A Great British Success Story

A company I have long admired is Hargreaves Lansdown (HL.), a retail investment broker co-founded by two former accountants — Peter Hargreaves and Stephen Lansdown. They founded the company in 1981 with just £500 each and turned it into one of the UK’s largest independent financial service providers. Today the company is a FTSE 100 giant with over £25 billion of assets under administration.

Secret of success

In an interview with the telegraph, Peter Hargreaves put HL’s phenomenal success down to “giving clients what they want”. Speaking in the Daily Telegraph, he said:

“If you call our helpline, a real person answers. If we say we will get back to you, we will. Emails are answered within four hours and letters answered by return of post.”

It sounds beautifully simple. They pride themselves on delivering a “knock your socks of customer service”, as a delighted customer I can testify to this. The firm’s philosophy of putting clients first is underpinned by its marketing strap line “to provide the best service, the best information and the best prices”.

A competitive AdVantage

When looking for great companies, one of my most important criteria is to identify businesses with a strong competitive advantage. In this case HL’s competitive advantage is its flagship vantage service – a wrap platform allowing clients to manage all their investments under one roof; it’s essentially a one stop-shop.

In addition to this, while most of its competitors in the platform market sell through Independent Financial Advisors, HL is one of the few businesses to operate an investment platform which deals directly with the customer. This not only enables it to build closer relationships, but extract higher margins as well. For example, its operating margin presently stands at a lofty 62.50% — demonstrating the firm’s low-cost business model.

Structural drivers

Its strategy is built around increasing the amount of assets under administration; this is aided by two important structural drivers of growth. Firstly, we have ultra-low interest rates, courtesy of the bank of England. This provides a strong incentive for savers to move their savings into higher yielding investment vehicles, such as equity income funds which HL specialise in.

Secondly, the UK has very high rates of personal taxation and faces the prospect of even higher taxes to pay down the large fiscal deficit. This should underpin inflows into tax efficient vehicles, like ISAs and SIPPS. According to HMRC, HL in 2010/11 held a 6.9% market share for new subscriptions into the vantage stocks & shares ISA, an increase from 4.2% two years ago.

Beating analyst expectations

HL has a knack for consistently beating earnings expectations. In 2011, the company trounced analyst expectations and boosted pre-tax profits by 46%! In its latest trading update the firm increased assets under administration from £23.4bn at the end of 2011 to over £26bn by the end of March.

This is despite concerns over the FSA’s Retail Distribution Review (RDR), which comes into force at the beginning of next year. The FSA has proposed banning rebates from fund managers. Since HL derives a large portion of its income from rebates, it would have to recoup the lost revenue through direct charges to customers.

However I believe fears have been overdone; because HL consistently achieves high levels of customer loyalty and asset retention. For example in 2011 HL’s vantage platform achieved an asset retention rate of 92%, up from 88% in 2008.

Ownership model

When researching potential companies, I look for how much equity the directors and staff own. A larger stake by the employees indicates that their interests are aligned with the shareholders; they therefore have a strong incentive to protect and grow the business. HL is a pertinent example of this, the directors and staff own over 60% of the equity in the business. And the co-founders Peter Hargreaves and Stephen Lansdown collectively own just over 50% of the company!

Management

Lately I find myself spending an increasing portion of my time looking at the quality of the management. This is because competent and dedicated managers can set the business apart from its competitors, allowing the firm to discover new growth opportunities which that don’t always show up in the share price.

I have a particular fondness for the co-founder and now executive director Peter Hargreaves. His dislike of ostentation; borrowing and love of criticism are traits I’d like to see in every CEO. Moreover, he is very cost conscious, checking every purchase invoice! I believe these qualities imbued into the company have helped it to deliver 30 years of profitable trading and generate record profits during the worst financial crisis in living memory.

Premium price

HL’s strong business model and robust financials are well reflected in the share price. At a current forecast P/E of 23.2, the company trades at a premium to its peers. However, the firm boasts a cash rich balance sheet, zero debt and a current forecast yield of 3.7%. In my view, HL is a first class company that justifies its hefty price tag.

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