Recent reports of brokerage companies have shown that the retail investor is returning to the stock market. Share of Morningstar (MORN +2.17%), a company that provides investment research to individual investors and financial advisors, is up 20% this year. Investment data firms FactSet (FDS +1.43%) and Thomson Reuters (TRI +0.48%) have shown similar performance, up 17% and 14%, respectively. Will these companies profit from the emerging trend?
Cautious outlook
Typically, the engagement of retail investors is tied the performance of the stock market. As the market rises, more and more people want to participate. Morningstar, which is betting on retail investors both directly and through investment advisor services, may be best positioned to profit from this. The company has recently reported its quarterly earnings, with revenue rising 5.7% while net income was up 11.6%.
The company states that the environment remains challenging. Interest rates are low, and clients continue to be risk-averse. This restrains market activity and also hinders subscriptions to Morningstar's services.
Thomson Reuters has reported its revenue was up 2%. The company's financial business segment showed a 1% decline, offset by performance from the legal, tax, and accounting segment. Thomson Reuters is oriented toward big clients more than consumers, and the company has stated that headwinds in Europe continue to pressure its financial business segment. Banks continue running their cost-cutting programs and reducing their headcounts. In this environment, it's impossible to show meaningful progress.
FactSet has shown mid-single-digit revenue growth recently, but the company shares the same headwinds as Thomson Reuters. Its products are very expensive, and most clients pay more than $24,000 per year for them. This means FactSet is suitable to big institutions, but not every hedge fund could afford to pay that much.
Valuation
Despite the lack of impressive growth figures, these stocks have managed to grow to pretty expensive valuations. Thomson Reuters is the cheapest one, trading at 17.5 times its forward price-to-earnings ratio. At the same time, the company has the lowest operating margin at 9.2%. In comparison, Morninstar operates at 24.16% margin, while FactSet operates at 33.7% margin.
Morningstar trades at a premium to peers, scoring a 25 forward price-to-earnings ratio. Unlike Thomson Reuters, the company is debt free. Thomson Reuters' amount of debt is nothing impressive, however, leading to a 0.41 debt-to-equity ratio. FactSet stays in the middle in terms of valuation. The company trades at almost 22 times forward price-to-earnings ratio.
Analysts' mean target prices suggest a 6.5% downside for Thomson Reuters and 10.5% downside for FactSet. These estimates reflect the underlying softness of the sector. The combination of cautiousness among retail investors and cost-cutting measures at big firms is not good for selling financial data.
My take here is that this trend will most likely continue. Despite the fact that retail investors are returning to the market, they will likely stay cautious when it comes to purchasing external products. Brokerage houses provide free basic research, and "free" is a powerful competitor. As for financial companies like banks and hedge funds, they have shown no sign of increasing their expenses. Almost every bank has actually announced additional money-saving measures.
Bottom line
In my opinion, all three stocks are overvalued. I do not see where the growth would come from to justify the valuation of these stocks. Thomson Reuters is in a better position with a cheaper valuation and a dividend that yields 3.71%. FactSet and Morningstar are bleak from the income perspective, with 1.27% and 0.64% yields, respectively.
The environment suggests growth would be mostly anemic for these companies. As a result, they are likely to perform in line with the S&P 500. This isn't ideal for most investors; after all, you are searching for outperformers, aren't you?
