Last week, we looked at how financial companies are feeling the pain of lower fees.
But I hinted at one group of financial companies that is not feeling the pain.
It’s one of my favorite groups to own – so when the market sold off last month and these stocks began falling towards a Cost of WAR of less than 1, I was pretty excited and ready to break open some bubbly.
Unfortunately, the decline halted and stocks have rallied back, so I did not get a new opportunity to buy them. The numbers are getting there, and I hope that before too much longer I can send Heatseekers members the call to arms with buy recommendations on these powerhouse firms.
These financial companies are private equity firms.
It’s hard for most of us to invest directly in a private equity fund, since most require you to be an accredited investor and have minimum investment levels of millions of dollars. However, we can buy shares of private equity firms and reap the benefits of the high returns they earn.
Let’s take a look at exactly how to do so…
Private Equity Firms Print Money, but We Can Make 2x the S&P Too
There has been talk over the years about private equity firms lowering their fees. Most of them get a 2% management fee and 20% of the profits generated by their portfolios of companies.
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The private equity firms themselves pretty much ignore the call to lower fees, and the investment community has had to go along with them for one simple reason: Private equity firms make more money than anyone else in the game.
Consider the results announced a few weeks ago by the biggest private equity firms. The lowest performance was turned in by Apollo Global Management LLC (NYSE: APO), who reported that their largest private equity fund returned about 13% over the past year. That’s about twice the return of the S&P 500. The Carlyle Group (Nasdaq: CG) reported that their funds averaged 17% across the board. KKR & Co. LP (NYSE: KKR) turned in a one-year performance of 19%. And the big winner in 2018 is The Blackstone Group LP (NYSE: BX), where CEO Stephen Schwartzman reported returns in their private equity funds of over 30%.
Private equity firms are not lowering their fees for the same reason Manny Machado and Bryce Harper are not looking for pay cuts anytime soon. They perform at a very high rate, and if you want the returns, you have to pay them the money. Private equity has been outperforming for decades, and they should continue to do so for decades to come.
But when we buy shares of private equity firms, we take mutual part in these high returns.
The management and incentive fees are earnings, and most of the firms distribute a very high percentage of these earnings as dividends to their shareholders. When one of their funds cashes in big, so do we as investors.
We also benefit in another significant way. All of the big private equity firms invest their own money alongside their fund investors. That builds the asset value of the company and helps drive the stock prices over time. Since we are shareholders, their money becomes our money too. And thus, the value of our investment goes up when these companies double and triple their money over a few years.
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When we buy shares of private equity firms, we become significant investors in buyout strategies, commercial real estate, private credit businesses, energy ventures, and infrastructure projects. We are owners of hotels, insurance companies, food service companies, and an incredible range of businesses. In fact, we own a huge chunk of the American economy, as private equity firms own thousands of companies and employ millions of people.
Here’s When to Buy Your Next Private Equity Stock
I am a serious student of private equity companies. They are the most successful investors in the recent decades, and I have worked very hard to figure out the hows and whys of their approach.
Much of our Sabermetric approach to investing in the financial markets is based on how these firms have made so much money for their investors. I read their conference call transcripts every quarter and scour their websites on a regular basis to see how they are thinking – and more importantly, what they are doing with their money at any given moment in time.
These firms are economic powerhouses, and the benefits can be enormous when we can buy them at bargain prices. We get large cash flows in the form of dividends, even as the value of the balance sheet investors are growing in value.
I think it’s kind of cool that we can use Sabermetric investing to buy the firms that pretty much invented many of the concepts we use to identify bargains in the first place. Long-term ownership of private equity companies at a bargain price should pay off in a huge way.
These stocks are close to being bargains, but they are not here just yet. We like to invest in companies when they trade for what we call a “Cost of WAR,” in our system, of less than 1.
Right now, when I look at the leading private equity firms, the ratio is around 1.2 to 1.5. You will know when they do become bargains from the sounds of champagne corks popping and me yelling from the rooftops about all the money we will make as private equity owners.
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The post How to Play the Private Equity Game Without a Million Bucks appeared first on Max Wealth.
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