Can You Manage Big Gains with These 4 Companies?

By Chad Henage - October 29, 2012 | Tickers: BLK, BEN, IVZ, TROW | 0 Comments

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Certain industries almost act like counter-cyclicals. In plain English, these companies do well once the economy is moving along at a good pace, and things are generally good. However, in order to really benefit from the higher profits these companies produce during these times, you have to be willing to buy their shares when no one else wants to. One of the primary industries that acts in this fashion is the investment management and mutual fund industry. If you think about it, this makes perfect sense, as more people are willing to invest their money when they feel secure and the economy is growing. The hardest time to buy these companies is when there is uncertainty. With this as a backdrop, I recently ran a screen on the Fool.com CAPS Screener to try to find successful financial services firms. I wanted companies with at least 10% revenue growth and over 20% EPS growth in the last few years. Four different firms made the cut, but I want to know which one could be the best investment at the present time. 

The four different companies that met my criteria were BlackRock (NYSE: BLK), Franklin Resources (NYSE: BEN), Invesco (NYSE: IVZ), and T. Rowe Price Group (NASDAQ: TROW). Two of the companies, BlackRock and Invesco, operate as investment managers and the other two are more traditional mutual fund companies. All four companies are highly profitable, and generate significant free cash flow. To get an idea of which one might be the best investment, let's first look at their valuations and expected growth rates over the next few years:

Not surprisingly, the two investment managers are valued similarly, and the two mutual fund companies are also valued almost the same on a PEG basis. That being said, Invesco offers the best combination of growth and valuation by its 1.11 PEG ratio. This naturally puts BlackRock in second place, and T. Rowe comes in third. The reason T. Rowe scores the third spot is that the company is valued relatively the same as Franklin, but offers a higher growth rate. (BlackRock – 3, Franklin – 1, Invesco – 4, T. Rowe – 2)

Current valuation is one thing, but how much confidence can we have in analyst estimates for growth? I know the saying goes that past results are no guarantee of future returns, but I feel a lot better about buying a company knowing they have been consistently able to meet or beat estimates in the past. If a company meets or exceeds estimates, it seems reasonable that investors should be able to have more confidence in analysts predictions for the future. With this in mind, look at how each of the companies has performed over the last four quarters:

Coincidentally, the companies stack up from best to worst performance in alphabetical order. BlackRock is clearly the most consistent beating expectations more times and by a higher average. T. Rowe comes in last place with the most misses and a negative average. (BlackRock – 4, Franklin – 3, Invesco – 2, T. Rowe – 1)

Some investors take earnings per share with a grain of salt and tend to look at a company's free cash flow as a more important measure. I've heard it said that you can't spend earnings per share, but you can spend free cash flow. To get an apples to apples comparison, I look at free cash flow per $1 of sales. This allows us to compare companies of different sizes and see which one is the most efficient, turning sales into cash that can be used. By this measure, T. Rowe is actually the winner with $0.32 of free cash flow per $1 of sales. BlackRock comes in second at $0.30, and both Franklin and Invesco tie for last at $0.21. (BlackRock – 2, Franklin – 1, Invesco – 1, T. Rowe – 3)

Speaking of free cash flow, there are few investors that don't appreciate a good dividend. In particular in today's low interest rate environment, investors are attracted to income producing stocks. If income is what you crave, then BlackRock is the winner. The company pays out the highest yield at 3.17%, and has the second lowest payout ratio at 39.32%. Second place belongs to Invesco at 2.79% and a 45.85% free cash flow payout ratio. This leaves T. Rowe in third at 2.07% and Franklin at a relatively minuscule 0.82% yield. (BlackRock – 4, Franklin – 1, Invesco – 3, T. Rowe – 2)

Last but not least, let's compare each company's balance sheet for relative strength. I personally favor the equity to assets ratio, as Peter Lynch called it the most fundamental measure of a financial institution's strength. The higher the ratio the better, and by far the two highest belong to the mutual fund operators. T. Rowe has a ratio of 0.89 and Franklin's equity-to-assets ratio is 0.64. Though BlackRock and Invesco are similar businesses, there is a relatively big gap between the two by this measure. Invesco shows an equity-to-assets ratio of 0.44 and BlackRock comes in at just 0.14. (BlackRock – 1, Franklin – 3, Invesco – 2, T. Rowe – 4)

Looking at our totals, the winner is BlackRock with a total score of 14. When you look at the categories the company was strong in, they are arguably some of the most important, with valuation, growth, and dividend yield as important high scores. The company also is the most consistent when it comes to beating earnings expectations. Tied for second place with a score of 12 are Invesco and T. Rowe, but I would give the edge to Invesco with the second highest dividend and the best relative valuation. In last place is Franklin with a total score of 9, this also seems to make sense as the company pays the lowest yield, and it has the least attractive relative valuation. If you believe the economy will continue to recover and are looking for an under-recognized way to take advantage of this, BlackRock should be where you start your research. Use the above information as a starting point, and add any of the above companies to your personalized Watchlist to keep up with developments.

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