The Frugal Fund Company That's Up 38%

SmartMoney Apr 10, 2012 Back to press

An investment company known for its frugal approach to stock selection has seen its own shares reach lofty levels on Wall Street.

WisdomTree Investments (WETF) shares have gained 38% this year -- nearly four times the broad U.S. stock market's gain. The company now has a stock market value of $965 million. Last year it posted its first profit: $3.1 million on $65.1 million in revenues.

That puts the company's value at nearly 15 times its trailing revenues. Among the large, midsize and small companies in the S&P Composite 1500 index, the median sells for 1.4 times trailing revenues.

WisdomTree provides four dozen exchange-traded funds, or investment funds that trade like stocks. Many of its funds combine some of the the passivity of index investing with the preference for cheap shares shown by many stock-pickers.

For example, its Dividend ex-Financials fund (DTN), which surpassed $1 billion in assets in February, tracks an index of stocks selected for their high dividend yields. The fund recently had a dividend yield of 3.8%, close to double the broad market's dividend yield. And since a stock's dividend yield is a function not only of its dividend payment but also its price, high-yielders tend to have modest valuations. The index recently carried a price-to-revenues ratio of 1.1, a discount of around 20% to the broad market.

WisdomTree has benefitted from a general flow of investor dollars to exchange-traded funds, as well as from the popularity of its front men, famed hedge fund investor Michael Steinhardt, who is the company's chairman, and Wharton professor Jeremy Siegel, who is an advisor. Mr. Steinhardt owns more than one-quarter of the company's shares.

WisdomTree has also catered to investor demand with specialty funds. It has emerging-market funds with exposure to the fast-growing economies of countries like Brazil and Taiwan; funds focused on commodity-rich countries like South Africa and funds that offer exposure to non-U.S. currencies, like the Indian rupee and Chinese yuan.

The irony, of course, is that WisdomTree stock wouldn't make the cut in most of its funds: not the ones that prefer overseas shares, not the ones that look for big dividends or plentiful earnings and not the ones that exclude financial shares. But might it nonetheless be worth paying up for?

WisdomTree is certainly on a growth tear. During the first quarter of 2012 it brought in $2.3 billion in net investor inflows, its best quarter to date. The fresh cash, combined with strong performances for stocks in general and emerging market stocks in particular, drove assets under management 30% higher.

And WisdomTree isn't the only mutual fund company whose shares have been popular with investors this year. T Rowe Price Group (TROW) is up 12%, Federated Investors (FII) is up 50% and Janus Capital (JNS) is up 33%.

T. Rowe is the priciest of these based on its price-to-revenues ratio of about six. It offers a useful comparison. The company over the past year turned 45 cents of each revenue dollar into operating profit. For WisdomTree, that figure was just six cents.

That's not a sign of underperformance on the part of WisdomTree, but rather, an illustration of how mutual fund companies are highly scalable businesses. There's not much added cost in managing a $1 billion fund than a $500 million one -- but there's about twice as much revenue, because fund companies collect a percentage of assets. Last year, WisdomTree reported a 59% jump in advisory fees, but only a 26% increase in expenses.

Look for explosive earnings growth from here. Among four analysts with predictions for WisdomTree's earnings this year, the average expects them to multiply more than four times to $12.8 million. In 2013, earnings are expected to nearly double again, to $33.9 million. If those predictions are reliable, the stock, although it trades at more than 300 times trailing earnings, is a somewhat more reasonable 28 times 2013 earnings.

That's still an ambitious price, however. The median S&P Composite 1500 stock sells for around 15 times trailing earnings.

WisdomTree's success will depend on the continued health of stock markets, especially emerging-market ones, and on its ability to demonstrate that its investment fund tactics work. Jason Weyeneth, who covers the stock for investment bank Sterne Agee with a "buy" recommendation, likes the company's fast growth and notes that its stock could get a technical boost in the short term. It's a prime candidate for addition to the Russell 2000 index of small-company stocks, wrote Weyeneth in an April 2 research note.

That would mean that investment funds that track the Russell 2000 would have to buy WisdomTree shares, possibly nudging the stock price higher.

That aside, investors considering a purchase of WisdomTree shares may want to refer to the company's own explanation of why it shuns traditional indexing: "in the quest for pure growth, we believe investors often pay too much."

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