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3 reasons I’d buy Challenger Ltd shares today

One company nicely positioned to deliver investors long-term growth is ready to profit from two powerful demographic tailwinds in baby boomer wealth and the ageing population.

Australian annuities provider Challenger Ltd (ASX: CGF) also has a surprisingly dominant market position that is partly explained by the narrow moat it boasts via the capital-intensive nature of its business.

It’s the group’s market position that means it’s likely to keep growing sales over a 5 to 10-year period as it now has most of its potential competitors such as the banks like Commonwealth Bank of Australia (ASX: CBA), or financial services groups like AMP Limited (ASX: AMP) as partners.

In fact two thirds of financial advisers in Australia use platforms that have access to Challenger annuity products.

Moreover, its expansion into the huge Japanese annuities market has proven successful and has potential to grow further over the long term.

In FY 2017 Japan delivered 15% of its annuity-related sales and the group is strengthening its relationship with Japanese partner and financial services giant Mitsui Sumitomo.

In fact Challenger recently sold $500 million worth of shares to Mitsui at $13.06 per share to give it a 6.3% stake in the business, with Mitsui committed to lifting its stake in the business to 10% roughly within FY 2018.

The $500 million in proceeds will buffer Challenger’s capital position and feed the balance sheet to growth annuity sales.

Challenger also has a successful, but relatively small funds management business that provides leverage to capital markets and appears to be a well run and highly profitable operation.

Challenger then could be a real deal growth story, but that doesn’t mean investors should buy shares at any price as paying too much for growth businesses is one of the commonest investing mistakes to avoid.

Still, I have three core reasons why now may be an opportune time to buy Challenger shares.

Valuation – At $12.49 the stock changes hands for around 18x analysts’ estimates for 68 cents in earnings per share over FY 2018. This looks reasonable given its medium-term outlook and fact that management is guiding for normalised net profit growth of between 8% to 12% in FY 2018.

Dividends – Over FY 2017 Challenger paid out 34.5 cents in fully franked dividends, which places it on a trailing yield of 2.8%. The group has doubled dividend payouts since 2011 and for investors dividends often make up a good part of total returns. The trailing yield and its prospects for growth look attractive to investors buying today with a long term view.

Dividend Growth – Since 2011 the group has managed to double its dividend payouts and if it’s able to lift its dividends with cash earnings over the 3 to 5 years ahead the share price is almost certain to follow higher. At the end of the day share prices will follow earnings and dividends higher or lower and Challenger looks positioned to deliver higher dividends over time.

In fairness, almost every company on the ASX has a good story to tell, tailwinds, or ‘growth prospects’, but not many are the real deal and available on a reasonable valuation.

Challenger may tick the boxes at today’s prices, but it comes with significant risks around its asset book quality, balance sheet management, rising interest rates, and the competitive environment.

As such it should only represent a small part of a balanced investment portfolio.

A better bet than Challenger?

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Motley Fool contributor Tom Richardson owns shares of Challenger Limited.

You can find Tom on Twitter @tommyr345

The Motley Fool Australia owns shares of Challenger Limited. 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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