Financial Analysis State Street State

Financial Analysis State Street

State Street Corporation is a financial services company, focused primarily on the brokerage sector. They are a medium-sized operator, mainly based in the U.S. But with some small international operations.

They operate in a highly competitive environment. Their competitors include small niche firms, discount brokers and multinational financial institutions much larger in size than they are. This environment has resulted in a degree of downward price pressure. There are few barriers to entry for competitors who are established in other geographic locations. The reverse is also true for State Street - there is significant room for growth in both domestic and international growth.

Among State Street's key operating strengths is the fact that its business, within the brokerage subsector, is diversified. As shown on page 31 of the current annual report, they have an even distribution among different types of products. Another strength of State Street is that they have shown a consistent track record of growth. Revenues, net income and Earnings per Share (EPS) have grown steadily over the past few years. Page 33 of their annual report outlines the growth in assets under management. In the past year, over 50% was attributable to growth in new business, rather than market increases in existing assets.

In terms of weaknesses, State Street is caught in between being a small niche player and being a large multinational player. They do not have the capacity that niche players have to meet individual needs of specialized clients, but also do not have the fiscal resources to compete with the scale and advertising budgets of their larger competitors. There is an upside, however, in that should the industry move towards consolidation, State is a potential takeover target.

The greatest threat to State Street is their competitive environment. The highly competitive nature of their environment presents many challenges. The first is that the consumers hold significant power. The cost for consumers to switch brokerage firms is low, and their expectations in terms of service and price are high. In terms of price, competition within the industry has put downward price pressure on State Street. Many of State Street's competitors hold more power in the industry, in that they are in a better position to dictate price points.

Moreover, many of these competitors have the ability to poach State Street's talent. In the brokerage business, talent is one of the most important sources of competitive advantage. Intellectual property can at times provide some advantage, as will to a certain degree the company's trademark and reputation. State Street, as with other firms in this industry, is in constant competition to attract and retain key talent.

Another major threat is that of market decline. State Street derives a significant portion of their income from fees based on the value of assets held. Adverse movements in the market will have an adverse impact on these fees. Thankfully, State Street derives its income fairly evenly from many sources, which will moderate the impact of a major market downturn.

State Street has relatively strong financials for the industry. Their growth rates are stronger than the industry average, and this has been reflected in their P/E ratio, which is also higher than the industry average.

State Street has a high degree of leverage. Its debt-to-equity ratio is 11.6, reflecting that their balance sheet is over 90% debt. This is reflected as well in the fact that relative to the industry State Street has a high Return on Equity but a low Return on Assets. ROE for State Street is 16.17%, versus 10.79% for the regional bank sector and 9.74% for financial services as a whole. State's ROA is just 1.12%, compared with a sector average of 2.9%. Yet, this compares favorably with the industry as a whole, which has just a 0.9% ROA. This indicates that although State has a higher-than-average degree of leverage in its sector, it is not out of line with the industry as a whole.

State Street has acceptable liquidity ratios for the industry. Their current ratio is 0.93, the quick ratio is 0.296 and the cash ratio is 0.04. The low cash ratio is not a concern given the nature of the industry. Financial institutions are required by law to carry a certain percentage of cash as a liquidity buffer but beyond that, they tend to invest their free capital. In the past year, they have shifted their asset mix to incorporate a greater amount of short-term fixed income product, at the expense of equities. This seems to have been in response to the perception of an upcoming slowdown and indicates that the firm is both cognoscent of its liquidity position and is taking steps to ensure the robustness of that liquidity position.

Moreover, in terms of cash flow coverage, State Street is in a solid position. Cash flow coverage measure the ability of the firm to pay its interest expense. In each of the past three years, State Street has generated more interest revenue than they have incurred interest expense.

Because it is difficult to separate operations and investments in a financial services firm, such as State Street, measuring the firm's operating efficiency is valuable. State Street's asset turnover is 6.7%. The gross margin was 15.1% in the past year, slightly down from the previous year. Overall, the gross margin has been steady and healthy over the past few years. If one were to separate out the interest-related activities, State Street's operating margin reveals a strong decline in the past year. Operating margin in the past fiscal year was just 2%, compared with 10.2% and 9.3% in the two years previous. State Street's cost structure has worsened in the past year. Their salary expense increased nearly 23%. A provision for legal exposure was added and the company incurred merger and integration costs. The latter pertains to a pair of small acquisitions the firm made in the past year. The acquisitions were made to access certain intellectual properties, the benefit of which have not yet been realized. Inclusive of investment activities, the operating margin is much stronger, but has remained consistently below the industry average over the past five years.

State Street has consistently carried a P/E ratio akin to a growth company within the financial services sector. Yet, dividend yield and dividend growth are significantly lower than the industry and sector averages. It is also worth noting that State Street's equity is owned by institutions at a much higher rate than comparable firms in either the sector or the industry. Moreover, State's beta indicates a greater degree of risk than in the industry as a whole. This indicates that the growth component of State is the more attractive component of the company - a higher dividend yield can be found elsewhere with less risk.

My conclusion is that I would not invest in State Street Corp at present. The stock appears best suited for the institutional investor, who wishes to incorporate a bit of growth within the industry into their portfolio. As a retail investor, I see the P/E ratio as being too high to justify such a poor yield. The financial services component of my portfolio is going to be a place where I seek to gain a healthy yield at low risk, which State Street does not give me.