A Less Risky Financials Company for Your Portfolio

This week’s hot stock offers many different investment services, including investment management, underwriting, insurance, and mutual fund management. Waddell & Reed (WDR) is not the biggest player in the industry, but it is certainly one of the most profitable. The company’s recent strong quarterly results continue a longer-term trend that has the potential to greatly reward investors.

Waddell & Reed has grown after tax profit (NOPAT) by 17% compounded annually since 2008 and 25% year over year on a trailing twelve-month (TTM) basis. The company currently has an impressive 53% return on invested capital (ROIC) on a TTM basis, placing it seventh in this respect among the 600 Financials stocks we cover. Waddell & Reed has also generated $331 million in free cash flow over the past 12 months, and positive economic earnings for the past 16 years. At the end of the fourth quarter of 2014, Waddell & Reed announced that its annual sales were up 16% over 2013 and operating income was up 26%. This continued growth confirms that Waddell & Reed is becoming more efficient with its capital, and that the company has the ability to ride out volatility in the investment markets.

We upgraded Waddell & Reed on January 22 and the stock now receives our Very Attractive rating. At the moment, the market is undervaluing WDR, even after the company’s impressive 2014. At its current price of ~$45/share, Waddell & Reed has a price to economic book value (PEBV) ratio of 1.1, which implies that the market expects Waddell & Reed to only grow NOPAT by 10% for the rest of the life of the company. This expectation seems overly pessimistic, especially given the fact that Waddell & Reed has grown NOPAT by 17% annualized over the past six years. Waddell & Reed is positioned well to surpass such low expectations.

If Waddell & Reed can grow NOPAT by just 11% compounded annually for the next 10 years, the stock is worth $59/share — a 31% upside. Coupled with the near 4% dividend yield, this upside potential could make Waddell & Reed the star of your portfolio.

Kyle Guske II contributed to this report.

Disclosure: David Trainer and Kyle Guske II receive no compensation to write about any specific stock, style, or theme.

Photo credit: Joan Campderrós-i-Canas

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