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Is Challenger Ltd a buy at this share price?

The Challenger Ltd (ASX: CGF) share price has grown strongly over the last few months to reach $11.73 today. Challenger has been steadily growing since the GFC and there are several reasons to still be excited about the business.

However, that shouldn’t mean that you buy the business at any price. There is just as much chance of the share price going down as going up over the short to medium term.

The bull case for Challenger

There is a large baby boomer cohort that is starting to enter retirement. These retirees will want to find investment products that can safely fund their retirement at a reasonable price. Challenger’s annuities are a good choice to provide that low risk safety.

Challenger’s products are so good and affordable that other companies are rebranding Challenger annuities and selling them under a different brand, one example of a company doing this is Suncorp Group Ltd (ASX: SUN).

The superannuation system’s pool of assets is expected to grow strongly over the coming years which could boost Challenger for decades.

It’s also starting to work with overseas financial institutions wanting fixed income products. It recently announced that Mitsui Sumitomo Primary Life, Japan’s largest annuity provider, will work with Challenger because Australia has a much higher interest rate. This portion of Challenger’s business could become a decently sized section of earnings over time.

There is a lot of discussion about how to ensure that superannuation fits its purpose of providing income in retirement. There have been reviews and recommendations which may result in at least a portion of superannuation being legislated to include an income product, like an annuity. Challenger could receive a significant boost if this occurred.

The bear case

Financial companies are particularly vulnerable in market downturns and Challenger isn’t immune from this. As its funds under management (FUM) business grows it would be more affected if there was a stock market crash.

If Challenger continues to make significant money in a growing market a competitor may decide to try to steal some of that market share. Other large financial groups aren’t trying to disrupt Challenger now, but that may not always be the case.

In the future there may also be a risk that Challenger has misjudged the potential cost of its liabilities. Some annuity holders may live significantly longer than predicted and this could cause Challenger problems. It will need to grow its assets well to make sure there is no risk of this.

Foolish takeaway

There is a lot to like about Challenger. Whilst it is trading at 17.7x FY17’s estimated earnings, I think it is still currently better value than higher priced growth stocks like REA Group Limited (ASX: REA).

It also has a pleasing grossed-up dividend yield of 4.08% which has been growing nicely since the GFC. Challenger offers investors a decent dividend yield and potentially substantial growth over the long term.

For another stock that is growing well, with a much bigger dividend yield than Challenger, you should read our report on this stock.

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Motley Fool contributor Tristan Harrison owns shares of Challenger Limited. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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