In an article published on Feb. 13 of this year, PatientValueInvestor recommended Eaton Vance (EV, Financial) to investors prepared to take the long view. At the time, the share price of this financial stock was near the $28 mark.
As it turned out, investors who took his advice did not need much patience. Following a better than 7.5% jump on Nov. 9 and 10, the two days after the American elections, the stock closed at $38.15, an increase of about 36% in less than nine months. Still, as this 20-year chart shows, the company has some distance to go before it gets back to the lofty prices it enjoyed in 2007:
In this article we profile and analyze this investment manager, with an eye on both its current challenges and its potential for more capital gains.
Eaton Vance history
1924: Massachusetts Investors Trust created by Learoyd, Foster & Co.
1924: Eaton & Howard formed by Charles Freedom Eaton Jr. and John Glenny Howard in Boston.
1929: Eaton & Howard starts creating mutual funds for its customers.
1944: Vance, Sanders & Co. created by Henry T. Vance and David T. Sanders through a partnership of Learoyd, Foster & Co., Slayton, Learoyd & Co. and Massachusetts Distributors Inc.
1959: Vance, Sanders & Co. becomes a publicly traded company and acquires an economic interest in Boston Management & Research, a mutual fund management company.
1961: Vance, Sanders launches the Diversification Fund, the first of several exchange funds it created in the 1960s.
1979: Eaton Vance arises out of a merger of Eaton & Howard and Vance, Sanders & Co.
1995: Investors Bank & Trust Co, an offshoot of Eaton Vance, is spun off as a separate company.
1996: Eaton Vance listing moves from NASDAQ to the New York Stock Exchange.
2001: Eaton Vance buys Atlanta Capital Management and Fox Asset Management and expands into the retail-managed account business.
2003: Eaton Vance buys a majority interest in Parametric Portfolio Associates.
2004: Scudder Private Investment Counsel is acquired from Deutsche Bank AG.
2012: Eaton Vance acquires a 49% interest in Hexavest, a Canadian manager of global equity and tactical asset allocation strategies.
2012: Parametric Portfolio Associates acquires The Clifton Group, which provides futures and options-based overlay services and custom risk management solutions to institutional investors.
2014: Receives approval to offer exchange-traded managed funds (ETMFs), the first actively managed exchange-traded products that do not require full-transparency of portfolio holdings and trading activity.
2016: Acquisition of Calvert Investments, which serves investors looking for sustainable corporate environmental, social and governance policies. The deal comes just days after Calvert agrees to pay a fine levied by the Securities and Exchange Commission (SEC) for mispricing bonds and subsequently profiting on the mispricing.
History based on information at the company website, except for the Calvert news which comes from Barrons.
Comments: A company with a long history in the financial community and one that has grown through innovation and acquisitions as well as building its investment management products and services.
The business
In its 10-K for 2015, the company reports, "Our principal business is managing investment funds and providing investment management and advisory services to high-net-worth individuals and institutions.” (Unless otherwise noted, information in the following sections comes from this 10-K for 2015.) Within that context it focuses on “equity funds designed to minimize the impact of taxes on investment returns."
In the main, it specializes in actively managed mutual funds, or as an article title in the Wall Street Journal/Seeking Alpha puts it, “The Dying Business of Picking Stocks.”
Chairman and CEO Thomas E. Faust Jr. recognized this reality in the Letter to Shareholders section of the 2015 Annual Report.
“The year ended Oct. 31, 2015 was a challenging period for active asset managers, as investment trends and business dynamics favored low-cost index investing over active management. Across a range of investment categories, active managers as a group underperformed their benchmarks, net of expenses. Across distribution channels, actively managed strategies lost market share to their passive counterparts. Among other contributing factors, the expanding exchange-traded fund (ETF) market has opened up a convenient and efficient outlet for index investing that, as yet, has no broad parallel for active strategies.”
The company’s business operates through four main business segments. This excerpt from the 10-K shows some of the funds offered by each:
Eaton Vance provides advice, services and products to both retail and institutional investors. Its sales are made through what it calls “a network of financial intermediaries, including national and regional broker-dealers, banks, registered investment advisors, insurance companies and financial planning firms.”
