One of the most overlooked aspects of the market is the fact that as the economy rebounds, consumers aren't alone in loosening their purse strings -- businesses do, too.
Specifically, 2014 should see a higher level of securities trading and companies looking to make strategic investments. That means companies will increasingly be looking for advice and to raise money and buy up competitors.
Thus, investment banks should perform fairly well in 2014. On the other side, there should be a higher level of trading this year, which is good news for brokerage firms.
One of the best growth plays for 2014 is a company that has exposure to both the brokerage and investment banking industries. Stifel Financial (NYSE: SF) is just that, and it appears to be one of the best plays in this highly fragmented industry.
Stifel is also playing its part in consolidating the industry. The company has spent upwards of $2 billion on acquisitions since 1997, and now has total client assets under management of $154 billion and 5,800 employees. Acquisitions and mergers should continue to be a great way for Stifel to snatch up market share, as well as gaining market share through organic growth.
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5 Different Business Segments
Stifel has built a fairly diverse business: Not one of its five major segments accounts for more than 35% of total revenue. Its revenue streams include commissions, principal transactions, asset management fees, interest and investment banking.
Stifel is also becoming a bigger name on the advisory side. Toward the end of last year, they managed to book their largest advisory deal in history, orchestrating the sale of mines from Consol Energy to Murray Energy for $4 billion.
The big tailwind for the likes of the brokerage industry is that as the economy rebounds, so should the level of trading and M&A. For the third quarter, Stifel's revenues were up across the board, with total revenue up 19% from the previous quarter. Revenue from commissions and principal transactions were up 16% and 20%, respectively. Investment banking was up 29%, thanks to an increase in the level of advisory and capital raising services.
Strong balance sheet leads to M&A
Stifel also has one of the best balance sheets, with a Tier 1 risk-based capital ratio of 23% at the end of the third quarter. The company hopes to drop this to 18%, which Stifel estimates would allow it to add $4 billion in assets, which could in turn boost earnings per share (EPS) by 20%.
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Besides purchasing Knight Capital's fixed-income sales and trading unit, Stifel purchased KBW in November 2012 for $575 million. A month later, Stifel purchased Miller Buckfire to add to its restructuring advisory business. Late last year, Stifel purchased Ziegler Lotsoff Capital Management, which added $4.2 billion in assets under management, and Acacia Federal Savings Bank, with $500 million in net assets.
With nearly 40% of its market cap covered by net cash, Stifel's strong balance sheet should allow it to continue its acquisition spree.
Stifel has also shown that it can integrate its acquisitions to drive growth. As a result, Stifel has been able to gain market share and increase revenues in both its equity flow and investment banking businesses.
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Risks to Consider: Stifel is heavily reliant on a rebounding economy. A stronger economy should lead to higher M&A services and trading, but a weak or delayed recovery could lead Stifel to underperform. Furthermore, any weakness in the capital markets could lead to reduced public underwriting and M&A advisory service fees, as well as higher turnover of financial advisors.
Action to Take --> Buy Stifel for upside to $63. Stifel trades on the cheap side of the brokerage industry at a price-to-book value ratio of 1.5, but its return on equity is one of the industry's best at 9.2%. The likes of Raymond James (NYSE: RJF) and BGC Partners (Nasdaq: BGCP) trade at price-to-book multiples of 1.9 and 2.7, respectively. Assuming Stifel should trade at a price-to-book multiple of 2, which is well in line with its pre-financial crisis average, the upside is to $63, or 30%.