The Motley Fool

Why I think the Challenger share price is a buy

The Challenger Ltd (ASX: CGF) share price has fallen 23.4% in 2019 so far – I think it’s time to buy.

Background on Challenger

Challenger is an investment management firm that provides retirement solutions. The firm operates by distributing products through a network of financial advisors and financial institutions. It provides income products and managed funds to customers.

Why I think it’s a buy

Challenger has a price-to-earnings (P/E) ratio of 13.03x at the time of writing, versus the ASX 200 which has a P/E ratio of 18.34x. Challenger’s earnings were slightly down in the 2018 financial year, however, its cheap valuation makes it an attractive investment. According to expectations released by the group in June, financial year 2019 earnings should be around the same as financial year 2018.

Challenger has a grossed-up dividend yield of 7.2%, which is a solid return at current interest rates. The company has a payout ratio of 45–50%, meaning that we can expect dividends to remain steady. Additionally, it means that management have surplus funds that can be paid to shareholders if they choose to increase dividends.

In its investor day briefing in June, the company released its planned growth strategy, which outlined that assets invested in retirement accounts in Australia are set to double in the next ten years. As one of the key players in the superannuation industry, Challenger will undoubtedly benefit from this growth. Additionally, Challenger is building its partnership with a Japanese financial group in order to further its expansion into the Japanese market.

Challenger has a price-to-book ratio of 1.21. This is low and arguably means that there is great value to be found in the company’s shares. While the return on equity of Challenger has reduced recently it is still close to 10%, which means investors can anticipate a good return. Additionally, there is plenty of room for growth as the business weathers a few tough years.

Challenger does face, pardon the pun, challenges. While it has not been identified as a problem in the Hayne Royal Commission, changes to the financial planning industry have affected its business. Costs have been higher and lower interest rates are making it harder for the group to profit from its popular annuities. However, growth potential should compensate for these headwinds.

Foolish takeaway 

Challenger trades on a low price-to-earnings valuation and has a great dividend yield. Additionally, it has scope for growth and its share price is currently down while it goes through a few tough years. I think it’s a buy.

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Motley Fool contributor buylowsellhigh5 has no position in any of the stocks mentioned. 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.