Is the well-known ISA and SIPP provider a good investment itself?
Popular investment services provider Hargreaves Lansdown (LSE: HL) published a third-quarter trading update this morning.
The FTSE 100 firm, whose Vantage range of tax-free ISAs and low-cost SIPPs has made it a big hit with private investors, reported operating revenue up by 16% to £175m in the year to date, with Assets under Administration standing at a new high of £26bn at 31 March.
The third-quarter performance, in the traditionally busy time leading up to the end of the tax year, puts Hargreaves Lansdown (HL) firmly on track for a fifth consecutive year of record profits since its flotation on the stock market.
Ahead of the competition
HL tells us it has seen no material impact from increasing competition in the sector. The company is confident its philosophy of "best prices, best service and best information" is ensuring it continues to compete profitably.
While partial withdrawals of money from funds, especially ISAs, remain higher than last year -- "driven by client personal expenditure requirements in tough times" -- HL says outflows have been less than competitors and more than offset by substantial inward transfers of ISA and SIPP money, leading to net business inflows of £1bn during the period.
HL's operations are highly cash-generative, and its balance sheet is extremely robust. In addition to operating revenue, the firm has received £1.5m of interest on its own cash surplus in the past nine months.
When I wrote about HL just over a year ago, the shares were trading at 575p. That put the company on an eye-watering trailing 12-month price-to-earnings (P/E) ratio of 35, falling to 27 on forward 12-month earnings forecasts.
I said at that time that, while the fundamentals for the business remained sound going forward, HL would have to continue growing at breakneck speed to justify the market's rating, and that the valuation was too rich for me.
That's proved to have been a decent call, the shares having fallen 16% against a market decline of 5% at yesterday's close. So, how does the valuation look now?
The market has responded favourably to this morning's news, and HL's shares are trading up 5% at 505p at the time of writing. The trailing 12-month P/E is 22, falling to 19 on forward 12-month earnings forecasts -- perhaps a little lower than 19 if forecasts are revised upwards following this morning's update.
On the face of it, then, HL's shares appear a lot more attractive today than they were this time last year. However, last year's forecast P/E of 27 was on forecast earnings growth of 40%. This year's forecast P/E of 19 is on forecast earnings growth of 18%. In other words, while HL is cheaper today on P/E, it's actually more expensive on a P/E-to-earnings-growth (PEG) basis.
As the table below shows, growth in one of the main drivers of the business -- increasing client numbers -- is on a moderating trend.
| ||Active "Vantage" clients||Increase|
|30 Jun 2008||245,000||--|
|31 Dec 2008||252,000||2.9%|
|30 Jun 2009||282,000||11.9%|
|31 Dec 2009||300,000||6.4%|
|30 Jun 2010||330,000||10.0%|
|31 Dec 2010||346,000||4.8%|
|30 Jun 2011||380,000||9.8%|
|31 Dec 2011||396,000||4.2%|
As you can see, from 2009 the company's first-half numbers run 6.4%, 4.8% and 4.2%; the second-half numbers run 11.9%, 10.0% and 9.8%.
For investors, then, judging an appropriate valuation for the moderating speed of client-numbers growth and more modest earnings-growth forecasts looks the key call.
A PEG ratio of 1 is said to indicate fair value, and I reckon that's about where HL is.
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> The Motley Fool owns shares in Hargreaves Lansdown.