Guardian: Better Than It Seems

Guardian Capital Group (GCG) is in an unfavoured industry, which could offer long-term investors an opportunity to profit. As discussed previously, the market has soured on the business of money-management. A recent article in a mainstream newspaper discussed Guardian as a potential deep value play, noting that it's substantial assets plus its operating business are worth substantially more than what the market is willing to pay for them at the moment.

While Guardian trades for $370 million, it owns equity securities of almost $386 million as of its most recent quarter. The bulk of these securities is in a single position: $294 million in the stock of Bank of Montreal (BMO), one of Canada's largest banks, currently trading at a price to book of 1.3.

The bank's shares are down about 10% since the last time Guardian provided an update. But even after making this adjustment, Guardian still trades for barely more than the value of these securities, much of which it doesn't need to run its money-management business. As such, the company's profitable operating business comes almost free to the investor.

Operating earnings have averaged about $14 million per year since 2005, including the $17 million the company earned in 2011. But there is a trick here! The company *includes* its dividend income as part of its operating revenue. This dividend income amounted to $17 million and $15 million for 2011 and 2010, respectively.

Presumably, this is high-margin stuff (i.e. there are no costs associated with accepting BMO's dividend cheque every quarter), meaning substantially all of this money flows right to operating earnings. Unfortunately, if you exclude these amounts from operating earnings, the company essentially breaks even. As in, the money management business makes no money!

The Globe article essentially gave the operating business a value of 1% of its assets under management (AUM). Valuing investment managers by their AUM is common, but such valuations should not be applied blindly. Guardian generates revenue (excluding dividend income) of just 0.2% of AUM, and doesn't turn a profit in its operating business, making a valuation at 1% of AUM seem ludicrous!

There's no doubt that the market has soured on the investment management industry. Unfortunately, Guardian is in this business only by name! In reality, it appears to be a holding company for various securities, generating much of its income from the dividends of a large Canadian bank.