To quote the late gonzo journalist Hunter S. Thompson: “When the going gets weird, the weird turn pro.”
I would characterize the current state of the market as weird -- so, following the Good Doctor's advice, it’s definitely time to turn pro and capitalize on that weirdness. Fortunately, I’ve found just the stock for the job.
If you’re familiar with my work for StreetAuthority, then you know about my penchant for asset management stocks. I favor these stocks for the predictability of their fee-based revenue streams and because they're often undervalued by the market.
Oaktree Capital Group (NYSE:OAK) complements those criteria with an extra attribute that makes the stock even more attractive -- its focus on alternative investment strategies.
Now, “alternative investments” is an extremely broad category that encompasses everything from simple shorting strategies to complex hedging and everything in between.
Oaktree deals primarily with six particular asset classes: distressed debt, corporate debt, control investing, convertible securities, real estate, and traditional listed equities. If you don't know what one or more of these categories are, that just shows the firm's uncommon expertise. Oaktree has a special skill set, and the numbers show it.
Oaktree generates consistent revenue by charging fees for its management of assets. The firm earned $77.8 billion in fee revenue in the first six months of 2014, up 20% from the same period last year. This trend is expected to continue.
The company’s second-quarter earnings report exceeded expectations, but the firm remains undervalued. OAK is trading near $49, off 21% from its 52-week high, and sports a forward price-to-earnings (P/E) ratio of 12, well below the S&P 500's estimated P/E of 16 this year. OAK also pays an impressive dividend yield of nearly 8%.
On top of being undervalued, Oaktree shows strong signs of growth. Earnings per share (EPS) came in at $0.75 a share in its most recent quarter, beating analyst estimates by 12%. Oaktree's EPS is forecast to grow 12% in its 2015 fiscal year, to $4.61.
As mentioned, Oaktree’s wheelhouse as a money manager is the alternative investment space. Typically, the types of investment strategies have little to no correlation to the mainstream stock and bond markets.
For example, distressed debt investing is largely unaffected by the broader market. Investment managers like Oaktree will purchase the debt of a troubled or bankrupt company for pennies on the dollar. When the company is restructured, acquired or recapitalized, investors are in a position to reap huge rewards. It doesn’t really matter if Apple (Nasdaq:AAPL) or Google (Nasdaq:GOOG) went up or down a couple of points.
And as the broader markets slow down, grow more volatile or return gains, institutional and ultra-high-net-worth investors use these strategies to enhance a portfolio's performance and mitigate risk. Declining markets or heightened uncertainty bring customers to Oaktree’s door -- and that means increased fees and revenue. That’s why I love asset management stocks.
Risks to Consider: Oaktree is good at what it does, but its ability to raise money and earn fees is only as good as the performance of its investment products. If weak and uncertain markets bolster performance, then strong equity markets can hamper the performance of alternative investments. This in turn hurts client acquisition and fee increases (as seen with PIMCO's Total Return fund recently).
Action to Take --> Based on the current uncertainty of the broader markets in relation to the climate of geopolitical risk and fears of rising interest rates, Oaktree Capital is poised to benefit. This should translate into accelerating earnings. With its solid operating history and unique business model, the price could reach $60 again in 12 to 18 months. With the nearly 8% dividend, that's a potential total return of 30%.
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