Why SDR and HL look far too expensive

Updated: 
Hargreaves Lansdown head office

Asset management specialist Schroders (LSE: SDR) has released a positive interim management statement. It shows that the company is making good progress with its strategy, with its diversified business model providing a robust performance. However, alongside sector peer Hargreaves Lansdown (LSE: HL), Schroders lacks appeal for value investors.

Schroders' pre-tax profit (before exceptional items) increased slightly from £453m to £455m in the nine months to 30 September when compared to the same period of the previous year. It was able to generate £2.7bn of net new business and assets under management increased to £375bn. In particular, Schroders made good progress in North America and its diversified business model means that its risk profile is relatively low.

Looking ahead, Schroders is forecast to report a fall in earnings of 3% in the current year, with a return to growth of 8% forecast for next year. This means that Schroders' bottom line is forecast to be less than 5% higher in 2017 than it was in 2015, which is behind the performance of the wider index. However, Schroders trades on a relatively high rating, with its price-to-earnings (P/E) ratio standing at 16.5.

A P/E ratio of this magnitude indicates that Schroders offers high growth prospects. However, the company's forecasts indicate that the near term will be tough. As such, it appears as though Schroders is overvalued - especially given the uncertain outlook for the global economy. This means that it offers little margin of safety, which could limit its capital gains and mean there is considerable downside risk.

Overvalued?

It's a similar story with wealth management peer Hargreaves Lansdown. Like Schroders, it's a high quality business that's well diversified and has a track record of strong growth. However, Hargreaves Lansdown trades on a P/E ratio of 29.2, which is exceptionally high given the fact that its bottom line is due to rise by 8% in the current year. In fact, it puts Hargreaves Lansdown on a price-to-earnings growth (PEG) ratio of around 3.6. Alongside Schroders' PEG ratio of 2.1, this indicates that now isn't a good time to buy either company.

Furthermore, neither stock offers a high income return. For example, Schroders has a yield of 3.1%, while Hargreaves Lansdown's yield is 3%. Although Schroders has scope to increase dividends at a faster pace than profit over the medium term, since its dividends are covered 1.9 times by profit, uncertainty in the macroeconomic outlook means that it may take a relatively cautious stance on dividend growth. And with Hargreaves Lansdown's dividend being covered 1.1 times by profit, it lacks the headroom to deliver rapid dividend growth.

While both companies are high quality and have bright long-term futures, their high valuations mean that the risk/reward ratios on offer lack appeal. Therefore, it may be prudent to look elsewhere at the present time.

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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has recommended Hargreaves Lansdown. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.