INTRINSIC VALUE ASSESSMENT OF BLACKROCK (BLK)

INTRINSIC VALUE ASSESSMENT OF

BLACKROCK (BLK)

OCTOBER 7, 2017

This article was written in collaboration with Christoph Wolf from The Investor's Podcast and Christoph Wolf Value Investing

Introduction

Blackrock is an outstanding asset management company, and its stock had a remarkable run - not only since going public in 1999 but especially during the last five years. That said, its current stock price of $464 is too high and does not reward investors with an adequate risk premium.

The Business

Blackrock is the world's largest asset management company doing business with many global companies, pension funds, foundations, public institutions, and private investors. Run by its legendary CEO Larry Fink, it has traditionally relied on mergers and acquisitions to grow and especially its takeover of Barclays Global Investors in 2009 drastically increased its clout in index funds.

BLK has two major components:

? Aladdin is a collective intelligence tool for risk management. It is used by almost all major financial institutions to track the effect of $14 trillion in 20,000 portfolios.

? Through its iShares division, it offers a vast array of investment funds. These are mostly index funds (ETFs) covering almost every existing security class, including stocks, bonds, retail, and several others. It also has short or leverage ETFs, smart beta funds, and various actively managed funds in its portfolio.

The Intrinsic Value of Blackrock

To determine the value of BLK, let's start by looking at the company's history of free cash flow. The free cash flow is vital because it represents the company's ability to retain earnings and grow the business. Most importantly, it demonstrates a return on the principal that might be invested into the ownership of equity of the business. Below is a chart of BLK's free cash flow over the past ten years.

INTRINSIC VALUE ASSESSMENT OF

BLACKROCK (BLK)

As one can see, the results in the past have been impressive, but we should use a conservative estimate of the future free cash flow. To build this estimate, we make use of an array of potential outcomes for future cash flows.

Each line in the above graph represents a certain probability of occurring: We assume a 20% chance for the upper growth rate of 3% per year, a 50% chance for zero growth and a 30% chance for the worst-case scenario of -7% annual growth. Assuming these growth rates and probabilities are accurate, BLK can be expected to return -1% annually, indicating that the stock is overvalued at the current price. Now, let's discuss how and why those free cash flows could be achieved.

The Competitive Advantage of Blackrock

BLK is the ultimate giant of asset management companies. This results in many notable advantages over its competitors:

? Quality/branding Aladdin and iShares are well-known and trusted tools that have been used for a long time by a vast array of clients worldwide. This is almost impossible to replicate by a competitor.

? Economies of scale With Aladdin tracking more than $14 billion and over $5 billion covered by iShares, BLK is in a league of its own with no competitor coming even close. This gives BLK many important business connections and allows it to keep costs low.

? Financial strength. As is normal for asset managers, BLK enjoys very high net profit margins of almost 30%. It is also in a very capital-light business with almost no capital expenditure needed to keep its business running. This allows BLK to spend most its earnings to pay dividends, buy back stock or reduce its already low debt load even more.

INTRINSIC VALUE ASSESSMENT OF

BLACKROCK (BLK)

Opportunity Costs

When looking at various investing opportunities on the market today, let's compare the expected return of Blackrock to other ideas. First, one could invest in the ten-year treasury bond which is producing a 2.1% return. Considering the bond is completely impacted by inflation, the real return of this option is likely below 1%. Currently, the S&P 500 Shiller P/E ratio is 30. As a result, the US Stock market is priced at a 3.3% yield. If one were to invest in the S&P500, they might purchase a low-cost ETF to take advantage of this return.

Macro Factors

Due to the business BLK is operating in, the situation of the global markets heavily influences the success or failure of its business. During the bull run since 2009, investors have naturally put more money into investment funds which became a boon for BLK.

Conversely, its business might be strongly affected negatively during the next downturn: Not only will panicked investors sell their funds, but also the remaining money kept in BLK's funds will be worth less. Both can strongly hurt BLK's results. Considering that global markets are at very high levels right now, the current moment makes BLK vulnerable.

Risk Factors

BLK's business includes a vast amount of risks that might undermine its business. Some of the important ones are:

? Its results might be strongly negatively affected during the next downturn. ? Due to its massive size, BLK is closely monitored by regulators and might even be declared "too big to

fail," which would force it to comply with much more restrictive capital requirements and tighter rules. ? The vast amount of money already controlled by BLK raises the question, how much larger the company can still grow. ? BLK's balance sheet contains a significant portion of goodwill and intangibles ? resulting in a nonexisting tangible book value. This would leave shareholders with nothing if BLK ever defaulted. Its financials are also quite opaque and not easy to understand. ? The amount invested in ETFs has grown immensely during the last years. Many worry about a liquidity crisis in the next market downturn when many investors try to sell their liquid ETFs, but the underlying securities are illiquid. This would undermine faith in BLK's core business.

Summary

BLK is a mind-boggling company with impressive leadership and unparalleled size ? the latter being both a blessing and a curse for its future outlook. Due to its strong correlation with the global markets, its results and stock price are highly vulnerable to a market downturn.

INTRINSIC VALUE ASSESSMENT OF

BLACKROCK (BLK)

What is more, its current stock price of $464 seems very rich and does not promise an adequate return for shareholders. BLK might be a very interesting stock to buy during the next market crash at possibly depressed prices, but for now, investors might be better advised to stay clear of its stock.

? BuffettsBooks Academy content is for educational purposes only. The calculators, videos, recommendations and general investment ideas are not to be actioned with real money. Contact a professional and certified financial advisor before

making any financial decisions. Preston Pysh and Stig Brodersen are not professional money managers or financial advisors. BuffettsBooks, The Investor's Podcast, and parent companies that own The Investor's Podcast are not responsible for financial decisions made from using this assessment or the tools mentioned in the assessment.

 ................
................

In order to avoid copyright disputes, this page is only a partial summary.

Google Online Preview   Download