With Quiver Quantitative’s recent institutional holdings data, we can see that hedge funds and asset managers have been increasing their holdings in LPL Financial Holdings Inc. (NASDAQ: LPLA). Firms such as Lone Pine Capital, Eminence Capital, and Samlyn Capital have all added to their LPLA positions recently. Most notably, Lone Pine Capital increased shares held by 7.71% (as filed on 6/30), bringing their total LPLA holdings to 2,003,058 shares worth around $461.6 million dollars at current share prices. With this in mind, we took a closer look at some of the reasons why many investors may be bullish on LPL Financial Holdings Inc.
In July, LPL Financial Holdings’ released strong second quarter earnings results for fiscal year 2023. The business reported gross profit of $990 million dollars in the second quarter, representing a 39% YoY increase. Additionally, LPL Financial Holdings reported EBITDA of $519 million dollars (67% YoY increase) and diluted EPS of $3.65 a share (85% YoY increase) in the second quarter. In terms of business results, total advisory and brokerage assets were up 16% YoY to $1.24 trillion dollars, with total organic net new assets coming in at $22 billion dollars, which represents a 7.4% annualized growth. Furthermore, the business’ capital allocation priorities were strong in the second quarter, with management repurchasing $350 million dollars worth of shares and paying out $23 million dollars in dividends. With these strong earnings results in mind, we believe that LPL Financial Holdings Inc. is a compelling investment opportunity trading at a very fair valuation.
LPL Financial Holdings Inc. serves the advisor-mediated marketplace as the nation’s largest independent broker-dealer, a leading investment advisory firm, and a top custodian. LPL Financial Holdings serves more than 21,000 financial advisors, which includes financial advisors at 1,100 enterprises and around 500 registered investment advisor (RIA) firms nationwide. The business provides the front-, middle-, and back-office support that are essential to advisors. These services include brokerage and advisory platforms, integrated technology solutions, compliance services, clearing services, business services and planning services, and in-house research to help their customers (advisors) run successful businesses. Management believes that LPL Financial Holdings is the only business that offers a unique combination of comprehensive self-clearing services, integrated technology platform, and an array of non-proprietary products that are all delivered unencumbered by conflicts from underwriting, product manufacturing, and market-making.
Management acknowledges that LPL Financial Holdings is a well established leader in the independent advisor market. The business’ scale allows for continual reinvestment (management actively reinvests into the business’ comprehensive technology platform and practice management support, improving advisor or customer productivity), economies of scale (as one of the largest distributors of financial products in the United States, LPL Financial Holdings is able to obtain compelling economics from product sponsors), and high payout rates to advisors (as one of the largest broker-dealers in the United States by number of advisors, the business offers the highest payout rate to advisors in the industry). As we can see, LPL Financial holdings operates with a strong reinforcing moat within the independent advisor market. They are able to enjoy the best payout rates for advisors and strong economies of scale for their products, giving them a strong moat within the industry. Furthermore, with the ability to reinvest back into the business, this moat is self reinforcing, allowing LPL Financial Holdings to grow and maintain a strong moat over a long-term time horizon.
LPL Financial Holdings competes with a variety of financial firms to attract talent and retain experienced advisors. These financial firms operate in different markets, including independent broker-dealers, wirehouses, and independent RIA firms. The broker-dealer channel / industry is highly fragmented and consists largely of regional firms that rely on third-party technology providers and custodians to support their operations. Additionally, management acknowledges that competition for advisors also includes regional firms that focus on specific geographic areas or client niches. LPL Financial Holdings’ customers or advisors compete with financial advisors of brokerage firms, insurance companies, banks, investment advisory firms, and asset managers.
Management is solid, and their capital allocation priorities do a great job of aligning shareholder and management interests. Management likes to repurchase shares to enhance shareholder value. In the fourth quarter of 2022 alone, the business repurchased 636,326 shares, with the business repurchasing 1,566,527 shares total in 2022. This came as the Board of Directors authorized an additional $2.1 billion dollars to the amount available for repurchases in September of 2022, with $2 billion dollars set aside for repurchases in 2023. In addition to share repurchases, management also offers a quarterly cash dividend, further showing management’s superb capital allocation priorities that do a great job of enhancing shareholder value and aligning shareholder and management interests.
In terms of management incentives’, LPL Financial Holdings’ management compensation structure does a good job of aligning shareholder and management interests, while also retaining executive talent long-term. Outside of a base salary, the executive compensation structure largely rewards management with performance-based compensation, which includes annual cash-based bonus opportunities and long-term incentives (paid out in the form of equity rewards). In 2022, equity grants paid out to the CEO consisted of 70% of PSUs (performance-based stock units) and 30% RSUs (restricted stock units), whereas all other NEOs were granted equity in the form of 60% PSUs and 40% RSUs. Additionally, the business’ equity ownership guidelines focus on long-term stockholder value by requiring all executive officers to own a significant amount of the business’ equity. Not only do these equity grants and equity ownership rules align shareholder and management interests, they also do a great job of retaining executive talent over the long-term, as NEO compensation is largely based on long-term performance and equity rewards (which means management is incentivized to ensure that shares perform well) over the long-term. We believe that the best business’ treats shareholders like partners, and we feel this is the case with LPL Financial Holdings Inc., making the business an attractive long-term compounder.
