Standard ratios such as P/E and dividend yield aren’t always enough to tell you whether a firm is attractively valued. In this article, I’ll take a look at Hargreaves Lansdown (LSE: HL) and Sky (LSE: SKY), both of which released interim results this morning.
Each company looks fully priced already, using conventional metrics — but may actually be a hidden bargain.
Hargreaves Lansdown
After factoring in today’s results, Hargreaves trades on a trailing 12-month P/E ratio of 29.
You’d be forgiven for thinking that’s pretty expensive, and normally I’d agree. In this case, I’m not sure — Hargreaves is incredibly profitable:
|
Quality |
Value |
|
Operating margin |
52% |
|
Return on capital |
108% |
|
5-year average earnings per share growth |
25% |
These aren’t ordinary numbers. Hargreaves’ exceptional profitability means that 45% of total revenue feeds through to post-tax profits, much of which are distributed to shareholders via the firm’s dividend, which has risen by an average of 25% per year since 2009.
Many investors, including me, thought that Hargreaves’ profits might be affected by the Retail Distribution Review (RDR), last year, but this hasn’t happened. Nor has competition driven down profit margins, as you’d expect.
Hargreaves shareholders have done very well, and the firm’s 3.4% prospective yield remains in-line with the market average, making the shares look a reasonably attractive buy at today’s price — although you do have to wonder whether customers might one day demand a cheaper way to invest their money.
Sky
Another high-quality business with strong profit margins is Sky. However, Sky has undergone a major change during the last six months, spending £2.5bn to acquire Sky Italia and £4.4bn to take control of Sky Deutschland.
As a result, the firm’s net debt rose from £1.2bn in July 2014 to £6.3bn at the end of December. Factoring in the assets acquired as part of these deals, this has lifted Sky’s net gearing from 120% to 246%.
It’s too early to say whether this move will pay off, but I suspect it might: Sky believes it can benefit from economies of scale, and the firm’s businesses in all three countries reported multi-year high levels of customer growth during over the last six months.
Leaving aside the costs of the acquisition, Sky’s adjusted free cash flow of £450m was 25% higher than during the same period last year, and comfortably covered the firm’s dividend payments during the first half, making the 3.4% prospective yield look quite safe.
In my view Sky remains an appealing stock, and could make a good buy on any market weakness over the next few months.