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State Street: A Good Business Model

October 23, 2014 | About:

In this article, let's take a look at State Street Corporation (NYSE:STT), a $29.10 billion market cap bank holding company with more than $27 trillion of assets under custody and $2 trillion of assets under management. It operates in 26 countries and more than 100 geographic markets worldwide.

Global reach

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.

The company's customers include a great number of players in the financial industry, like mutual funds, collective investment funds and other investment pools, corporate and public retirement plans, insurance companies, foundations, endowments and investment managers. 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 $2.5 trillion in assets under management, State Street is taking advantage of investors' increased interest in cost-effective investments both domestically and in international markets, making this business segment also very attractive


The company is an effective cost-cutter, and this is very important to reduce the pressure on margins in a scenario of low interest rates.

Due to these rates, the bank had to cut costs 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 (NYSE:BK). 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%; we consider it at a good level.

Good cash

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. Dividends have been paid since 1910.

Revenues, margins and profitability

Looking at profitability, the revenue growth (0.86%) seems to boost earnings per share, which increased by 11.3% 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%. During the past fiscal year, the company increased its bottom line. It earned $4.61 versus $4.19 in the previous year. This year, Wall Street expects an improvement in earnings ($4.82 versus $4.61).

The gross profit margin is currently very high, at 96.61% and the net profit margin of 23.14% is above that of the industry average.

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.



ROE (%)


State Street



Bank of New York






Franklin Resources



Industry Median


The company has a current ratio of 10.00% which is higher than the one exhibit by the Bank of New York (NYSE:BK). In general, analysts consider ROE ratios in the 15-20% range as representing attractive levels for investment. We expect ROE to improve to 15% in the medium term. For investors looking at a higher ROE, BlackRock (NYSE:BLK) and Franklin Resources (NYSE:BEN) 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 14.9x, trading at a discount compared to an average of 19.0x for the industry. To use another metric, its price-to-book ratio of 1.4x indicates a premium versus the industry average of 0.99x while the price-to-sales ratio of 3.0x is below the industry average of 6.9x. 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 $13.212, that is a 6.4% 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 John Rogers (Trades, Portfolio), David Dreman (Trades, Portfolio), Charles Brandes (Trades, Portfolio), Bill Nygren (Trades, Portfolio), Richard Pzena (Trades, Portfolio), James Barrow (Trades, Portfolio), Paul Tudor Jones (Trades, Portfolio), Mario Gabelli (Trades, Portfolio), Andreas Halvorsen (Trades, Portfolio) and Ronald Muhlenkam added this stock to their portfolios in the first quarter of 2014, as well as RS Investment Management (Trades, Portfolio) and Pioneer Investments (Trades, Portfolio).

Disclosure: Omar Venerio holds no position in any stocks mentioned

About the author:

Omar Venerio is a capital markets, derivatives, corporate finance and financial management professor. He is passionate about the stock market and providing independent fundamental research and hedge fund and insider trading-focused investigation.

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