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

There are many reasons why I think the Challenger Ltd (ASX: CGF) share price is a buy, so I will talk up three points in this article.

Challenger is a financial business that has shifted its business model to focus on being the leader in the annuity/fixed income market.

The Challenger share price has fallen by 30% over the past year, these are some reasons why I think you should be interested:

Dominant market share

When a company provides an outstanding product that’s better than the rest of the market it normally wins so much market share that it becomes very hard to dislodge it. You could call this an economic moat.

Think of how dominant Google is in the ‘Search’ category or how Facebook (combined with Messenger, Whatsapp and Instagram) dominates social media.

Challenger is supposedly winning over 90% of new annuity business. Its product is so hard to beat that many potential competitors have simply launched Challenger products instead of creating their own such as IOOF Holdings Limited (ASX: IFL) and Suncorp Group Ltd (ASX: SUN).

Growing demand

Total funds turning into annuities should grow over time.

The number of retirees, Challenger’s key client base, is expected to grow by 40% over the next decade and 70% over the next two decades.

The mandatory 9.5% superannuation contribution and compounding of superannuation balances should mean that annuities steadily get larger over time.

The government has introduced supportive policies that should increase the awareness of attractiveness of annuities and other guaranteed income products. One recent improvement includes requiring all superannuation funds to offer a guaranteed source of income as an option. As a leader in the space, Challenger is likely to be a beneficiary of this policy.

Valuation

The fall in Challenger’s share price has meant that it’s now trading at under 14x FY19’s estimated earnings. This is low for a business that likely has many years of underlying profit growth ahead of it.

Even if it just stays at the current price/earnings ratio throughout the next decade it could likely deliver double-digit shareholders returns when combined with its grossed-up dividend yield of 5.2%.

Foolish takeaway

Challenger is one of my favourite growth ideas on the ASX and it’s currently trading at an attractive price. I will probably buy more shares of it this month if it stays at this price or lower.

However, market volatility and rising interest rates could hurt Challenger’s balance sheet and therefore its share price in the shorter-term.

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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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