Every once in a while you come across a company that is trading at a cheap valuation that makes you scratch your head. Sometimes these cheap valuations can present a great opportunity to enter a stock market at bargain prices. Other times, these cheap valuations could mean investors aren’t expecting further growth.
Only after you dive into the numbers can you get a good idea if it’s one or the other.
A business with a low cost valuation that presents a great opportunity is B. Riley Financial (NASDAQ: RILY). This financial services firm has focused on meeting the needs of small-cap companies with a price-to-earnings (P / E) ratio of just four, significantly lower than its five-year average P / E ratio of 28.5 .
This begs the question: why is Wall Street discounting this stock so much?
Rapid profit growth reduced its P / E ratio
B. Riley Financial provides a variety of financial services through various subsidiaries, which include activities such as investment banking, wealth management and brokerage, as well as debt liquidation and restructuring. The company has been serving small and mid caps for over 25 years now.
One of the reasons B. Riley trades so cheaply is his rapid growth in bottom line to which the stock price has not adjusted. In the nine months of this year, the company’s diluted earnings per share (EPS) stood at $ 13.07, up sharply from its diluted EPS of $ 1.14 posted in the nine months of the year. Last year. Since EPS is the denominator when calculating the P / E ratio, the rapid rise in EPS has caused the P / E ratio to contract despite the share price rising 107% since the start of 2021.
This has been an exceptional year for B. Riley’s earnings, with the company’s capital markets segment leading the way. This segment, which includes investment banking business and trading revenue, posted nine-month revenue of $ 559 million this year. This represents a growth of 743% compared to last year. However, this segment represents nearly 90% of the company’s total revenues in 2021.
B. Riley’s outperformance this year can be attributed to strong investment banking activity. As a result, investors may be wary of investing in the company if they do not believe that it can sustain such growth. It is concerning to see its capital market segment generate 90% of its income. However, the financial services company has positioned itself well by leveraging its cash flow to diversify its revenue streams.
B. Riley’s goal is to resist all economic conditions
In my opinion, a strong investment banking activity has helped B. Riley significantly increase his cash balance to $ 378 million from $ 104 million at the end of last year. It also saw its investments and other securities rise to $ 1.3 billion, from $ 777 million at the end of last year. B. Riley worked hard to put that money to good use by acquiring wealth management companies like National Holdings and 272 Capital.
The takeover of these two companies by the firm illustrates its efforts to diversify its sources of income. The addition to its wealth management segment is positive for B. Riley as it helps provide the company with a consistent revenue stream regardless of market conditions. Companies typically earn commissions on the Total Assets Under Management (AUM) they manage for high net worth clients. Wealth management can be an attractive source of income for investment banks because it is recurring and easier to predict.
The purchase of National Holdings gives B. Riley a bigger footprint in wealth management. Prior to the acquisition, B. Riley Wealth Management had over 170 registered representatives and $ 10 billion in client assets. National Holding gave it a big boost by adding 733 registered representatives and nearly $ 19 billion in client assets.
So far this year, B. Riley’s wealth management segment has generated revenue of $ 277 million, up 433% from a year ago. However, the segment has seen its selling and administrative expenses increase almost as much, which is why it does not yet represent a larger share of its net income. The sector’s spending increased mainly due to the purchase of National General, which cost it $ 203.3 million.
As B. Riley continues to integrate this purchase, margins should improve. While wealth management generated nearly $ 17 million in earnings before interest, taxes, depreciation and amortization (EBITDA) this year, co-CEO and founder Bryant Riley said he believes it could represent a business. from $ 50 to $ 60 million within a year.
Insiders can’t stop buying stocks
Wall Street overlooks B. Riley Financial because of its outperformance in investment banking. Investors may not think the company can continue to perform at such a high level. While investment banking may not be experiencing the same growth, the steps the company has taken to diversify its revenue streams to make its business more robust cannot be ignored.
Another bright spot for the company is that management has their skin in the game, with 40% of their shares held by company insiders. High levels of insider ownership are positive for investors because management is motivated to make it successful. With focused management in mind, B. Riley looks like a stellar value stock poised for long-term growth.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.