In a reprise of a role from the 1980s, fictional Wall Street titan Gordon Gekko recently returned to the big screen in Wall Street: Money Never Sleeps. In the sequel to the original Wall Street, Gekko states that in investing, "It's not about the money -- it's about the game." And although it falls far short of his now-famous proclamation that "greed is good" in the original movie, he is on to something...
Despite a couple of major market booms and busts in the past decade, investors will endlessly pursue the chance to strike it rich in the market. These days, this pursuit is being driven by hedgefunds and private equity groups. And in a world where speculators and investors will always be around, there will always be a need to handle the immense amount of trades and related transactions that stem from increasing amounts of market activity.
That's good news for Bank of New York Mellon (NYSE:BK), which has origins that date back to 1784. The bank counts itself as the largest asset servicing firm in the world, and it would be safe to say it has seen more than its fair share of market ups and downs after more than two centuries in business.
The 2007 merger of Bank of New York and Mellon catapulted the bank ahead of its two main rivals, State Street (NYSE:STT) and Northern Trust (NASDAQ:NTRS). Bank of New York Mellon now boasts more than $24 trillion in assets under custody and administration and also has a sizeable asset management arm that manages about $1.4 trillion in assets.
This industry is driven by scale, so being the largest is a clear competitive advantage, as it allows Bank of New York Mellon to offer its clients low costs and operating efficiencies such as rapid execution and services across the globe. Just to demonstrate the scale I'm talking about, the company estimates it processes $1.5 trillion in global payments every day.
Another benefit of the firm is that its bread-and-butter is fee-based. As such, it is less susceptible to the loan activity that drives other bank balance sheets. This is evidenced by a revenue mix last year of $1.4 billion in net interest income from the spread between interest received from loans and interest paid on deposits, and fee-based income of $4.8 billion. Many other banks generate more in net interest income than on fees.
The bank was still adversely affected by the credit crisis in that it did have loans that went sour, and many of its clients were hit by lower activity. Customer credit quality is improving, however, and some clients have been forced to close shop, but overall volatility has been less than at other banks, given there are fewer loans that can go bad.
Action to Take ---> Bank of New York Mellon's book value as of the most recent quarter was $25.92, or right about where the stock currently trades. A bank stock that trades at book value or below is generally a very solid entry point for investors. Additionally, the forward price-to-earnings (P/E) multiple of about 11.4 is quite low for an industry leader.
The bank's returns on equity (ROE) are in the process of recovering from the credit debacle and stood at only 7.8% during the third quarter, but it should eventually return to double digit levels. An ROE of 10% equates toearnings greater than $2.50. It was as high as 23% back in 2000 and reached nearly 16% back in 2005 before the credit crisis hit.
Overall, ROE has a good chance of returning to 15% within the next few years. This means earnings could reach almost $4 per share, which, if we apply a conservative multiple of 10, equates to a $40 stock price -- more than +50% above current levels.
-- Ryan Fuhrmann
A graduate of the University of Wisconsin and the University of Texas, Ryan Fuhrmann, CFA, adheres to a value-based investing viewpoint that successful companies... Read more...
This article originally appeared on StreetAuthority