow is swelling at an average rate of over 30% each year during the last 3 years. And there are not many companies that can turn 40% of revenue into profits. Therefore, if you are in for some cash income, this stock is on top of the charts. The first 3 dividend payments (totaling $1.50 per share) in 2013 has already doubled that for the same period last year ($0.75). With a low, safe payout ratio based on cash flow of only 4.5%, there is a concrete reason to think the dividend is safe. In terms of volatility, Mastercard’s beta is 0.59, higher than the average of its competitors at 0.32 but is below 1 which means that it is less volatile compared to the market.

Credit businesses like Mastercard are strong even in trying times and at a period when the rest of the financial sector is barely getting by. The economic recovery phase will likely fuel the company’s thriving business even more and consequently its attractiveness. The outlook remains positive; the EPS is expected to grow by roughly 18% annually in the next 5 years. During the last 5, EPS had grown at an annual rate of 22%.

Conclusion

It is easy to see why the fund manager had picked Mastercard to be one of its top buys in the first quarter. It had chosen the rest perhaps because of the positive outlook. Indeed, the expectations for the financial sector is generally attractive in the current. But the risk of volatility is also undeniable. I strongly suggest that investors carefully pick from among companies that offer the least amount of such risk. That is why among these picks by Blackrock Advisors, I’d be more confident in recommending Mastercard.

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Aubrey Tabuga has no position in any stocks mentioned. The Motley Fool recommends American International Group, Bank of America, and MasterCard. The Motley Fool owns shares of American International Group, Bank of America, and MasterCard and has the following options: Long Jan 2014 $25 Calls on American International Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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