Edmond Jackson's Stockwatch: How exposed is wealth manager Brewin Dolphin?

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Are the FTSE Mid 250 shares in wealth manager Brewin Dolphin Holdings positioned for continued strong progress? Or are they a prime example of how markets are overvalued and exposed to central banks' winding down monetary stimulus?

The situation is interesting as a long/short play according to how events unfold, and it raises questions about wider trends.

The five-year chart shows the stock performing exceptionally well from end-2011 after trading volatile-sideways. Following a strategic review in 2011, management targeted various improvements including a step change in the operating margin from 15% to 20%, so the chart can be viewed as reflecting the results of this initiative.

But there is undoubtedly a macro theme: how investors overcame fears of US and eurozone debt in late 2011, to trade share prices substantially higher - driven by banks and hedge funds capitalising on the cheap money being created.

Lately there has been something of a "head and shoulders" pattern in this stock, marking a point of consolidation where some shareholders have locked in gains and fresh money bought the dips. Profit-taking after the 28 May interims saw the price drop to 300p but it quickly bounced to its up-trend line - or at least that's how it looks for now.

Can you stomach volatility?

Macro influences on Brewin Dolphin contrast. If the "rockstar economist" Thomas Piketty is right to assert that capitalism is trending to increased divisions of wealth with a fast-growing class living principally off income from capital, then a respected wealth manager like Brewin has years of prosperity ahead.

But if those who warn of the risks of excess monetary expansion are correct (see my recent macro piece citing Charles Bean at the Bank of England) then a stock like this is truly exposed. When sentiment turns (Bean: "it will surely come at some point") the sense of "risk-off" is liable to be concentrated in asset management shares, similarly as they benefited from the up-trend.

You could even consider both perspectives as valid hence Brewin being useful to follow as a potential long/short trade, or if you can stomach volatility then a tuckaway for the long run.

In stock-specific terms, note how a cyclical business is being valued as a growth share - a trait that is liable to represent a peak in the wider market. Brewin trades on a high price/earnings ratio of 25 times historic earnings although forecasts for strong earnings growth mean the price/earnings versus growth (PEG ratio) is about 0.7 where a measure under one implies value.

Obviously this assumes forecasts for annual earnings growth over 20%; but there are some in the market who are becoming wary of euphoria.

The respected fund manager Sebastian Lyon warns: "It is difficult to recall another time in the recent past when optimism about the stockmarket, profits and the UK economy was so widespread.

"Fear has unquestionably succumbed to greed and stockmarkets look more expensive than any time since 2007. Many stocks are trading on, in our opinion, nosebleed valuations."

In fairness to Brewin management they have buttressed the company against adversity, for example raising managed and advised funds from £20.4 billion to £22.7 billion in the year to end-March 2014, prioritising a focus on core services to enhance the company's risk/reward profile, and exercising control over wage inflation - salary costs recently declined by 4% despite higher IT personnel costs.

Subject to market trends

A dilemma with some asset management shares is star fund managers' remuneration taking a lion share of profit, although this tends to apply mainly to hedge fund groups.

Also a new dividend payout policy was declared last December targeting a total annual payout of 60-80% of adjusted earnings per share. It means that despite Brewin shares' strong performance since end-2011, the yield is projected to rise from about 2.2% currently to a more meaningful 4.2%.

So there is quite a prop (assuming forecasts) were markets to suddenly sell off. In such a scenario the question would become, do central banks revert to yet more monetary stimulus like China and Europe are currently considering - or could markets fester in a sense that policy options are discredited? We can only see what transpires.

Revenue growth has been achieved principally from new funds managed within the discretionary (i.e. clients who defer to Brewin's judgment) side of the group, while other operations remained flat.

The only real glitch in the story is a substantial IT write-off: in 2011 a previous executive team put new software into Stocktrade, an execution-only service, as part of the corporate efficiency drive; but it ran into problems and the board decided not to extend it into discretionary wealth management.

Consequently there will be a circa £32 million exceptional charge in the second half of 2014 although this is said not to affect the target for a 25% operating margin run rate by the end of 2016 where "significant progress has now been made." Also the write-off is promised not to compromise dividend policy.

Altogether, at 327p I rate Brewin as "potentially over-priced" on the basis that financial markets are exposed to the wind-down in exceptional monetary stimulus. Despite management's overall good progress, an asset manager remains subject to key trends in markets. Yet it is precisely this near-term risk that makes the situation worth watching, lest volatility offers a useful long-term buying opportunity.

For more information see brewin.co.uk.