The Magellan Financial Group Ltd (ASX: MFG) share price hit a record high of $59.74 today and is now up around 146% over just the past year. This is no small-cap spec stock either, rather it has more than doubled its valuation from around $4 billion to more than $10 billion in less than a year.
So what the hell is going on?
First up, I'd note that the stock at $24.66 this time last year was undervalued.
In July and September 2018 I wrote a couple of articles here and here outlining why I felt sell-side analysts and in particular Morgan Stanley were too bearish on the fund manager.
Morgan Stanley actually put an "underweight" rating and $20 share price target on Magellan shares in early July 2018, which saw some heavy selling in the stock between prices around $21 to $24 in early July 2018.
Needless to say anyone selling then gave up one-year returns in the region of 150% plus $1.64 per share in fully franked dividends, with another one due in August 2019. Ouch.
While it's true that investment banks like Morgan Stanley can afford to hire the "smartest guys in the room", or at least those who scored the top grades at university this doesn't always mean their calls are correct.
Another reason the investment community was too bearish on Magellan shares this time last year was the rise of passive investing and ETFs that are putting fee pressure on and taking funds under management (FUM) away from active managers.
This is a structural headwind facing the industry, but again it's worth noting that around 75% of Magellan's FUM is institutional mandates that are not as susceptible as retail investors in looking to passive investment strategies.
However, the general earnings multiple de-rating applied to all fund managers through 2017 and 2018 undoubtedly contributed to Magellan shares looking cheap in 2018.
However, the stock's rise is far from just a change in sentiment, as it's also because the business is on track to deliver some very strong profit growth in FY 2019, with potential for more double digit growth in FY 2020 if it maintains the investment outperformance that will deliver a similar level of performance fees.
Even if it doesn't outperform, the rising FY 2020 FUM versus FY 2019 should still deliver substantially higher normalised profit growth if we assume FY 2020 does not see a bear or down market.
New product?
Another factor investors are perhaps buying into is that Magellan's founder Hamish Douglass has repeatedly talked about how the group is working on a plan to deliver a new "annuity type" income product to investors that it will reveal more details on when it hands in its full year results before mid-August 2019.
It has reportedly been in discussion with regulators about the plan, perhaps over any capital adequacy retirements, although I would not suggest buying the stock on the basis it's about to launch a new financial product.
Outlook
While the earnings multiple is far higher now, over the long term the business still has the foundations in place to consistently grow FUM organically and with a little luck via market appreciation.
In other words if we assume markets rise 9% in an average year and Magellan can add 5% organically to its FUM then a 14% growth in FUM could translate to stronger profit growth on the assumption the business boasts operating leverage where revenues rise faster than generally fixed costs of staff remuneration.
So while I'm not suggesting anyone rushes out and buys Magellan shares today it's worth remembering it's the only asset manager (Macquarie Group Ltd (ASX: MQG) aside) on the ASX that has the building blocks of a strong balance sheet, investment performance, and institutional business development to keep growing its business.
For what it's worth analysts are forecasting Magellan to earn $2.05 per share in FY 2020 according to Commsec, which would place it on 29x forward earnings.
However, again these forecasts look on the light side to me which could be due to them being not up to date forecasts or any other number of reasons. Anecdotally, a common mistake retail investors make is to rely on forecasts that are out of date.
So while the short term could see some downside for Magellan, over the long term I remain positive on this business.
