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Date: 2022-01-25 12:43:37
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As the market continued to sell off this past week, with seemingly nowhere for investors to hide, I find myself experience feelings of joy, that I can only equate to a kid at Christmas. While many flee in fear, the value investor in me begins to scour my wish list, searching for quality businesses, that rarely go on sale, trading at, or below intrinsic value. For those with a long-term horizon, this is the moment we have been waiting for.
One of the names on my list, that have I longed to own shares of, is BlackRock, Inc. (BLK). As the largest asset manager in the world, BlackRock serves clients in more than 100 countries around the world. BlackRock offers institutional and retail investors alike, a way to achieve solid performance through passive investments in BlackRock's index funds and ETFs ( exchange traded funds) with minimal fees. The recent market volatility has given long-term investors an opportunity to begin accumulating shares of BlackRock, a business of the highest quality, at a fair price. I believe investors purchasing shares of BlackRock today can achieve market beating returns over the long run.
BlackRock currently has $10.01 trillion AUM (assets under management), making them the largest asset manager in the world. BlackRock's iShares ETFs account for around two thirds of total AUM, and currently have the highest market share of any ETFs, both in the United States, and globally. In total, BlackRock accounts for over one third of total managed assets in the U.S., with Vanguard being their closest rival, with just under 29%.
BlackRock's CEO, Larry Fink, has run what would eventually become BlackRock, going back to 1988. Fink has exhibited extreme leadership skills and has instilled a culture of unity, which has led to decades of success at BlackRock. While maintaining low leverage, Fink has managed to expand globally and make key acquisitions, which have allowed for BlackRock to expand product offerings and maintain consistent performance. Fink has also made it a point to return ample amounts of capital back to shareholders, through dividends and share repurchases.
BlackRock reported fourth quarter earnings on January 4th, missing analyst expectations on top line results, but exceeding on the bottom line. Revenue of $5.11 billion missed expectations by just $40 million, but still represented growth of 14.1% Y/Y. Non-GAAP EPS came in at $10.42, a beat of $0.28. BlackRock's total AUM of $10.01 trillion was up 15.1% Y/Y. In just the last three years, AUM has grown by an impressive 67%.
Over the past year, shares of BlackRock have risen by 7.9%, underperforming the market's, as measured by the SPDR S&P 500 Trust ETF (SPY), return of 14%. Yet, their 5 and 10 year returns handily beat the SPY by a total of 17% and 105% respectively. However, as the market has sold off without bias to start the new year, shares of BlackRock have plummeted by 12.5% in just three weeks. Therefore, with analysts expecting BlackRock to grow their bottom line by 12.66% over the next 5 years, BlackRock's valuation is starting to look too juicy to ignore.
BlackRock has proven themselves to be a trustworthy steward of shareholders' capital, only experiencing losses in earnings just twice in the past 20 years, with one of those times being in 2008, during the financial crisis. This consistency has rightfully earned BlackRock a premium valuation, and over the past 5 years they have traded with an average, blended P/E of 20.36x. However, just under 3 months ago, investors were paying over 25 times earnings for shares of BlackRock.
Fortunately, at $800 a share, the recent weakness has lowered BlackRock's P/E down to a much more reasonable 20.35x, right in line with their 5 year average. While this does not seem to offer a high margin of safety, I often follow Buffett's advice to buy quality businesses, trading at fair value or better. If BlackRock were to trade at this level by the end of 2024, investors can expect annual returns of around 13%, which meets my requirement for double digit returns, when purchasing dividend paying stocks.
Of course, achieving this return is contingent on BlackRock meeting analyst earning expectations, something BlackRock has consistently done every year, for the past 12 years, when given a 10 percent margin of error.
As a dividend paying stock, and one with a streak of 12 years straight of growing that dividend, I also believe we can use BlackRock's yield to determine a fair value range. BlackRock's dividend has risen by an average of 12% annually over the last 10 years, and earlier this month investors received another impressive raise of 18%, for an annual payment of $19.52 a share. At BlackRock's current share price of $800.92, the yield is 2.44%. Over the past 10 years, BlackRock's yield has spent majority of the time in a range between 2.24% and 2.76%. Therefore, with shares of BlackRock trading nearly at the center of this range, I believe this is another measure that shows that BlackRock's shares are trading right around intrinsic value. However, if BlackRock's share price were to fall below $707, this would place BlackRock's yield outside of the normal range, and signal to me that shares are historically undervalued.
