The Motley Fool

3 reasons why I think the Challenger Ltd (ASX:CGF) share price is a buy

There are few shares on the ASX that can genuinely say it is exposed to a tailwind like Challenger Ltd (ASX: CGF).

I’ve held Challenger shares for quite a while and I’m even more optimistic about its long-term future compared to when I first bought shares, although the share price has been a strong performer over the past few years.

Here are three reasons why Challenger is one of my favourite growth share ideas right now:

Supportive demographics and policies

As I mentioned in my introduction, Challenger is directly exposed to the ageing demographic tailwind in Australia because it provides annuities to retirees looking for a source of guaranteed income from their capital.

The exciting thing is that the number of retirees is expected to grow by 40% over the next decade and 70% over the next two decades. This should mean more annuities for Challenger considering it’s the clear market-leader. Growing superannuation balances through the 9.5% mandatory contribution and compounding will increase the size of the annuities.

Challenger has a wide economic moat due to the regulations surrounding annuities. That’s why so many providers are deciding to just sell Challenger annuities instead of making their own.

The government is improving the means testing rules for annuities and in the recent budget announced it would require all superannuation funds to offer guaranteed income as an option. This again should benefit Challenger.

Compound growth

Challenger is not a flashy tech share nor a business on an acquisition spree. However, it is steadily increasing its profit year after year. Although high single digit profit growth doesn’t do much in a single year, continuous growth year after year means compounding could significantly rise the value of Challenger shares over the next decade or two.

Compound returns look even more attractive as the dividend is growing year after year too.

Solid income option

Challenger currently offers a grossed-up dividend yield of 4.6%. This soundly beats the potential income offered by term deposits from the bank. Yet, the dividend has grown every year since the GFC and will likely keep growing at high single digits thanks to the underlying profit growth.

I think it could offer a significantly larger dividend yield on the current share price in 10 years. If things go well the dividend could double.

Foolish takeaway

Challenger is currently trading at under 16x FY19’s estimated earnings. I think this is a very reasonable price to pay for a business that has a long-term growth tailwind.

The share price may become volatile when interest rates rise or when global share markets falter, but I think this would actually be an even better time to buy.

Along with Challenger, another top growth share I have my eyes on is this top ASX growth stock which is dominating the online retail space.

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Motley Fool contributor Tristan Harrison owns shares of Challenger Limited. The Motley Fool Australia owns shares of and has recommended 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 Scott Phillips.

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