I’ve always had a soft spot for asset manager stocks, especially mutual fund managers. As an advisor/portfolio manager, I’ve been dealing with them on a daily basis for over two decades. Honestly, I don’t use a lot of mutual funds in my practice, but it’s a stylistic choice, not an indictment of the product. 

That said, over the years I have owned a decent handful of mutual fund management company stocks. They can be great businesses and, in turn, great investments. I’ve written about asset managers off and on over the years. Here’s a piece from a few years back. 

Recently, another asset manager has piqued my interest, primarily on a yield and valuation basis. Running $86.5 billion out of their Overland Park, KS headquarters, Waddell and Reed Financial (NYSE: WDR) has a fund complex and distribution model that merits a look.

The stock has had a bit of a ride over the last few years, climbing over 200% only to give it all back. But it just might be time to get back in. Here’s why.

#-ad_banner-#At its core, the asset management business is pretty simple, at least from a model standpoint. You take in client money, you invest and manage it, and you charge a fee. There are no huge factories to build. Most of the capital is invested in people to manage the money and to sell/distribute the products. You bring in enough money and keep it in the barn, the fees get fairly predictable.

The biggest challenge, of course, is performance not just of your funds but the financial markets as a whole. Shaky markets create nervous investors. Nervous investors withdraw money. Assets go down. Management fees go down. Pretty simple.

Since the financial crisis of 2008, asset management firms have fought the seemingly never ending battle against negative fund outflows. WDR is no different.

In fact, as of the 2nd quarter of 2016, WDR has experienced outflows of $9.7 billion. That’s the bad news. The good news is that Q2 revenues and earnings per share (EPS) increased thanks to cost controls. The company turned in total revenue for the quarter of $319 million, beating forecasts by 3%. Actual operating income beat estimates by 2.3%, coming in at $53.8 million, while Q2 EPS came in at 41 cents, beating estimates by 2.5%.

While I like to see organic growth, management deserves all of the credit. General and administrative costs came in 17.5% under forecast, while compensation costs were 8.6% lower than expected. The result was pre-tax operating margins of 24.4% versus estimates of 16.9%: a 44% surprise. So, despite the challenge of outflows, management has a steady hand on the tiller.

WDR also owns what I see as an undervalued asset: its retail, financial advisory/brokerage arm. This distribution channel contributes over $130 million to net income annually.  Currently WDR is recruiting more productive advisors while trying to improve production among existing advisors. While the plan seems to be to increase revenues, it would also make sense for the company to spin off or sell the brokerage business outright, especially with the Department of Labor (DOL) fiduciary standard pending implementation in 2017.

Risks To Consider: The biggest, most obvious risk to WDR’s business is continued fund outflows. Fleeing money means disappearing fees. Luckily, management is good at what they do. But you can only cut so much. At the end of the day, revenue matters. Challenging financial markets are also an obvious risk. Volatility spooks investors. WDR does have an extremely broad product portfolio. A large menu of style choices in uncertain markets is much better than being a one trick pony.

Action To Take: Despite the headwinds facing the company and its sector as a whole, WDR shares are extremely attractive at their current levels. Priced at $18.94 with a forward P/E of 10.28 and a 9.65% dividend yield, the company currently has $7.70 per share in cash on the balance sheet and debt to capitalization of just 11%. 

With management’s successful execution and improving external conditions, a modest forward P/E expansion to just 12 would result in a 12 month price target of $22.44. Factoring in the dividend yield would translate into a total return of 28%.

Editor’s Note: Most people think you have to sacrifice growth for income. But we’re holding 23 monthly dividend payers… and have seen our portfolio grow 50%. Get all the details here, including names and ticker symbols.