Top Picks 2016: Federated Investors

01/12/2016 7:00 am EST

Focus: STOCKS

Crista Huff

Editor, Cabot Undervalued Stocks Advisor

Federal Open Market Committee board members are talking about three more rate hikes in 2016, observes Crista Huff, editor of Smart Investing in Turbulent Times.

Our Top Pick for conservative investors—Federated Investors (FII)—is a 60-year old global investment management company that’s uniquely positioned to increase its net income from asset management fees as short-term interest rates rise. 

Federated is an industry-leading provider of money market mutual funds, which make up 70% of their assets under management.

The company has been waiving management fees on money market funds, a move that was necessitated by the shockingly low interest rate environment produced by quantitative easing.

Now that rates are rising, the company has reinstituted its management fees, thereby dramatically increasing 2016 revenue.

In addition, Federated’s third-quarter 2015 report showed assets under management growing at a faster rate than its peers. 

What’s more, as investors flee from heightened volatility in junk bond mutual funds, they will likely park their money in money market funds, bringing an additional surge of fee income to Federated Investors.

Federated’s earnings per share are expected to grow 13.4% and 24.2% in 2015 and 2016 (December yearend). The dividend yield is substantial at 3.5%.

The 2016 price/earnings ratio (P/E) is quite low in comparison to the earnings growth, at 14.2, making the stock distinctly undervalued. FII traded at a P/E of 20 or higher in seven of the last ten years.

Since the 2016 consensus, EPS estimate is $2.00, if the stock trades at a 20 P/E in 2016, it would put the share price at $40. That’s an exciting price target.

FII traded between $28 and $35.50 in 2015. First, the stock’s got to complete its recent 28-32 trading range, which could happen this winter.

Then, barring any significant bad news, the stock will likely rise to its first-half 2015 trading range of $32 to $35.

Accurate earnings projections—and a neutral-to-bullish stock market—should be able to push FII toward 40 in the second half of 2016.

Institutions own 83% of FII shares, which tells you that professional investors think FII is a smart investment.

FII is my number one choice in financial stocks, based on strong earnings growth, low P/E, big dividend, and continued prospects for Fed rate increases. Buy FII now. The next Fed rate increase is around the corner.

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