Asset management firms are generally characterized by strong profit margins, high returns on equity, and scalable business models, as noted in fellow Fool's Stephen Ellis's recent article recommending the stock of Legg Mason (NYSE:LM). Federated Investors (NYSE:FII) shares an attractive investment profile with other asset managers, but its stock performance has suffered from the firm's focus on managing slow-growing and low-margin money market funds. Investors were so impressed by Federated's earnings announcement, however, that on Friday they bid up the share price to $35.44, a 6.1% increase for the day.

Investors were apparently pleased with both Federated's improved earnings and the company's long-term outlook. For 2006, Federated increased net income to $197.7 million, which is 23% higher than in 2005. The company's earnings per share grew to $1.86 and income from continuing operations grew to $1.83. The change in EPS represents a 26% improvement over results in 2005, or 20% on a continuing basis. Federated delivered solid revenue growth of 9%, but the company's bottom line improved largely as a result of better capital management rather than better operating performance. In particular, lower debt expense in 2006 was responsible for nearly one-third of Federated's increase in pre-tax earnings.

Long-term trends indicate an improving competitive position for Federated. The company's assets under management grew to a record $237.4 billion at the end of 2006, an 11% increase over 2005; strategic acquisitions, net inflows, and market gains all contributed to the growth. Perhaps most encouraging for investors was the record $40.9 billion of equity assets that Federated reported. Equity funds typically provide investment advisors with higher fees than fixed income or money market products. Federated has traditionally been known for its money market products, and the majority of the firm's assets under management are invested in money market products. Federated has a leading 6.5% market share in the fragmented money market category.

Federated's relative success at using existing sales channels to generate increased sales of equity products will help close the performance gap with other asset managers in terms of profitability and return on invested capital. Last week's earnings announcement is an encouraging sign of progress, especially for shareholders who hope to see faster growth and expanding valuation multiples for Federated's stock.

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Federated Investors and Legg Mason are Motley Fool Inside Value recommendations. For more information on companies with great growth opportunities, try out the newsletter free for 30 days.

Fool contributor Michael Leibert welcomes your feedback. He does not have a position in the shares of any of the companies mentioned above.