2023-08-13 11:07:56 ET
Summary
- BlackRock is a potential compounder, a rare type of stock that consistently compounds returns at higher-than-average rates.
- BlackRock has demonstrated strong resilience and growth over time, and sports impressive supply and demand dynamics for its shares.
- The current valuation of BlackRock presents an attractive entry point for investors, with management forecasting continued growth.
In the vast universe of equity markets, there's a unique type of stock that stands above all the others: Compounders. These rare entities are characterized by their ability to consistently compound returns at higher-than-average rates, providing investors with attractive long-term appreciation.
One such opportunity presenting itself right now is BlackRock ( BLK ). This powerhouse has demonstrated the resilience and growth characteristics that all compounders share, backed by impressive supply and demand dynamics for its shares.
Today, we'll take a look at what makes a compounder in our view, why BlackRock fits squarely into this category of companies, and why now is a great time to get involved in the stock.
What Makes A Compounder?
So, what exactly defines a compounder? As we just alluded to, compounders are companies that have unique characteristics that make them potentially great long-term investments.
In our view, at its core, a compounder is a company that consistently increases its revenue and free cash flow while simultaneously reducing its share count. This potent combination creates a wealth-building engine for investors.
Remember, for capital appreciation to occur, buyers and sellers in the market to agree that an asset's value has increased vs. the year before - this doesn't happen automatically.
Instead, demand for shares needs to be stimulated, and the supply of shares needs to be shrinking.
What drives demand for shares? More profits and an increasing scope of the business.
What drives shrinking supply? Companies buying back shares.
Take UnitedHealth Group ( UNH ), for instance. Over the past decade, UnitedHealth has displayed the quintessential traits of a compounder.
Its TTM revenue has consistently grown, from $147 billion in 2015 to an astounding $348 billion in 2023, a testament to its strong market position and business strategy. In parallel, its free cash flow has increased from $8 billion to nearly $38 billion during the same period:
Meanwhile, UNH's outstanding share count has steadily decreased due to its share buyback program, from 991 million shares in 2015 to around 940 million in 2023. This isn't as aggressive as some other buyback programs, but share count has still dropped by 5% in that time nonetheless.
As a result, the company has seen a dramatic increase in share price, with a total return over that time of nearly 400%:
Companies with the inverse characteristics; no demand growth and an increasing supply, struggle to hold onto gains. Verizon ( VZ ), a company like this, has seen essentially zero total returns over the same period of time:
Why BlackRock Is A Compounder
Shifting our lens to BlackRock, the compounder qualities are readily apparent. Over the past seven years, BlackRock's TTM revenue has steadily grown from $11.4 billion to an impressive $18 billion, reflecting a compound annual growth rate ((CAGR)) of ~7%:
Simultaneously, its TTM net income has soared from $3.1 billion to $5.1 billion, reflecting a compound growth rate of more than 7%:
It's true that net income is been a bit 'lumpier' due to a transaction in 2018, but remove that and the overall trend is unmistakable.
This is doubly as impressive given the ability for the company to keep its net margins stable around 29% (again, remove the transaction in 2018):
That said, the magic of compounders lies not only in expanding financial results (and an increasing demand for shares), but also in a shrinking share count.
During the same period as discussed above, BlackRock has diligently bought back shares, reducing the outstanding count from 168 million to 150 million:
While this reduction only adds up to a ~10% decrease in outstanding shares, this action, coupled with strong financial growth, enhances the value of remaining shares, thus benefiting long-term investors.
Plus, the consistency of the reduction in supply is heartening.
Why Now?
All of this seems well and good, but with a clear understanding of Company X's compounder characteristics, the question arises: Why now?
In short, because the current valuation presents an attractive looking entry point, and management is forecasting continued growth.
At the moment, the stock currently trades at a 27x multiple of free cash flow, a bit lower than its five-year average of ~30x. Similarly, its price-to-revenue ratio sits at an attractive 5.7x, compared to its historical range as pictured below:
While some may view these multiples as elevated for a financial company (as Seeking Alpha's Quant Rating System does), we believe that a better comparison would be a company like Visa ( V ). Visa has similarly stellar operations, and trades within a similar range.
Additionally, buyers at this point are getting the stock below the 5-year linear regression, within the lower band of standard deviation. Sure, buying BlackRock at 20x FCF would be ideal, but the opportunity may not present itself.
In addition to the decent price, results have also begun to swing back around in favor of the bulls.
While the company has done well in almost all market environments, late 2021 into 2022 was a rough spot for the company. Revenue was reduced somewhat, and net income dropped for the first time, organically, in a long time:
Thankfully, results are beginning to turn around, and management has begun to strike a more bullish tone. On the most recent earnings call, CFO Martin Small had the following to say:
Clients entrusted BlackRock with an industry-leading $190 billion of net inflows in the first half of 2023. Our $9.4 trillion in assets, 9.4 trillion units of trust are up over $830 billion since year end.
This increase reflects continued strong organic growth and ongoing client confidence in the work that BlackRock is doing on their behalf as markets evolve. Clients choose BlackRock for performance.
CEO Larry fink continued:
BlackRock's industry-leading results reflect our client's continued confidence in our long-term performance. We are delivering sustained organic growth and base fee growth even as the traditional asset management industry logs persistent outflows. BlackRock generated $190 billion of total net inflows in the first half of 2023, including $80 billion in the second quarter, reflecting positive flows from wealth and institutional clients across regions.
This growth in assets looks like its translating to a bottom in financial results, and potentially a bottom in the stock price.
Risks
It's hard to pick out many risks for BlackRock, given the scale of its offerings and the ingrained nature of its business into the world economy.
There are two potential ways we think the narrative around BlackRock could change meaningfully.
First, if burdensome financial regulations come out that constrain BlackRock in some way, that could negatively impact the stock. We see an incredibly powerful moat around BlackRock's business, and thus one of the only entities capable of piercing it would be the U.S. Federal Government.
Additionally, the company is making a big bet on its "Aladdin" software. Aladdin runs a considerable amount of the company's processes, and a cyber-attack could present a serious risk to BlackRock and its reputation going forward. If clients begin to perceive weakness in security of info or funds, we expect the stock will behave poorly.
Overall though, BlackRock is a company with an incredibly small number of risk vectors.
Summary
In conclusion, the investment thesis for BlackRock is compelling and straightforward.
As a proven compounder, it has consistently demonstrated robust financial growth and efficient capital allocation. Its track record of increasing revenue and net income, coupled with a consistently decreasing share count, underscores its commitment to delivering shareholder value.
Despite the recent bumps, BlackRock's strong fundamentals remain intact.
Now, more than ever, represents an opportune moment for savvy investors to tap into this undervalued gem, poised to continue along its trajectory.
For further details see:
BlackRock Is The Next Compounder You Should Own