Model Portfolio teriksen:ESVF

Back in April 2006 I wrote a Marketscope article on the attractiveness of U.S. Global Investors (ndq: GROW). At the time it was trading for $7 per share, adjusted for splits, and had a run rate of $0.50 in earnings. Assets under management (AUM) were growing rapidly. In fact, AUM grew from $3 billion as of December 2005 to over $5 billion by the end of April 2006, before flattening out. The stock took off as earnings jumped sharply. I sold at what I thought was fair value based on flattening AUM, but the stock surged further ahead, finally reaching $36, or 40 times trailing earnings, just before year end.

By the end of 2006 I was shorting the stock in some accounts I managed due to its lofty price. Within a month it fell to $20, and has since trended downward as AUM has bounced between $5.0 and $5.7 billion. While I haven’t owned the stock for a while I have continued to monitor it. So the question is - Is it a buy now? In short, No, and let me explain why.

GROW’s AUM held steady during the first half of the year due to the strong performance of resource related (commodity) stocks. Most asset managers, other than Diamond Hill (ndq: DHIL) have seen AUM fall in 2008. If AUM has held up, why am I so negative? The reason is that GROW has typically earned a large amount of its earnings in the June quarter ( the company’s 4th quarter) from incentive fees related to its management of funds for Endeavour Financial (Cdn: EDV), which will likely not happen this year due to poor performance. Whereas in last year’s fourth quarter GROW earned 42 cents per share, they will likely only earn about 17 cents in this year’s fourth quarter. The difference is due to the lack of incentive fees.

With the stock at $14 and current trailing earnings of $0.88 it may appear attractive to some at first glance. After the June quarter report, trailing earnings will fall to about 62 cents, which will put GROW at a significant premium to most asset mangers in terms of P/E valuation (22 times). Another metric I use is market capitalization to AUM, which is above 4% for GROW, and that is too high for an asset manager that doesn’t manage all of its funds in house (GROW’s emerging market funds are sub-advised by Charlemagne Capital (AIM: CCAP).

To make matters worse, resource related stocks have had a rough time since the start of July. Based on fund performance alone, which ignores inflows and redemptions, GROW’s AUM has declined by about 900 million since June 30. Thus GROW is still a SELL in my book.