Can you make money owning a piece of a company that deals in money? If that company is Houlihan Lokey Inc. (HLI, Financial), then, yes, you likely can.
Over the past three years, it has grown its earnings per share without nonrecurring items by an average of 38.40% per year. And over the past decade, earnings grew 26.44% per year.
Normally, we would expect that bottom-line growth to push up the share price, but it has been pulled down by the market downdraft and the share price has gone down rather than up. That makes it undervalued, but do not think of this as a value trap because it has an excellent set of fundamentals.
It also boasts a dividend yield that beats the S&P 500, but beware of share issuance dilution.
About Houlihan Lokey
Based in Los Angeles, the company is one of America’s largest investment banking companies. In a July investor presentation, it claimed to be a market leader in several areas, including these:
Source: Company presentation.
As a $5.30 billion company, it is much smaller than some companies with which it competes. Three of the public companies referenced in the first column of that slide—Goldman Sachs (GS, Financial), JPMorgan Chase & Co. (JPM, Financial) and Morgan Stanley (MS, Financial)—have market caps of more than $100 billion.
It operates through three segments:
- Corporate Finance, which includes merger and acquisitions and capital markets advisory.
- Financial Restructuring, which handles out-of-court and formal bankruptcy or insolvency proceedings.
- Financial and Valuation Advisory, offering financial opinions and a variety of valuation and financial consulting services.
As this excerpt from a table in the 10-K (for the year ended March 31) shows, Corporate Finance is the big money maker, and especially in the latest year.
Competition
With perhaps the exception of financial regulations, there are few barriers to entry into the financial services industries, so it is no surprise Houlihan Lokey has a long list of competitors:
- For Corporate Finance, the main, publicly traded competitors include Jefferies LLC (JEF, Financial), Lazard Ltd. (LAZ, Financial) and Moelis & Co. (MC, Financial), as well as the so-called bulge-bracket investment banking companies (the giants in the industry).
- Financial Restructuring faces Evercore Partners (EVR, Financial), Lazard and Moelis & Co.
- For Financial and Valuation Advisory, named competitors included the “big four” accounting firms as well as Duff & Phelps Corp. (DPG, Financial) and various global financial advisory and accounting companies.
It argued in its 10-K that it has competitive advantages: “A majority of our engagements relate to mid-cap transactions, which we believe is an attractive segment that is underserved by bulge-bracket investment banks. We believe that our deep sector expertise, significant senior banker involvement and attention, strong financial sponsor relationships and global platform provide a compelling value for our clients, engendering long-term relationships and providing a competitive advantage against our peers in this segment of the market.”
In support of that contention, it has reasonable margins for the industry and a performance record that beats two key benchmarks.
Financial strength
At 8 out of 10, this is a surprisingly low ranking for a company that essentially has no debt (no short-term debt and only $1 million in long-term debt). The company does have a $100 million line of credit, but had no principal outstanding on March 31.
As we see in the table, it has a high Altman Z-Score of 5.39, indicating no default is likely. In addition, the Piotroski F-Score of 6 out of 9 is reasonable, suggesting the company’s overall financial management is good.
Houlihan Lokey is also a value creator, as shown by the WACC versus ROIC ratio. The weighted average cost of capital is just 4.82%, while its return on invested capital is 27.85%.
Profitability
In regard to profitability, the company received a 9 out of 10 rating from GuruFocus.
Looking below the surface at a couple of those yellow bars, we get interesting relationships with the capital markets industry. First, Houlihan Lokey has a gross margin of 37.73% while the industry median is 48.50%, a significant difference. Second, the company’s net margin is 18.25%, which is significantly higher than the industry median of 13.56%.
Return on equity and the other returns all lead the industry, and note as well that the company has been profitable over nine of the past 10 years. In other words, it has been a relatively stable performer through economic cycles.
Growth
The growth rank is also high at 9 out of 10. There is lots to like on this table, starting with its revenue, Ebitda and earnings growth. Over the past decade, revenue growth averaged 17.22% per year, while Ebitda has averaged 23.53% and earnings per share without non-recurring items have grown 26.44% per year. Those are all good metrics, especially since earnings per share without NRI has grown faster than revenue over both the past three years and 10 years.
Even better is the growth rate of free cash flow.
Dividends and share buybacks
Lots of free cash flow means ample funds for expansion, share buybacks and dividends.
And, yes, the company has boosted its dividend per share significantly, increasing it by 28.20% over the past 12 months and by an average of 18.80% per year over the past five years. That’s a very good rate for shareholders who want income, yet it does not push the dividend payout ratio too high..
According to Nasdaq’s S&P 500 Dividend Yield by Month page, the average yield for the S&P 500 was 1.62% at the end of September. As we see, the Houlihan Lokey yield comes in well above that at 2.47%.
But some of that yield has been diluted by the continuing growth of shares outstanding. Since 2015, it has increased the number of shares outstanding, presumably to take care of stock and option grants to management and staff.
Valuation
Houlihan Lokey’s share price has met the same fate as many other currently undervalued stocks: It was pulled down by external events, including geopolitical and economic shocks. Despite that, long-term shareholders have enjoyed good capital gains.
The GF Value Line considers the shares to be modestly undervalued based on historical ratios, past performane and future earnings projections, suggesting the intrinsic value should be $109.08 (compared to its Oct. 10 closing price of $77.99).
Its price-earnings ratio is 12.74, slightly below the industry median of 13.89. The price-earnings ratio divided by five-year Ebitda growth rate, or PEG ratio, is 0.50, well below the industry median of 1.11 and the fair value mark of 1.
Fundamentals summary
Overall, the company's GF Score of 92 out of 100 indicates it has high outperformance potential. It received excellent marks for its growth, profitability and GF Value categories.
Gurus
Five gurus had stakes in Houlihan Lokey at the end of June. The three biggest belonged to:
- Ron Baron (Trades, Portfolio) of Baron Funds; he made a slight reduction, about 0.01%, to finish the quarter with 1,300,895 shares. They represented 1.89% of the company’s shares outstanding and 0.33% of the fund’s holdings.
- Chuck Royce (Trades, Portfolio) of Royce Investment Partners made no changes and continued to own 231,260 shares.
- John Rogers (Trades, Portfolio) of Ariel Investment added 12.84% and ended the first half of 2022 with 142,312 shares.
Institutional investors held just under two-thirds of Houlihan Lokey’s shares, 64.14% to be precise. Insider ownership was low at just 0.12% and neither CEO Scott Beiser nor Chief Financial Officer J. Lindsey Alley appear to own shares.
Conclusion
There are many quality stocks now within reach of value investors because the entire market has dropped so far since late last year. Houlihan Lokey is one of those companies, with strong fundamentals, a dividend and potential capital gains.
Eventually, we can expect the stock price to catch up with the earnings growth and when that happens, investors could enjoy profitable returns.
Given the insignificance of its debt and its distressed share price, value investors may wish to look more closely. And assuming the share price will follow earnings, sooner or later, it may be worth the attention of growth investors. While Houlihan Lokey seems to offer a good dividend yield, income investors should remember the dilution factor.
