The Stock Behind iShares

04/07/2006 12:00 am EST

Focus:

Charles Carlson

Editor, DRIP Investor

In a special report last week, we looked at ETFs. But one of the biggest beneficiaries of this growing market is not a particular fund, but a British bank. Here, Chuck Carlson looks at Barclays, the banking firm behind the popular iShares exchange traded funds.

"One of the fastest-growing investment vehicles in the history of the financial markets is the exchange traded fund. ETFs are a hybrid investment of sorts; they look like open-end mutual funds but trade like stocks on the various stock exchanges. The attractions of ETFs are many—low costs (most ETFs have lower expense ratios than mutual funds), tax friendliness, and flexibility (you can buy and sell ETFs during the trading day, unlike open-end mutual funds, which are purchased and sold at the end of each day).

"Investors have been dumping big money into ETFs in recent years. Indeed, at the end of 2005, assets in ETFs exceeded $310 billion, a 207% increase since 2002, according to the American Stock Exchange. While that asset number pales in comparison to some $9 trillion in assets in mutual funds, ETFs are clearly gaining market share at a rapid rate. The market-share leader in ETFs is the iShares family of ETFs. Money held in iShares-sponsored ETFs totals nearly $200 billion, or more than half of all assets in ETFs.

"Interestingly, the company behind iShares is not an American company. It is a United Kingdom-based company. That company is Barclays PLC (BCS NYSE). Barclays, based in London, operates one of the largest financial-services and banking organizations in the world. The firm operates in more than 60 countries and manages more than $1 trillion of the world’s money. Barclays is coming off a decent year in 2005. The company’s investment management business showed excellent growth. However, the firm’s credit-card business had sluggish results.

"Per-share earnings growth should accelerate in 2006. The consensus earnings estimate for the firm is $4.25 per share. While results will depend on growth in the United Kingdom economy, Barclays should benefit from continued gains in markets outside the UK. The firm said that 40% of its 2005 profits came from outside the United Kingdom—up from 20% five years ago—and the company expects that figure to rise to 50% in the next three years.

"A major driver of this growth outside the United Kingdom will be asset management, especially iShares business. ETFs are still very much in their fast-growth phase. While assets have grown sharply, many investors still are not familiar with these investments. That will change over the next few years, which will accelerate the growth in the number of ETFs—there are less than 300 ETFs in the marketplace, up from just one in 1993—as well as assets in those ETFs. And with a strong brand and big first-mover advantage, Barclays has positioned itself to be the major beneficiary of this huge expected growth.

"Barclays trades at just 11 times the 2006 consensus earnings estimate of $4.25. That’s a reasonable valuation to pay for a firm expected to post decent earnings growth this year and with a huge growth kicker with its asset-management business. Investors should also note that the stock currently yields nearly 4%, enhancing the issue’s total-return potential.

"Barclays has performed well and is trading around its 52-week high. A strong breakout above $48 would be especially bullish for the stock. And the good news for DRIP investors is that Barclays offers a direct purchase plan whereby any US investor may buy stock directly, the first share and every share. Barclays is part of the GlobalBuyDIRECT program offered by Bank of New York. Minimum initial investment in the company’s direct-purchase plan is $200. There is an enrollment fee of $10. Subsequent investments are a minimum $50."

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