This is from the AMM Dividend Letter released December 6, 2014. If you want to see the latest “Dividend Stock in Focus” as soon as it’s released then join our mailing list here.
Despite its value barely keeping up with the rate of inflation (not to mention all the maintenance costs), why do most people say buying their home was their greatest investment?
Time.
Buying a home is about buying a place to raise and protect your family rather than making a short-term profit. A rising property value usually becomes a concern only when it is time to sell the home. Subsequently people own their homes on average for long periods of time, 13 years on average from the latest study. Allowing the value of a home to grow over a long time period (even at a low rate) coupled with paying down a mortgage produces large gains in a home’s equity.
Owning a cash flow positive business is arguably a better investment than owning a home since the business pays you. Like owning a home the more time you give a free cash flow generating business to grow the better off your investment will become. People are not doing this.
From Morgan Housel’s How to Ruin Your Life.
In 1940, a 50-year old had a life expectancy of 21.9 years, and the average stock was held for about seven years. By 2010, a 50-year old had a life expectancy of 29.6 years, and the average stock was held for less than a week.
Now compare that to John Hay’s goal of buying two shares of the New York Tribune Newspaper back in the early 1870s.
Hay joked to Bigelow “I shall take my own medicine as soon as I own two or three shares of Tribune stock” – an impossiblity, at least for the foreseeable future, since only one hundred shares existed, each valued at $10,000.
From All the Great Prizes: The Life of John Hay, from Lincoln to Roosevelt by John Taliaferro
$10,000 back in the early 1870s is about $180,000 today. If you had to save up $180,000 to buy one share in a company how long do you think you would hold onto that share? Also, how selective would you be in determining which company to buy shares of?
Because it is so easy to trade stocks, it is easy to forget what owning stock really means. It is an equity stake in a company. You are an owner of the business and you have a claim on its profits.
Businesses need time. The time to reinvest profits. Time to reduce costs. Time to gain market share. Time to increase cash flows. Time to increase value for its shareholders. Giving a business time is one of the hardest things to do in our fast paced world, but it is the greatest thing you can give an investment. In the long run your portfolio will thank you.
Sincerely,
Your Portfolio Management Team
Dividend Stock in Focus
BlackRock, Inc. (BLK): $364.40*
*price as of the close December 5, 2014
It began over a disagreement about compensation. One manager, Larry Fink, wanted to share equity with his employees. The other manager, Steve Schwarzman, did not. Unfortunately for Mr. Fink, Steve Schwarzman was/is the Chairman and CEO of the Blackstone Group (BX). Larry Fink and his fixed income investment management unit had to go. In 1995 the unit was sold to PNC Financial for $240 million and during the sale process the money management unit changed its name to BlackRock.
Then in 1998 PNC merged its equity and mutual fund business into BlackRock and in 1999 the company IPO’d at $14 per share with $165 billion in assets under management. The company continued to grow its assets under management and it also bought other companies: State Street Research & Management in 2005; Merrill Lynch Investment Managers in 2006; and then during the financial crisis Barclay’s Global Investors and its large Exchange Traded Fund (ETF) business iShares. Today BlackRock is the world’s largest asset manager with over $4.5 trillion in assets.
BlackRock is so large it is now the single largest shareholder in many of our portfolio holdings including JPMorgan Chase, Exxon Mobil, Apple, and McDonald’s. According to an Economist article from 2013, BlackRock owns a stake in almost every listed company in America and around the world.
What does Steve Scharzman think about that sale of BlackRock back in 1995?
Blackstone Group LP’s Steve Schwarzman said his decision 19 years ago to sell what would become the world’s largest money manager was a “heroic” mistake. – Bloomberg
Dividend History:
Over the last 10 years BlackRock has grown its annual dividend at a compound annual rate of 21%. For fiscal year 2014 BlackRock is on track to pay $7.72 per share in dividends a 14.8% increase over fiscal year 2013.
From S&P Capital IQ. Click to enlarge.
Catalysts for Dividend Growth and Price Appreciation:
Diversified Asset Manager
No matter what happens in the capital markets BlackRock is in a position to succeed. As you can see in the table below BlackRock is diversified between asset classes: 53% Equity, 29.5% Fixed Income, 2.5% Alternatives (Hedge Funds).
From BlackRock’s 10Q ending September 30, 2014. Click image to enlarge.
BlackRock also has a good mix between retail (11.6%) and institutional (60.1%) assets. According to Morningstar, the average annual redemption rate for retail assets is 30% and institutional assets, which are managed by committee, have an even lower annual redemption rate.
BlackRock’s assets are also blended between active (retail + institutional active at 32%) and passive (iShares + institutional index 60.5%) management strategies.
From BlackRock’s 10Q ending September 30, 2014. Click image to enlarge.
The large institutional and passive assets are a strong asset base for BlackRock to work off of. However, these assets generate lower fees. Retail assets and active strategies generate higher fees but make up a lower percentage of BlackRock’s assets. The majority of BlackRock’s active fixed income strategies are performing above their benchmarks and outperforming their peers. BlackRock’s active equity strategies are having trouble, only half of their equity funds are beating their peers. Management is dedicated to “fixing” their equity strategies. If management can improve performance asset growth should follow along with higher revenue growth.
iShares
The passive ETF business is a lower revenue business as ETFs generally charge significantly lower management fees than their active counterparts. The misperception about the ETF business is that it is a low margin business too.
