This Industry's Best Value

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

I know that some investors are willing to buy multiple stocks from the same industry if they find each of the companies attractive. However, I fall into the camp that I want diversification, but I would rather choose the very best of an industry and put my money into that one stock. Brokerage and investment companies seem like good opportunities since they benefit from the need to grow wealth over time. Since very few people can grow their assets without investing in stocks or bonds, in theory these companies should do well over time. Looking at the different options, it seems like T. Rowe Price (NASDAQ: TROW) could be the best value at the current time.

In the brokerage and investment company businesses, there used to be a divide between companies offering full-service advice and management, and discount brokers. However, over the last few years the line has been blurred between discount brokers, mutual fund companies, and investment managers. Through natural expansion each of these types of companies is attempting to broaden their offerings. This puts companies like The Charles Schwab Company (NYSE: SCHW) and Franklin Resources (NYSE: BEN) in direct competition with T. Rowe Price and others. The difference between these two companies and T. Rowe seems to be T. Rowe has better organic growth, and analysts are expecting faster growth for the company in the future as well.

Given that I live in Maryland, some might say I'm just touting the home team by talking about T. Rowe, but I don't let the location of companies determine whether they are good investments, I let the numbers speak for themselves. Looking at the company's recent quarterly results, T. Rowe is making its case as the best investment management stock no matter where they are located. The company saw revenue increase 13.29% and EPS increased by 32.39%. In addition, T. Rowe showed significant organic growth, with average assets under management up 14%, and this growth was split evenly between stock and bond funds. The company is heavily weighted toward stock and blended asset funds with over 74% of assets in these types of investments. With investors increasing their stock and blended asset exposure by 16% on a year-over-year basis, it appears T. Rowe investors are anticipating better times ahead for the market. Though bond and money market funds sport yields that are historically very low, this asset class saw account growth of 13% itself. It's not hard to understand that investors are attracted to T. Rowe funds. Seventy-six percent of the company's fund classes have outperformed their averages over the last 1, 3, 5, and 10 year periods. T. Rowe's top and bottom line growth is impressive, but their financials tell an even better story.

T. Rowe earnings growth is impressive, but I also want to see that this earnings growth contributes to free cash flow as well. The good news for investors is T. Rowe is very successful in converting its sales and earnings into cash flow. In fact, if you compare the company to its peers, T. Rowe reports a very good sales to free cash flow conversion rate. When comparing free cash flow across different size companies I use free cash flow per $1 sales. This ratio allows investors to compare how effective companies are in turning $1 of sales into free cash flow. The leader in this category is Charles Schwab, which generated almost $0.48 of free cash flow for each $1 of sales. Schwab serves a higher-end clientele base and has more managed accounts than T. Rowe, so this lead isn't too surprising. That being said, T. Rowe generated about $0.29 of free cash flow per $1 of sales over the last nine months. By comparison, Franklin Resources only generated about $0.09 of free cash flow using this same measure. Given that T. Rowe operates more of a standard mutual fund business, the huge difference in free cash flow versus Franklin Resources is amazing.

T. Rowe also is improving its margins, with the company's operating margin increasing from 43.34% last year, to 46.63% this year. This higher margin allowed the company to generate almost 12% more operating cash flow over the last several months. In addition, T. Rowe has increased its cash and cash equivalents by 37.54% during this same timeframe. This shows that the company understands how to make the most of its cash flow by rewarding investors with its dividend, and shoring up the balance sheet at the same time.

When it comes right down to it, T. Rowe looks like a buy based on its growth potential and income generation versus its peers. Charles Schwab is expected to grow earnings in the next few years by 7.7% and Franklin is supposed to grow by 10% over the same timeframe. By comparison, T. Rowe is expected to grow earnings by over 13%. When it comes to income, T. Rowe also beats its competition by offering investors a nearly 2.1% yield versus 1.75% at Schwab and just 0.9% at Franklin. With the highest expectation for earnings growth and the highest yield, you would expect the stock to also carry the highest P/E ratio, but it does not. In fact, Schwab sells for nearly 19 times forward estimates versus about 17 times estimates at T. Rowe. While Franklin is cheaper at about 12 times estimates, the company's slower growth rate, lower yield, and much lower free cash flow makes this a difficult comparison to T. Rowe. If the economy continues to improve, the stock market should do well. Since T. Rowe has nearly three-quarters of its assets in stock and blended assets, the company would benefit tremendously by increased investment in stocks. The company has good organic growth, the best yield of the group, and the highest expected earnings growth as well. This sounds like the best value in its industry to me.


MHenage has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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!

blog comments powered by Disqus

Compare Brokers

Fool Disclosure