BlackRock sports an impressive balance sheet, rich in assets, and containing very little debt. At the end of 2021, all of BlackRock's debt came to only $7.2 billion, which they could more than cover with the $8.7 billion held in cash. Over the last 12 months, BlackRock's debt to EBITDA was a miniscule .16 and operating income covered interest payments by over 36 times. This low debt, combined with BlackRock's massive size, allows BlackRock to charge an extremely low cost for its funds, while still maintaining market leading operating margins, that consistently sit around 40%.
BlackRock's management has also consistently returned capital to shareholders through dividends and share buybacks. Along with the most recent dividend raise of 18%, BlackRock plans to repurchase $375 million in shares during each quarter of 2022. Management has also said they would buy back additional shares, if the price of their shares were to fall below what they view as intrinsic value. Over the last ten years, BlackRock's share count has been reduced by 13%.
Management intends to maintain an earnings payout ratio of between 40 and 50 percent for their dividend. Currently sitting at around 46%, there is room for BlackRock's dividend to rise higher, and I expect the dividend to track earnings moving forward. If analyst estimates are correct, this could mean double-digit dividend raises over the next 5 years or more.
I believe understanding why the market is selling off can help make investors more efficient in their decision making, both now and in the future. This market wide sell-off would seem to be the result of a more aggressive tone from the Federal Reserve, when it comes to fighting inflation. In December 2021, inflation rose by 7% from the prior year, the highest rise in 40 years. This rise in inflation has led to increase in household expenses and has eaten into the wage gains that we have seen over the past year. It has also proven hard on businesses, as it is difficult to pass the rising cost of goods and labor onto customers at such a high rate. Financial institutions, such as Goldman Sachs (GS), believe the Fed will respond with 4 separate rate hikes throughout 2022. As interest rates rise, investors are then able to achieve higher returns in the bond market, making equities less attractive. Also, the future growth of a business must then be discounted at a higher rate, causing the intrinsic value of stocks to fall. This is especially harmful to growth stocks, where investors are paying for earnings that are not set to materialize for many years to come.
Let us not forget though, that these interest rate hikes will come during a time when current rates are near zero percent. Even with four raises of .25%, we are still only talking about a rate of 1%. Once investors realize the returns on bonds are still relatively low, and stock prices have fallen back to reasonable, or even attractive levels, we could see many investors come pouring back into stocks. In the meantime, this selloff has given prudent investors the chance to buy shares in amazing businesses, such as BlackRock, at reasonable prices. So what makes Blackrock an amazing business?
BlackRock has found itself at the forefront of a trend that started two decades ago, in which investors have flocked to the types of low-cost, passively managed products that BlackRock offers. BlackRock's diverse offering of iShares ETFs currently holds a market share of 34%, both domestically and globally, which is no small feat when competing with some of the most well known asset managers in the world, such as Vanguard, Invesco (IVZ), and Charles Schwab (SCHW). Around 80% of BlackRock's AUM is tied to institutional investor, which have typically been more reliable than retail investors, when it comes to holding shares for the long term.
While this trend of investors seeking passive investments has been going on for decades, there would still seem to be a lot of runway left. In 2018, passive investing in equity funds overtook active investing, and today has grown to around 54% in the U.S. Based on a survey done in June of last year, in which investors were asked whether they prefer passive or active investments, the overwhelming majority believed that passive investing was the way to go. This held true throughout each age group and irrespective of whether the investors held a small amount of money invested, or a larger amount.
While the U.S. is BlackRock's largest market, they also serve clients in more than 100 countries, with around one third of their AUM coming from outside of the United States. If that's not diversified enough, BlackRock also diversifies their AUM in different mixes of products. Although around 53% of assets are in strategies involving equities, BlackRock also has 28% in fixed income, 8% in both multi-asset and money market funds, and 3 percent in alternative assets. No matter where the economic cycle leads investors, BlackRock is there to offer their services.