When Blackrock bought Barclays Global Investors in 2008 the iShares ETF business had $385 billion in assets under management. iShares’ AUM is now just shy of $1 trillion and is by far-and-away the global ETF leader.
From BlackRock’s Analyst Day Presentation. Click image to enlarge.
iShares accounts for 23% of BlackRock’s assets under management and provides 35% of BlackRock’s base fees. What has happened to BlackRock’s margins?
They’ve expanded.
From S&P Capital IQ. Click image to enlarge.
Succeeding in the ETF business is all about scale. The overwhelming majority of ETFs are managed to a passive index. Running an ETF and maintaining its index are not as costly as running an active strategy with its higher labor costs. However, ETFs still have costs which are mostly fixed. The more assets in an ETF, the less costs to operate the ETF as a percentage of AUM. So even if the ETF charges less in management fees its lower cost structure can still produce high margins if its asset base grows.
Even at $1 trillion in ETF assets, BlackRock still has room to grow. Most ETFs are focused on equities and even more so on U.S. equities. The daily liquidity of stocks and the ability to sort them by different metrics, i.e. market capitalization, made them the first and easy targets of ETFs. Now the opportunity is in fixed income ETFs. According to management, fixed income ETFs make up 0.4% of the total market compared to the 3% for equity ETFs.
Room to Grow
At $4.5 trillion in assets you would think there isn’t that much further to grow. However, according to Blackrock total global financial assets are $225 trillion with $62 trillion of it being managed. BlackRock is making the push to grab an even larger share of global assets.
From BlackRock’s Analyst Day Presentation. Click image to enlarge.
The Fall of the King
Bill Gross founded Pacific Investment Management Company (PIMCO) in 1971 based on the idea of actively managed bond funds. Due to Bill Gross’ investment skill the firm grew into a $1.87 trillion AUM behemoth and Mr. Gross was dubbed the “Bond king”. If the history of real life kings provides any guide, you don’t stay at the top for very long. This year Bill Gross left the company he built before being forced out over recent poor performance of his flagship mutual fund, his brash managerial style, a public feud with former CEO Mohamed El-Erian, and a developing internal coup.
Bill Gross’ departure has cost PIMCO $100 billion in AUM and the withdrawals are still building. PIMCO’s loss is every other fixed income managers’ gain. Billions have been flowing into Vanguard, TCW, DoubleLine, and BlackRock. If you do a search for Bill Gross on Google the very first thing you see is an Ad for BlackRock. PIMCO’s blood is in the water and the sharks are circling, looking to bite off a another chunk of their large fixed income asset base.
Click image to enlarge.
Pre-Mortem (Potential Risks to our Thesis):
ETF Price War
BlackRock is the ETF leader and a target for other ETF companies to gain market share from. Vanguard, the pioneer of index investing and low cost funds, offers some of the lowest cost ETFs and has gained market share at BlackRock’s expense. In 2009 BlackRock’s ETF market share was at 48% now it is down to around 39%. In an effort to fend off Vanguard, BlackRock lowered the management fees on 12 ETFs and has introduced a new line of low-cost “buy-and-hold” ETFs. Most of the management fee cuts were in ETFs that compete directly against Vanguard like the iShares S&P Total Stock Market ETF and iShares Total U.S. Bond Market ETF. So far the cuts have not and should not affect near-term profitability. A prolonged price war with cuts across more ETFs will have an affect on revenue growth and profitability.
Can’t Fix Active Strategies
Actively managed strategies account for 1/3 of BlackRock’s asset under management but generate almost half of BlackRock’s base fees. Actively managed fixed income strategies are doing well but BlackRock needs to improve its actively managed equity business. The potential for asset growth and revenue growth in actively managed equity strategies is extremely attractive. Revenue growth and profitability will be harmed if management can’t turn the performance around in its actively managed equity strategies.
Equity Market Risk
Fixed income and money market funds charge much lower fees than active equity strategies. When equity markets are in turmoil BlackRock will face increased redemptions in its equity strategies. Some of those redemptions will find their way into BlackRock’s fixed income funds but more than likely the redemptions will sit in cash. BlackRock’s assets under management will decline because of the general decline in asset prices but also because of the redemptions. BlackRock’s profitability and cash flow will come under pressure as a result. However, as long as BlackRock remains a well managed company any market turmoil and excessive decline in BlackRock’s stock price should be viewed as an opportunity to add to our position.
Conclusion:
We sold our position in Navient (NAVI) and SLM Corp (SLM) to take advantage of BlackRock’s price decline in October and start a new position in the company. We’ve owned BlackRock before and like Steve Schwarzman we regret selling our original position. We continued to follow the company and kept reevaluating our estimate of its fair value. In October we finally had a chance to buy BlackRock again at a price below our $352 per share estimate of fair value. While we would’ve liked to have held onto both Navient and SLM Corp., we saw a chance to buy a great company with what we view as much better long-term prospects for dividend growth and capital appreciation. Now we just have to give BlackRock the time to execute its strategy.
Chart courtesy of Stockcharts.com.Click image to enlarge.
All previous AMM Dividend letters are archived here.
