The Fool has looked at the recent earnings releases from each of the Drip Port's companies to report this year, except for Mellon Financial (NYSE: MEL).
Every quarter, Mellon, the Dreyfus Funds owner, issues a 20-page earnings report, and every quarter we break it down by looking at factors that are most important to us. As we've long said, you see little online analysis of financial companies and banks because they are complex. However, by knowing what to focus on, you can understand these businesses. Doing that, you can invest in them if you want to.
We want to. We believe that the "money industry" is attractive. Money, without a doubt, has indefinite staying power. So, put a smile on your face! After reading this column, you'll know some good ways to look at financial companies as an investor.
Fee revenue is important
Mellon is a financial services company rather than a traditional bank. In its case, and with others like it, the revenue number that is most important to us is called fee revenue, or noninterest revenue. At Mellon, this revenue is earned through investment management fees, and trust, administration, and custody fees, all of which are services. High noninterest revenue at a financial services firm usually means a higher return on tangible assets (ROA) than can be achieved at a typical bank.
Excluding one-time events, Mellon's fourth-quarter fee revenue grew 7% from the same quarter last year. Although 7% is a little light for our taste, for the year Mellon increased its fee revenue a strong 10% and trust and investment fee revenue 13%. These numbers are on track.
The company's total noninterest revenue reached $806 million in the fourth quarter, up from $770 million last year, and was $3.15 billion for the year. Earnings per share rose 10.6% to $0.51 in the fourth quarter, and 10% to $2.03 for 2000.
Operating expenses should be near flat
In the second quarter of 2000, Mellon's operating expenses decreased 2% compared to the previous quarter. That was excellent! In the fourth quarter, operating expenses rose only 1%. For all of 2000, operating expenses rose 5%. That's not bad, but it is a little higher than we'd like to see on a regular basis. (We excuse part of this rise due to transitions at the company.)
We keep an eye on operating expenses because a services company, if efficiently run, can increase revenue without increasing operating costs much, if at all. In Mellon's case, the 1% fourth-quarter increase in operating costs is a good sign of continued efficiency.
Profitability measures
In its most recent quarter, Mellon reported cash operating return on annualized equity (a form of ROE) of 46.4%, well above the 40% level that we want to see, and up from 45% last year -- although down from earlier in the year, when it peaked above 51%. This number is bound to bounce some, given general asset volatility at financial services firms.
Still more relevant is annualized cash operating return on tangible assets (a form of Return on Assets). Mellon achieved 2.48% ROA on this measure, up from 2.38% last year and 2.07% to end 1998. Seeing this number steadily rise is an excellent sign. Already, Mellon had one of the better ROA numbers in the industry, even when it was at 2.07% when we first bought it. (For much more on ROE, ROA, and valuing stocks, see the suggested links to the top right of the column, especially the Drip Port buy collection on Mellon.)
Nonperformance risk
With a financial services company, one risk is the ballooning of nonperforming assets -- largely loans that aren't being repaid. Mellon ended 1999 with a ratio of nonperforming assets to total loans and net acquired property of 0.53%, which was good, although it was above its 1998 record of just 0.44%. In 2000, this figure grew to 1.03%. That's unfortunate.
A healthcare provider whose loans were moved to "nonperforming" class caused much of the unhealthy rise this year, as did a manufacturing company debtor that filed for bankruptcy. Following these disappointments, we expect to see this number improve in 2001.
Now what?
When Mellon traded at $31 per share one year ago, we opined that it was a good company at a good price. The stock has risen about 55% since then. Now, at $46 3/4, Mellon trades at 20.4 times year 2001 earnings estimates and 17.9 times year 2002 estimates. For reference, one year ago the stock was at 15 times 2000 estimates.
Mellon reduced its sharecount by 7%, net of reissuances, through a share buyback program that just ended. Management recently instated a new buyback program of the same size. This program and the stock's 1.9% dividend yield, combined with Mellon's business growth, should help create consistent, long-term, annualized double-digit earnings per share growth. This is why the Drip Port continues to invest in Mellon's free dividend reinvestment plan.
If you have questions, visit us on the Drip Companies board. Fool on!
Jeff Fischer doesn't bank with Mellon right now, but he does own shares in the company -- the amount of shares that you see listed below. The Drip Port's money is his. To see what other stocks he owns, visit his profile. The Motley Fool is investors writing for investors.