LPL Financial Holdings Inc. is a very efficient business. The business currently operates at a LTM ROE of 59.3% and a LTM ROIC of 32.4%. With a WACC of 9.1%, LPL Financial Holdings currently operates at a ROIC to WACC ratio of around 3.56x, showcasing the business’ ability to reinvest cash back into the business at rates of return far higher than the business’ weighted average cost of capital. Additionally, a high ROIC to WACC ratio can signify that this is a compound business, meaning that the business is able to rapidly compound intrinsic value over a long period of time, handsomely rewarding shareholders. Looking further at efficiency metrics, we can see that this ROIC figure has rapidly expanded within the last decade, showing that the business may hold a stronger moat or competitive advantage in the industry that it operates in. In 2013, LPL Financial Holdings operated with an ROIC of 14.7%, compared to today where the business operates at a LTM ROIC of 32.4%.
Analyzing LPL Financial Holdings’ income statement, we can see some stellar sustained growth in revenue, gross profit, and earnings within the last decade. Since 2013, LPL Financial Holdings has grown revenue at a CAGR of around 7.7%, with gross profit growing at a CAGR of 12% in that same time period. The growth in gross profit can largely be attributed to expanding gross margins. In 2013, the business operated at a gross margin of 20.5%, compared to today where the business operates at a LTM gross margin of 31.3%. In terms of earnings, LPL Financial Holdings has grown EBITDA at a CAGR of 14% since 2013, with EPS growing at a CAGR of around 21.6% in that same time period. This growth in EPS can largely be attributed to share repurchases. LPL Financial Holdings is a cannibal, decreasing shares outstanding by 24% since 2013.
Looking at LPL Financial Holdings’ balance sheet, we can see that the business operates in good financial health. The business currently holds around $800 million dollars worth of cash and short term investments on their balance sheet, coupled with $3 billion dollars in long-term debt. While we would like to see a business have more cash on hand than debt, this is a perfectly manageable long-term debt to cash ratio. Adding credence to the point that the business has plenty of runway to cover its debt obligations, LPL Financial Holdings currently operates at an EBIT / Interest Expense (interest coverage ratio) of 11.23x, meaning that the business generates $11.23 of EBIT for every dollar of interest expense that they incur. As we can see, the LPL Financial Holdings’ earnings are sufficient enough to comfortably meet their debt obligations, putting the business in a good spot financially. With such a clean balance sheet, the business has plenty of runway to also repurchase shares, offer / increase a dividend, and reinvest cash back into the business, in addition to paying down its debt.
Looking at LPL Financial Holdings’ cash flow statement, we can see some stellar sustained growth in net income and free cash flow within the last decade, showcasing the business’ operational efficiency. Since 2013, LPL Financial Holdings’ has grown net income at a CAGR of 18.5%, with free cash flow growing at a CAGR of 32.3% in that same time frame. This massive growth in free cash flow within the last decade can largely be attributed to expanding free cash flow margins. In 2013, LPL Financial Holdings operated at a free cash flow margin of 2% of revenue, compared to today where the business operates at a LTM free cash flow margin of 19% of revenue. As we can see, LPL Financial Holdings has massively expanded free cash flow margins over the last few years, showing the business’ increased efficiency at converting revenue to cash. As the business is able to generate more and more free cash flow (as revenues increase and hopefully free cash flow margins continue to expand), the business has much more opportunity to reinvest cash back into the business, repurchase more shares, and / or offer / increase a dividend, handsomely rewarding shareholders.
After conducting a reverse discounted cash flow analysis, we can see that LPL Financial Holdings Inc. is trading at share prices that imply a -3% growth rate (CAGR) in free cash flow over the next ten years, using a perpetuity growth rate of 3% (largely in line with US GDP growth) and a discount rate of 10%. We believe that this growth rate is extremely cheap, especially given that LPL Financial Holdings was able to massively grow free cash flow within the last decade and expand free cash cash flow margins handsomely. While past performance is not indicative of future results, it seems unfair to us that current share prices imply a -3% CAGR in free cash flow within the next decade, especially after the business massively expanded free cash flow margins and grew free cash flow at a CAGR of 32.3% within the last decade. Additionally, Factset places a 19% long-term growth rate on the business (based on analyst estimates), further adding credence to the point that this valuation is extremely cheap. We think it is safe to assume that revenue will grow at a rate of 4-5% per year over the next 10 years, and assuming that free cash flow margins stay flat during that time, that brings us to an intrinsic value of $368 per share, or a 60% implied return from current share prices. While we believe that this business is undervalued by the market currently, that is just based on our models and thinking, and other investors may have different opinions. Therefore, we strongly advise that every investor looking into LPL Financial Holdings should do their own due diligence on the business and formulate their own opinions on future growth prospects and valuation.
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