In this article, let's take a look at State Street Corporation (STT, Financial), a $30.25 billion market cap bank holding company, with over $27 trillion of assets under custody and $2 trillion of assets under management.
A Dominant Player
State Street is one of the two largest custodian banks in the U.S. It is a dominant player when we look at its more than $27 trillion in assets under custody. The bank has the scale and scope necessary to serve institutional clients, and this is a great advantage because there are few competitors that can do this. In the asset custody and asset servicing businesses, the clientele is quite “sticky” and State Street takes advantage of that. Further, it is a naturally high-return and highly scalable business.
Asset Management Business
State Street provides a wide range of investment options for institutional investors, with special focus on passive investments, like index funds and exchange-traded funds. With more than $2 trillion in assets under management, State Street is taking advantage of investors' increased interest in cost-effective investments both at home and in international markets, making this business segment also very attractive.
Revenue Pressures
Due to consistently low interest rates, the bank had to cut cost, so as to help reduce the pressure on margins. In this sense, it has been much more effective than rival Bank of New York Mellon (BK, Financial). In this order, it plans to save $130 million for 2014.
Basel III Tier 1 Common Ratio
The bank remains strongly capitalized, with a pro forma Basel III Tier 1 common ratio of 11.3%, which we consider it at a good level.
Dividend & Share Repurchases
State Street has an attractive dividend policy showing its commitment to return cash to investors in the form of dividends. It has increased its quarterly dividend to $0.30 and repurchased $410 billion of shares.
Revenues, Margins and Profitability
Looking at profitability, the revenue growth (1.5%) has outpaced the industry average, despite a 19 bp drop in net interest margin to 1.12%. Earnings per share increased by 5% in the most recent quarter compared to the same quarter a year ago ($1.38 vs $1.24), due to a transitory reduction in the effective tax rate to 16.6% from 24.0%.
Finally, let´s compare the best measure of performance for a firm's management: the return on equity. The ROE is useful for comparing the profitability of a company to that of other firms in the same industry.
| Ticker | Company | ROE (%) |
| STT | State Street | 10.48 |
| BK | Bank of New York | 5.63 |
| BLK | BlackRock | 11.08 |
| BEN | Franklin Resources | 21.35 |
| Ă‚ | Industry Median | 8.21 |
The company has a current ratio of 10.48% which is higher than the one exhibit by the Bank of New Yok. In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. We expect ROE to improve to just under 15% in the medium term. For investors looking at a higher ROE, BlackRock (BLK, Financial) and Franklin Resources (BEN, Financial) could be the options.
It is very important to understand this metric before investing and it is important to look at the trend in ROE over time.
Relative Valuation
In terms of valuation, the stock sells at a trailing P/E of 15.7x, trading at a discount compared to an average of 20.8x for the industry. To use another metric, its price-to-book ratio of 1.5x indicates a premium versus the industry average of 1.04x while the price-to-sales ratio of 3.18x is below the industry average of 7.56x. That P/E indicates that the stock is relatively undervalued and seems to be an attractive investment relative to its peers.
As we can see in the next chart, the stock price has an interesting upward trend in the five-year period. If you had invested $10.000 five years ago, today you could have $15.505, that is a 9.2% compound annual growth rate (CAGR).
Final Comment
Revenue growth was the consequence of client asset growth which was the primary reason behind this; servicing fees grew 7% as assets under custody grew 6%, and management fees grew 8% on 16% assets under management growth. Moreover, the bank is poised to see an increase in ROE even if interest rates remain flat.
So in this opportunity, I would recommend fundamental investors to consider this attractive option for their long-term portfolios.
Hedge fund gurus like Ray Dalio (Trades, Portfolio), Andreas Halvorsen (Trades, Portfolio), Richard Pzena (Trades, Portfolio), Chuck Royce (Trades, Portfolio), Louis Moore Bacon (Trades, Portfolio), Bill Nygren (Trades, Portfolio) and Charles Brandes (Trades, Portfolio) added this stock to their portfolios in the first quarter of 2014.
Disclosure: Omar Venerio holds no position in any stocks mentioned
