Prior to making an investment in any stock, I always proceed with a clear investment objective in mind. However, my objectives are not necessarily the same every time I invest in a stock. There are times when my objective is current income, and in contrast there are other times when my objective might be maximum total return. At other times, I may be seeking a combination of both income and growth. My investment objective is determined by what my needs are at the time.
Additionally, I do not engage in vague or generalized objectives such as trying to beat the market. Instead, I endeavor to have an exact and realistic objective and precisely estimated return calculation that is commensurate with the type of common stock I may be examining. For example, if I was looking for maximum current yield and reasonable safety in order to provide a specific level of current spendable income, that is where my focus and analysis would be. With this need for a current income objective, I might turn to researching high-yield low-growth utility stocks.
However, and this is the crux of my position, I would not invest in a utility stock thinking that I will outperform the market in either capital appreciation or total return. Utilities tend to be slow growers, and as such, do not usually produce high capital appreciation. On the other hand, when I invest in a utility stock, I fully expect to receive significantly more income than the market would provide. Consequently, I would measure the success or failure of this investment based solely on the dividend income I expect to receive.
In contrast, if I was looking for high total return, my focus would primarily be on the earnings growth potential of the stock I was considering. If I was desirous of generating a high total return capable of beating the market, I would look for a company that I was confident would generate a higher earnings growth rate than the market. And most importantly, in either case, whether I was investing for current income or total return, fair and sound current valuation would have to be evident. Fair valuation is the universal principle that prudent investors are wise to consider regardless of the type of investment or return objective that is desired.
Once my general investment objective is clearly defined and established, my focus then turns toward a specific and precise return calculation. In other words, I never invest in a stock merely hoping that it might go up. Instead, I always have a specific return number and objective that I expect my investment in a specific stock can provide. Moreover, my precise return expectations are always based on rational assumptions which I input into standard rate of return calculation formulas. These rates of return assumptions, based on rational inputs, become my benchmark that I closely and continuously monitor and evaluate.
Ameriprise Financial Inc: Double Digit Total Return Potential and Dividend Growth
The research candidate I am reviewing in this article, Ameriprise Financial Inc (AMP), is offered for the consideration of those retired or dividend growth investors in need of above-average total return. In the long run, the future total rate of return that an investor can expect from a given stock will be a function of three critical inputs. These are the future rate of change of earnings growth, the future rate of change of dividends (if the company pays one) assumed to be consistent with earnings growth, and finally the valuation that was paid at time of purchase. Total return is comprised of two components capital appreciation plus dividend income (if any).
In the specific case of Ameriprise, the consensus earnings growth rate out to fiscal year-ending 12/31/2017 is 13.4%. However, the 3 to 5-year longer-term earnings growth expectation is even higher at 19.4%. That is significantly above expectations for the market, and therefore, a very attractive opportunity for potentially achieving long-term double-digit total returns.
Furthermore, if we input the logical assumption that Ameriprise will maintain their typical dividend payout ratio of 25%-30%, we can forecast that the dividend will increase accordingly. The company's announced 16% increase in the dividend supports that view. Finally, the company can currently be purchased at a blended P/E ratio of approximately 14.3 indicating fair value, and we can also assume that a fair value P/E ratio on future earnings of approximately 15 is reasonable.
Utilizing the calculating functionality of the F.A.S.T. Graphs™ Forecasting Calculator, these inputs indicate a total annualized rate of return out to fiscal year-end 2015 of 16.96%. This total return calculation is comprised of a potential for a price increase of $59.12 representing capital appreciation of 46.49%. Additionally, a pro rata dividend payout of $7.57 in addition to the price increase brings the total potential gain to $66.69, which equates to a total rate of return of 52.44% out to 2017. The details of this calculation are presented in the pop-up on the Estimates calculator below (red arrow). Note: Yesterday's announced dividend increase is not yet indicated on the graphs. The 2015 dividend will calculate to $2.59 ($.58 plus 3X $.67).
The longer-term 3 to 5-year estimated earnings growth rate is even higher at 19.4%. This would imply a 27.39% long-term (3-5 Year) rate of return (see pop-up box on graph). Consequently, both intermediate-term and longer-term total return opportunities appear very strong based on intermediate and long-term consensus estimates.
The following "Analyst Scorecard" summary of analyst accuracy when making 1-year forward and 2-year forward earnings estimates provides confidence that analysts have historically been quite accurate with their earnings forecasts on Ameriprise. This simply provides additional confidence that the company might meet current analysts' expectations.
The following earnings and price correlated F.A.S.T. Graphs™ on Ameriprise since they were spun out of American Express in 2005 provides further confidence in the company's ability to meet future consensus earnings estimates. In other words, forecast future earnings growth rates are consistent with what the company has been able to accomplish in the past. It is also noteworthy that this asset management company, with a strong S&P credit rating of A, maintained strong profitability through the Great Recession. Although stock price fell beyond what earnings results justified, the company raised their dividend each year and stock price quickly moved back to fair valuation.
Although the first quarter fiscal 2015 announcement was generally good, the following statement by Chairman and CEO James Cracchiolo announcing a long-term care reserve increase created a strong negative market reaction, and I contend buying opportunity:
"Overall Ameriprise had another good quarter and was situated well. However higher equity market volatility, unfavorable foreign exchange and continued low interest rates did effect results as did the long-term care reserves increase. That said, our capital position, ability to generate good free cash flow and deploy capital, all remained excellent. For the quarter our operating earnings per share were up 7%. From a return on equity perspective we continued to deliver."
