At first glance, the share price of Hargreaves Lansdown (LSE: HL) strikes me as attractive. Trading on a price-to-earnings ratio of 10 and with a dividend yield close to 6%, the shares seem cheap.
But is the Hargreaves Lansdown share price the potential bargain it seems to be?
Valuing the business
The answer to that, as with any business, involves looking at what the business is likely to be worth over the long term and how that compares to its current share price.
Profit before tax last year was a smidgen over £400m. That is impressive for a company with a market capitalisation of £3.3bn. But it is worth noting that it was a big jump from the prior year, when profits before tax came in at £269m.
The fact that the business is consistently profitable is a positive attribute in my book. But what about that big swing in profit? Hargreaves Lansdown can see revenues and profits move around based on whether people have cash to invest and how wiling they are to put it into the markets. That can lead to sudden jumps in financial performance – but it is also an ongoing risk to both revenues and profits.
Set against that, though, there are some notable strengths to the business.
It has a well-established brand, established customer base, and operates in a market where profit margins can be attractive. Last year, for example, revenue was £735m. So to turn a profit after tax of £403m implies a net profit margin of 55%. Many businesses would love to have such juicy margins.
Looking forward
What about the future?
In a trading statement last month, the stockbroker said that the first three months of its latest financial year had seen revenues 13% higher than the same quarter last year. Net new business was £0.6bn and it saw net new client growth of 8,000, pushing its active client base to over 1.8m.
But share dealing volumes fell, reflecting the fact that the business tends to be susceptible to wider market trends when it comes to stockbroking volumes.
Over the long term, I think the business ought to be able to play to its strengths. But, if stock market volumes in general fall (for example, because investors prefer to sit on cash) that could lead to lower revenues and profits.
Good not great
So although I think the Hargreaves Lansdown share price looks cheap based on last year’s earnings, I expect earnings could move around quite a bit in future.
A large reason for that is the general level of stock market activity, something outside the firm’s control.
While I see the large customer base as attractive, I also think there are fairly low barriers to entry in the industry. As a Hargreaves Lansdown customer myself I do not consider that the business has a strong, unique competitive advantage. If it pushes prices up too much, I expect a lot of customers would move their business.
So, for now, I have no plans to buy Hargreaves Lansdown shares.
