Finding Value in Investment Management

Using GuruFocus' Ben Graham Net-Net screener, I found a list of companies that could adhere to Ben Graham's stringent rules for businesses he would potentially add to his portfolio. I then excluded OTC stocks in order to find companies within a liquid market. Next, I sorted each company by operating cash flow per share in order to find companies that are generating a healthy amount of cash and can pay a dividend. This stock was at the top of the list.

Business Description

Manning and Napier Inc. (MN) is an investment management firm involved in providing financial solutions for individual and institutional clients. Since 1970, MN has been offering portfolios with different asset classes, such as equity and fixed income, to clients with various accounts including seperately managed accounts, 401(k) plans, pension plans, endowments, and even foundations. For these services, clients pay a fee, and this is the way MN generates revenue.

What Matters Most: Cash Money

Before we talk about the company’s cash holdings and ratios, I think it’s important to talk about its debt. What makes this company stand out is the fact that it has no debt on its balance sheet. This means that the company could potentially give a higher dividend to investors or reinvest their cash to grow the business even further. They do have a line of credit, but this hasn't caused any significant financial hardship when paying off whatever is borrowed. MN has $125 million in cash, which is a great sign. Their current ratio is 3.17, which is amazing since MN can pay off everything it will owe this year more than three times over. Free cash flow is $166 million, or $12.10 per share, which shows that this company generates a substantial amount of cash. With a P/FCF of 1.46, this company is definitely under my criteria for investing in companies with a P/FCF ratio of 15 or less, and may purchase shares of MN.

Dividends - The privilege of ownership

I like to invest in companies that pay a dividend in order to reduce my risk, earn a return on my capital invested, and reinvest those dividend payments into a snowball of dividend checks. Although I am not currently investing in MN, it could become a holding in my portfolio if the dividend stream is worth paying for, and I think investors should have the same outlook when looking for potential investments. MN currently has a dividend yield of 4%; they pay $0.16 quarterly, totaling $0.64 a year. The payout ratio when compared to earnings is 313%, which would be very alarming. Dividends are paid out through cash, so I like to use free cash flow per share instead of earnings when calculating the payout ratio. When compared with free cash flow, the payout ratio is just 5%, which tells me that the company is generating enough cash to significantly increase its dividend payments. I like to do some calculations to see how long it would take one share of a company’s dividend payments to equal another share, if prices remained the same and dividend payments were held for the sole purpose of buying one more share, with no compunding. It would take 25 years for one share to become two MN shares with the current level of dividend payments. I also like to calculate how many shares an investor would need to buy now in order to generate the equivalent of one share in dividend payments a year, all else being equal. Its interesting to note that if an investor wanted to generate the cash in dividend payments for one share this year, it is equal to the amount of time it would take for one share to double from its dividend yield. Buying 25 shares would result in an extra share at the end of the year, generated by passive dividend income.

Book Value - Real Company Value

MN's P/B ratio is 1.3, meaning it is priced almost one and a third times its actual value. I personally like to invest in companies with a P/B ratio of 2 or less, and in some cases I'll invest in companies with a higher P/B if the income stream of dividends is worth paying more for it. This is a good sign and a potential buy signal, considering its dividend income stream. Its really dificult to find companies trading at or below book value, so this is a major plus.

Income - How well a company is managed

I normally don't like to rely on the income statement as a measure of value. I do think it offers the best glimpse of how well a company is able to manage it's expenses while generating revenue, but I'll rely more on the cash flow statement to find value. The P/E ratio is 74.3. Most people invest in companies that have a P/E ratio between 15 and 25, while companies with a P/E ratio of 20 are seen as fairly valued. Honestly, I don't care too much about P/E ratios, but it can help me gauge whether or not I can pass up on a company that is priced too high, and look for other companies. A P/E ratio of 74.3 does set off alarm bells, and could be a sign that the company isn't able to manage its expenses. With a margin of 100%, and operating margin of 22.5% and a net margin of .7%, MN's biggest expenses are employee compensation, and has suffered some losses from minority interests.

Valuation

Using Guru's DCF calculator, and inputing FCF of $12.10 we get a valuation of $178.49 a share, and $190.64 a share after adding tangible book value. The company seems to be undervalued and could be a buying opportunity. For me, its P/FCF and P/B and a 4% dividend makes this very attractive. An investor would have to seriously consider their investment philosophy and see whather investing in this business coincides with their philosophy.

Leave a Reply