Stockwatch: A company in rude health

What further upside is there in asset management stocks? They appear balanced between attractive demographics - middle-aged "baby boomers" taking responsibility for their financial future - and big international risks such as US interest rate rises and reverberations from Greece. They can be more volatile than wider markets: on fundamentals due to "operational gearing" where costs are relatively fixed versus fluctuating demand for funds, which means profits are sensitive to revenue changes; and on sentiment, because traders act in anticipation of the profit impact.

There is also a long-term prize in sight. Private investors form 73% of clients' assets at Liontrust (LIO) and are often implored by the media and independent financial advisers to establish a plan to regularly invest money rather than try to anticipate market moves. The baby-boomer generation from the 1950s to 1970s is possibly substantial enough to mitigate cyclical demand for stocks/funds and certainly to build a long-term successful business.

Mind, however, this golden pot means strong competition and questions posed by the media/regulators regarding industry fees. Equity-wise, this implies an asset manager established enough to have credibility with potential clients, yet small enough for new business to boost earnings growth. Currently capitalised at £132 million at about 290p a share, Liontrust is listed in the FTSE SmallCap index, and things look to be coming together nicely since I first drew attention at 110p in September 2012 after a ninth successive quarter of positive inflows.

A company in rude health

Results for the financial year ended March 2015 reflect operational gearing in the way revenues rose 30% to £36.8 million with normalised pre-tax profit up 45% to £12.1 million. (After amortisation of intangibles and other non-recurring costs, pre-tax profit rose 125% to £7.3 million.) Such dynamics were helped by assets under management rising 24% to £4.5 billion as good performance by stockmarkets encouraged people to invest. With earnings per share measures nearly tripled to about 14p, the total dividend has leapt from 3.0p to 8.0p (the table's showing 4.0p reflects timing of payments). Recent forecasts are for normalised pre-tax profit to approach £14 million in the current financial year and £17 million in 2016/17.

That implies that Lion's P/E multiple drops from about 22 times on the latest numbers, below 12 to about 10 times. It makes the price/earnings-to-growth - or PEG ratio - very cheap, down to 0.15 regarding the current financial year (any value below 1.0 generally being attractive), although PEGs can be a snapshot, exposed to change, say if an extended downturn in financial markets affects people's confidence to invest. Recent forecasts may also reflect accumulated positive sentiment, that the good times will continue. Not to be critical, simply aware of propensity for change. Management emphasises "rigorous processes so clients know how their investments will be managed and affected by different market conditions" - which means a high degree of loyalty from investors even during challenging periods.

Bigger payouts to shareholders

See from the table how cash flow per share has also substantially improved relative to low capital expenditure needs - that improves the shareholder-friendly profile because it enhances dividend prospects. Possibly the board maintains earnings cover around 3 times lest market sentiment changes, although the end-March 2015 balance sheet had £16.4 million cash (up from £10.5 million over two years) while the cash flow statement shows just £1.7 million spent on dividends and £553,000 on share buybacks. In principle, the company is in a strong position to increase shareholder returns, despite note 4 to the income statement showing £3.1 million spent on director/employee costs, £734,000 on various benefits and £14.5 million "members drawings charged as an expense" - i.e. salaries. As ever with listed money managers, the set-up favours insiders, they will justify for competitive reasons.

Fund performance is relatively good

Underneath the chief executive's review in the prelims announcement, "Extracts from the Strategic Report" show 7 of 8 funds rated in their industry first quartile since launch (or manager appointed), despite the UK-oriented retail funds typically being second quartile in the last 1-3 years and the European growth fund fourth. A global income fund was also in the fourth quartile in the last year. Liontrust professes an ability to "meet the different demands across our client base through the market cycle" e.g. recently recruiting a global equities team as a response to the uncertainty presented by bond markets. A global strategic equity fund, a global water fund and an agricultural fund will all be launched later this year.

Along with the baby boomer generation "having the greatest capacity and incentive of any age group to save and invest", George Osborne's decision to abolish the need to purchase annuities "creates a significant pool of assets that require investment solutions and advice...we are well placed to meet these needs given our equity income and multi-asset propositions."

Non-executive director buys shares

So Liontrust is of sufficient size to make a competitive funds offering, but also a small-cap - i.e. more amenable to earnings growth. The chart shows its stock rising substantially in 2013 as a move into profits was correctly anticipated, testing 260p, then 2014 being a consolidation year before creeping up to 305p this year. With the restricted period on dealings over, a non-executive director has bought 10,000 shares at 300p, which may be fulfilling an obligation for non-execs to own shares, but it is still a meaningful buy - i.e. the stock's risk/reward profile is considered favourable.

If the Greek crisis festers to affect global markets, then financial stocks like this are more likely to drift than rise. There was a 15p mark-down to 290p at Monday's open, after the weekend headlines on Greece. In my last macro piece I noted the risks of US interest rate rises coinciding with the euro crisis, and the Chinese stockmarket is jittery. Events could conflate for a sense of "risk-off", but in a long-term context Liontrust has the wherewithal to prosper from British baby-boomers for further capital growth and dividends. Summertime volatility would be useful to buyers.

For more information see: liontrust.co.uk.