Even though, as I previously stated, I never invest in a company without first calculating a precise rate of return expectation, I also never rely on just one calculation. Instead, I prefer to run a rational expected case, a moderate case and typically my worst-case scenario. The following forecasting calculator runs future return expectations based on the historical normal P/E ratio of 13 that the market has applied to Ameriprise.
Assuming the earnings forecasts come in as expected, but that the company is only capitalized at a 13 P/E ratio by fiscal year-end 2015, still calculates out to a double-digit total annual return in excess of 11% (see pop-up on graph). I would consider this a very attractive moderate case scenario for potential future returns.
My final rate of return calculation is made based upon the lowest historical P/E ratio of 12.4 that the market has applied to this company over the past 8 completed years. Although I consider it unlikely for this company to trade at such a low P/E ratio in the future, it is encouraging to see that it would still calculate out to an annual rate of return in excess of 9%.
The following historical performance results for Ameriprise since they have been a public company, provides additional confidence and insights into the company's ability to generate above-average total returns. In summary, when examining the essential fundamentals at a glance that Ameriprise has historically achieved paints a picture of a very attractive long-term total return investment opportunity.
Ameriprise: Thesis for Growth
As indicated above, Ameriprise has provided their long-term shareholders extremely attractive total returns. It should also not go unnoticed that total cumulative dividend income has also been above average. In other words, even though the current dividend yield may not appear attractive at first glance (although the recent 16% dividend increase helps), the growth potential of the dividend going forward represents an attractive long-term income opportunity.
Nevertheless, as I previously indicated, future shareholder returns will be a function of the company's ability to grow earnings at or near the current expected high rate. Current valuation appears sound, so let's look under the hood and more deeply examine from where and how future growth might come from. The following slide from a recent investor presentation provides some important insights into how the company is positioned for growth.
First of all, they have a solid and growing base of assets under management in excess of $800 billion. Additionally, the advice and wealth management portion of their business generated 64% of operating earnings in 2014. The original Ameriprise was founded in 1894, operating primarily as an insurance company. However, since they were spun out of American Express in 2005, the company has rapidly been morphing into a wealth management company. The company claims to have more financial planning clients than any other firm.
In 2014 annuities and protection (insurance) has become a much smaller segment generating only 36% of their operating earnings. Although insurance provides stable and persistent revenues, for the most part it is becoming a commoditized industry. Therefore, I consider the company's objective of focusing more on the wealth management industry a strong positive.
The following slide also illustrates that the company has a very shareholder-friendly management team. The company has aggressively returned capital to shareholders through dividends and share buybacks in 2013 and 2014. Although share buybacks have been significantly greater than the dividends, since the company's shares have been reasonably valued during that timeframe, I consider that a good use of capital.
On the other hand, I was also pleased to see that dividend payments have become a larger portion of their return of capital to shareholders. This is a good sign, and considering that their payout ratio is rather low, it could indicate more future return of capital to shareholders in the form of dividends.
Their large and growing commitment to advice and wealth management is supported by strong demographic trends. The following slide represents the growth opportunity that they believe this segment offers.
The company believes that they are well positioned to participate in the long-term growth opportunity that advice and wealth management offers. Not only do they hold leadership positions in most of the important categories of advice and wealth management, their nationally-recognized branding from American Express is a huge competitive advantage. For additional insight into the growth opportunities, the reader can follow this link to the company's full presentation.
Ameriprise: Potential Risks to Future Growth
Ameriprise has a healthy balance sheet, and generates strong cash flows. However, since much of the revenues on their largest business segment (advice and wealth management AWM) are fee-based, they are vulnerable to a major market correction if one were to occur. There are two potential problems that a market correction or a recession could cause. Since these are based on assets under management, a large drop in equity prices could reduce them significantly, at least temporarily. Simultaneously, a weak market could instigate clients leaving.
Although I believe that Ameriprise is well-positioned for long-term growth, equity price volatility does pose a short-term risk, as evidenced by their most recent financial report. Although their business grew, according to their first-quarter fiscal 2015 financial report, results were lowered by a negative impact from foreign exchange, a decline in net investment income, and lower activity due to market volatility. I believe that the current drop in their stock price as a result has created a sound buying opportunity.
Although the company has a strong base of assets under management, it is heavily exposed to equities as evidenced by the following slide. This risk is partially offset by the company's reputation and commitment to building strong client relationships. Their recent $1.2 billion acquisition of Columbia Management from Bank of America added significant size and scale to their Threadneedle Investments management arm.
In spite of the risks cited above, Ameriprise CEO Jim Cracchiolo, a long-time employee of the company, is quite confident about the company's growth prospects as indicated by the following comments:
Number one is, we've invested, over the last number of years, hundreds of millions of dollars to build and enhance our capabilities, our technology, our online activities. And so we think that, for what we've invested in the platform capabilities, that will continue to help our advisors become even more productive, to attract and maintain their relationships and deepen those relationships with clients.
We also think that the positioning that we have in the market really around financial advice, our Confident Retirement approach, and what we're going to be launching next year is our confident wealth builder approach, which is helping people who are accumulating for retirement, and then transitioning ultimately where our Confident Retirement approach is today, is well-suited for what the consumer is looking for."
Summary and Conclusions
Ameriprise slightly missed their earnings estimates for the first quarter of fiscal 2015, and the stock has dropped over 3%. However, their return on equity increased to a record high 23.1 % and operating earnings were up 7%. Management appears to remain confident about the future as evidenced by the raising of their quarterly dividend 16% to $0.67 per share. Consequently, I consider the recent weakness an excellent opportunity for long-term oriented investors desirous of earning an above-average total return.
Disclosure: Long AMP at the time of writing.