BlackRock's largest market for future growth will likely be found outside of the U.S., with China perhaps offering the most potential. China's government recently opened their country to outside asset managers, and BlackRock has become the first to start a wholly owned, onshore mutual fund in China. They have also created ventures with two Chinese firms, in order to expand their footprint. Last May, they created a partnership with China Construction Bank in an effort to use BlackRock's expertise, and China Construction Bank's established network, to build " a sustainable ecosystem for investing" in China. BlackRock also teamed up with investment firm Temasek to create a fund tapping into the market for green energy.
China's current mutual fund industry is said to consist of around $3.5 trillion, which is set to nearly triple over the next decade. By cultivating relationships and building trust early on, BlackRock is setting itself up nicely to participate in this growth. It is worth mentioning that BlackRock's largest competitor, Vanguard, has scrapped plans to enter into the Chinese market, citing an over crowded playing field as one reason. Vanguard executives also believe the time and money spent building their business in China would ultimately not be worth the effort. However, this will now allow BlackRock to acquire a much larger share in the Chinese market, with less money and time spent on its part.
Finally, no review of BlackRock would be complete without touching on BlackRock's Aladdin Software. Created over 30 years ago, as a way for BlackRock to manage risk within its funds, Aladdin now manages the wealth of some of the largest companies around the world. Essentially, Aladdin allows the user to manage risk in their portfolios, and make split decisions, should any problems arise. Obviously, there is much more to this sophisticated system than I could possibly describe in this short article, but the gist of it is that Aladdin is the most sought after portfolio management system in the world, and currently manages over $20 trillion in funds worldwide. This article gives a good account of what Aladdin does, as well as the risk associated with having so much of the world's funds managed by one program.
Like all equites, there is risk involved when buying shares of BlackRock, and each investor must take honest inventory of their tolerance for these risk factors before deciding whether or not they are comfortable investing in a business. I believe the greatest risk for investors in BlackRock would be a drastic shift in investor behavior, or a large decline in the equity market, stemming from a change in economic conditions.
Currently, BlackRock derives around 80% of revenues from management fees, directly linked to total assets under management. Were economic conditions to change, resulting in a large decline in value for many of the world's equities, this AUM could be drastically lowered, which would in turn affect BlackRock's profits and cash flows. Even if investors were to shift funds over to fixed income assets, the difference in the amount of fees charged for this service, compared to an equity based strategy, would result in lower earnings.
While this risk is ever present in the asset management industry, history has shown time and again that stock prices do eventually recover, though sometimes not for many years, eventually resulting in new all time highs. Although the past is no guarantee for the future, I believe if equity markets were to never rebound, then investors' money would no longer be safe no matter which investment vehicle they choose. Therefore, I view this risk as an opportunity more so than a problem, and BlackRock's immaculate balance sheet should allow them to weather any downturns in the market.
The market has experienced a steady decline to start the new year, and watching the value of your assets decline can be scary for any investor, especially when the last decade plus has conditioned many of us to view the market as a way to consistently grow our wealth in a straight, upwards trajectory. Yet, as someone who has meticulously studied the history of the market, it has been clear that this was always going to be the result of an overvalued market.
To be fair, the market is only down 8.75% from its all-time high, meaning we technically haven't even reached bear market territory, yet. Fortunately, it is a market of stocks, rather than a stock market, and many quality names can be found trading well below their highs. I believe this is a time to start looking for an entrance into many of these names, not an exit.
One of the stocks I am looking to go long in, is the world's largest asset manager, BlackRock, Inc. I believe BlackRock's top class management sets them apart from the competition, and through the Aladdin software, as well as expansion into other markets around the globe, will guide BlackRock to sustained growth, well into the future. While shares of BlackRock do not currently offer a wide margin of safety, shares are trading at a fair valuation when compared historically to BlackRock's P/E ratio and dividend yield. With high quality businesses like BlackRock, there is nothing wrong with opening a position when shares trade at fair value. However, shares of BlackRock, as well as the market as a whole, may have much further to fall. Therefore, I believe prudent investors should build positions slowly, adding additional shares in set increments, should the stock fall further. As 18th-century, British nobleman Baron Rothschild once said " the time to buy is when there's blood in the streets".