Franklin Resources (BEN), parent company of the Franklin Templeton asset manager, reported lower Q1 earnings and assets under management (AUM) flows. However, BEN stock has already discounted this. With its 6.38% dividend yield and less than a 10x forward price/earnings (P/E) multiple, it is a buy here.

BEN closed at $20.06 on Friday, May 2, up 7% after releasing its Q1 earnings report earlier before the market opened. This is up from its low of $16.66 on April 8, but well off its high of $22.24 on Jan. 31 and an earlier peak of $22.76 on Nov. 29.

But it could be a bargain today. Given its high 6.38% yield today, BEN stock could be worth at least 20% more at $24.12 if it reverts to its average dividend yield. This article will show why.

The Bad News

Franklin Resources said its adjusted earnings fell from 59 cents per diluted share last quarter to 47 cents in Q1. That was a -20% decline Q/Q, although the Y/Y drop was less severe at -16% from 56 cents in Q1 2024.

The asset management company got hit with two headwinds - the failing stock market (which hit its performance) and net outflows of funds (and hence lower fees).

The point is that difficult markets hit money managers' revenue and earnings, but that is already reflected in the stock price. The market is more interested in what happens going forward.

Dividend Yield Target Price

I wrote about how cheap BEN stock was on April 4 ("Franklin Resources Stock Might Be a Safe Haven with Its 7.2% Dividend Yield"). I argued that the stock was cheap because its average dividend yield was much lower over the past 5 years.

Here's why.  Today, the annual dividend per share (DPS) of $1.28 gives investors in BEN stock an annual yield of 6.38% (i.e., $1.28/$20.06).

But over the past 5 years, Morningstar reports that its average yield has been 4.48%, and Yahoo! Finance says it's averaged 4.68%. So, using the highest of these two, BEN stock might eventually be worth $27.35, i.e., up +36.3%:

  $1.28 DPS / 0.0468 avg yield = $27.35 target

  $27.35 / $20.06 -1 = 1.3634 -1 = +36.3%

But, just to be conservative, let's use the stock's average yield in 2024 (6.16%) according to Morningstar:

  $1.28 DPS / 0.0616 = $20.88 target price, +4.1%

High-yield stocks like this tend to revert to their mean yield over time, if the company is profitable and can cover the dividend payment. That applies here. 

For example, analysts project earnings per share (EPS) this fiscal year ending Sept. 2025 will be $2.09 and $2.21 next year. These EPS forecasts more than cover the $1.28 annual dividend payment.

As a result, BEN could end up trading between $20.88 and $27.35 sometime over the next year. The average price target is therefore about 20% higher:

  ($20.88 +$27.35)/2 = $24.12 avg target

  $24.12 /$20.06 today = +20%

Nevertheless, there is no guarantee BEN stock can't fall again, especially if markets falter. One way to lower risk is to set a lower buy-in target price and get paid while waiting. That is why shorting out-of-the-money (OTM) puts is a good alternative strategy.

Shorting OTM Puts

For example, last month I recommended shorting the $17.50 strike price put option for the May 16 expiry period. The premium was $1.00, giving an investor an immediate yield of 5.71% (i.e., $1.00/$17.50).

Note that at the time, this strike price was 2.67% below the trading price (i.e., was out-of-the-money), and the delta ratio was high (elevated risk) at 44.8%. 

Today, the price for this strike has fallen to just 3 cents, making this an extremely profitable trade. The short seller can buy back these puts at a very low price. Investors may now want to do this again.

For example, the June 20 expiry period shows that the $19.00 strike price, 5% below the trading price, has a midpoint premium of 45 cents. In other words, the short-put play provides an investor who enters an order to “Sell to Open” an immediate yield of 2.37% (i.e., $0.45/$19.00) for the next 48 days.

This sets a lower potential buy-in point if BEN stock falls to $19.00. Note that the strike price is 5% out-of-the-money, and the delta ratio is just 28.8%. So, based on historical trading history, there is a less than 30% chance that BEN will fall to this point.

Downside Risks and Mitigation Factors

If BEN stock falls below $19.00, this could potentially result in an unrealized capital loss. But, even if it does, the investor's breakeven point is lower:

  $19.00 - $0.45 = $18.55, or 7.5% below $20.06

Moreover, an investor who shorted the May 16 put would have made a net $0.97 rolling that trade over (i.e., $1.00 premium - $0.03 “Buy to Close” cover payment). As a result, the actual net breakeven is $1.42 lower, or

  $19.00 - $0.97 - $0.45 = $19.00 - $1.42 = $17.58

  $17.58 / $20.06 -1 = -12.3% below the 5/2 trading price

Even if BEN stock falls to $19.00, the investor's net breakeven at $18.55 provides an annual yield of 6.90%:

  $1.28 DPS / $18.55 breakeven = 0.069 = 6.90% annual yield

Another factor that lowers downside risk is this: the investor who sold short last month's recommended put play has lower risk.

They will have accumulated a net yield of 7.47% ($1.42/$19.00) over the three months (i.e., 42 days in the first trade +48 days = 90 days). That works out to an annualized expected return (ER) of over 30%:

  365/90 x 7.47% = 4.05 x 7.47% = 30.3%

That assumes this yield can be repeated every 3 months, but this may not be the case, especially if short-term yields keep declining. 

The bottom line is that BEN stock looks undervalued here based on its annual dividend yield vs. its historical average. This is despite Franklin Resources' lower returns. Moreover, shorting OTM puts is one way to play this for more investors willing to take on more risk.

On the date of publication, Mark R. Hake, CFA did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.