Comments: While Eaton Vance has a long history in the investment management field, the foundation of its business is being chipped away by passive/indexing, lower-cost investing alternatives.
Revenue
Eaton Vance’s income comes primarily from investment advisory, administrative, distribution and service fees generated by Eaton Vance and Parametric funds and investment advisory fees from separate accounts.
This excerpt from the 2015 Annual Report shows the size of the major operating units.
In addition, Hexavest (of which Eaton Vance owns 49%) manages $13.9 billion of client assets.
The following 25-year chart shows how the company’s revenue has grown — and receded in fiscal 2015.
Comments: As the excerpt above shows, Eaton Vance Management and Parametric account for the lion’s share of assets under management and likely the same proportion of revenue (all operations in one segment). Both focus on actively managed mutual funds.
Competition
Not surprisingly, the company refers to its environment as "highly competitive." Because of low barriers to entry, the Investment Company Institute says more than 800 investment managers operate in this space and more than 9,300 funds are available to the public.
Many of those competitors are listed public companies as well. Two names that come to mind, because I’ve profiled them in the recent past, are T. Rowe Price (TROW, Financial) and Westwood Holding Group (WHG, Financial).
But other fund companies are just one aspect of the competition. The gorilla in the room is, of course, ETFs, exchange-traded funds, which charge fees just a fraction of those charged by actively managed funds.
Without an exceptional moat, stellar returns in most cases, investment companies that specialize in active funds face overwhelming competition from the likes of Vanguard, the giant offering ultra-low cost, passive baskets of securities.
Comments: In an already competitive market, Eaton Vance faces an onslaught of lower-cost investment alternatives.
Moat
In his 2015 Letter to Shareholders, Faust perceived a competitive advantage.
“Looking ahead, we foresee a continuing era of rapid evolution in the business of investing and the provision of investment advice. Through our NextShares and custom beta initiatives, we are positioned at the leading edge of some of the foremost issues and trends facing our industry: the active versus passive debate; exchange-traded products versus mutual funds; separate accounts versus pooled entities; and advisory versus brokerage models for serving individual investors in the U.S. Two hallmarks of the Eaton Vance organization over the years – the diversity of investment approaches represented by our affiliates and our embrace of product innovation as a source of competitive advantage – position us not only to benefit from ongoing industry changes, but potentially to lead and drive some of the most significant industry developments. This prospect brings the potential for compelling returns to Eaton Vance shareholders.”
From an investor’s perspective (meaning access to more capital at better prices), Eaton Vance looks attractive when compared with the 20 competitors listed on the GuruFocus Competitive Analysis page. Here’s an excerpt from that page:
We note that Eaton Vance is the only rated company in this group to enjoy a predictability rating of more than 1-Star (it has four stars).
A 2014 article at NASDAQ.com makes the argument that Eaton Vance belongs to a wide-moat group, based on the combination of exceptional free cash flow (as a percentage of revenue) and high return on equity:
Currently, GuruFocus puts Eaton Vance’s return on equity at more than 38%.
Comments: While Eaton Vance finds itself in a declining sector, actively managed mutual funds, it does have several competitive strengths that should secure a place in the industry in the years ahead.
Growth
With recognition that low-cost alternatives would continue taking away its market share, Eaton Vance developed four near-term priorities within its long-term growth strategy:
- "Capitalize on our strong investment performance across a broad range of active investment strategies."
- "Build out our global equity capabilities to address identified market opportunities."
- "Further develop our custom beta separate account offerings and distribution."
- "Advance our NextSharesTM exchange-traded managed fund initiative toward market introduction."
Presumably, those priorities helped generate generally improved results in the third quarter of fiscal 2016, as this excerpt from a press release suggests.
“Eaton Vance’s third-quarter earnings improved sharply over the preceding quarter, reflecting favorable market movement, positive organic revenue growth and continuing tight expense control.” said Thomas E. Faust Jr., chairman and CEO. “Our mix of strongly performing active strategies and value-added passive products and services positions us well for this challenging period for investment managers.”
Comments: The company recognizes it has a challenge with the shift to lower-cost products, and has a four-pronged strategy to address it and regain its growth path.
Other
Eaton Vance is incorporated in Maryland and headquartered in Boston.
Year-end: Oct. 31.
At the end of fiscal 2015, the company had 1,473 employees.
Chairman and CEO: Thomas E. Faust Jr., age 58, has held various management positions at the company from 1987 and became chair and CEO in 2007.
Chief Financial Officer: Laurie G. Hylton, age 50, has held this position since 2012. She joined the company as an internal auditor in 1994.
Ownership
Eaton Vance is lightly held by the eminent gurus followed by GuruFocus. Columbia Wanger (Trades, Portfolio) has a sizable holding, of 1,686,500 shares, while Mario Gabelli (Trades, Portfolio) has 10,000 and Paul Tudor Jones (Trades, Portfolio) has 7,500.
Looking beyond the gurus, this GuruFocus table show a strong contingent of institutional investors, a modest number of short sellers and a solid showing among insiders:
Comments: Company insiders hold a significant piece of the company, meaning management interests are aligned with the interests of shareholders, which includes a strong proportion of individual investors (although not many gurus among them).
Eaton Vance by the numbers
Comments: A $4 billion company, now nearing its 52-week high; high return on equity; a dividend of nearly 3% at the current price; and an active buyer of its own shares in fiscal 2015.
Financial strength
GuruFocus gives Eaton Vance a 6 out of 10 for financial strength. Judging by the red icons, the company’s balance sheet is not as clean as it once was. We can check this with a chart of its long-term debt, which shows the amount has roughly doubled over the past five years.
Earnings have been bumpy over the past decade, as this 10-year chart shows.
The outlook for fiscal 2016 is not encouraging. Analysts followed by Reuters.com see the full-year earnings coming in between $2.11 and $2.18, compared with last year’s disappointing $2.44.
Free cash flow did improve in 2015 but remains below the levels of 2007:
Despite all this, there are positive signs we should consider:
- Eaton Vance has grown its dividend and bought back shares.
- It has a Piotroski F-Score of 8 (considered very good).
- Weighted average cost of capital is 12% while return on invested capital is 48%.
Comments: Overall, the picture seems positive. It has grown its debt, but could significantly reduce that debt if it stopped buying back shares. A solid F-Score also adds to our confidence.
Valuations
First, we note that Eaton Vance has a 4-Star predictability rating, much better than the other firms listed in GuruFocus’ competitive analysis space. If we accept that the company’s four near-term priorities will help it cope with low-cost competitors, then we would also expect earnings to get back on track.
As to valuation, GuruFocus says, “Eaton Vance Corp. is more suitable for Earning Power Based valuation methods. This includes 1) Median P/S Value and 2) Peter Lynch Fair Value. The Median P/S Value of Eaton Vance Corp. for today is 40.11.”
The price-earnings (P/E) ratio currently sits at 18.5, but in historical context, that’s relatively low.
At the close of trading on Nov. 10, the PEG ratio stood at 1.45, which puts it in the middle of the fair-value range. GuruFocus reports that its median PEG, over the past 13 years, was 2.66, well above today’s number. It also notes, “NYSE:EV's PEG is ranked lower than 59% of the 230 Companies in the Global Asset Management industry.”
In February, with the price near $28, PatientValueInvestor said:
“From my view, Eaton Vance is a quality company with numerous strengths playing in its favor over the longer term. The company has a strong track record of growing dividends, and the price to valuation relationship seems reasonable.”
Comments: That price-valuation relationship still seems reasonable, even though the price has now poked above $38.00. With the P/E and PEG relatively low, in historical context, it doesn’t appear the price has gone into overvaluation territory.
Conclusion
We began this article by noting that the share price of Eaton Vance has popped by more than one-third since February and wondered where the price might go from here.
Fundamentally, the company is in good shape, with a long history and the management talent to work its way through the current macroeconomic and industry issues. It’s true earnings appear to have stalled, but the company has bought back its own shares at the same time.
From a valuation perspective, the P/E and PEG suggest Eaton Vance is in fair-value territory, and that there is room for the share price to advance further.
It is, as PatientValueInvestor said, a stock that deserves a place on the shortlists of patient investors.
Disclosure: I do not own shares in any of the companies listed in this article, nor do I expect to buy any in the next 72 hours.
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