Private-equity firm Kohlberg Kravis Roberts (NYSE: KKR) reported strong first-quarter earnings last week. The company said it earned $0.88 per share, 7% higher than
the $0.82 Wall Street was expecting. Henry Kravis is one impressive individual.
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In short, over the past few years, mutual funds and hedge funds have drastically underperformed benchmarks like the S&P 500 index. This is leading to a huge change in investment policy at pension funds. Pension fund assets topped a record $30 trillion last year. Management teams that help allocate this cash are turning to private-equity companies to increase their returns. This has created a major tailwind behind KKR. The company has a history of blowing away its benchmark year after year. And if the first quarter is any indication, it's on track to do it again this year.
KKR recently announced it has adopted a new distribution policy where it will return more of its income to shareholders. It will return 40% of its realized investment income from its balance sheet. That's a big deal – and caught most of Wall Street by surprise. Based on the new distribution policy, KKR should pay at least a 6% yield for 2013 and 2014.
KKR is expected to increase its assets under management from $78 billion to over $100 billion over the next six to 12 months. This is an easy goal given the tens of trillions of retirement assets stuck in hedge funds and mutual funds that have been under-performing the market over the past five years.
If I'm right, KKR has at least another 50% upside from here. Meanwhile, you can sit back and collect the 6% yield, which is three times higher than what the average S&P 500 company pays.
Based on the fundamentals, KKR is cheap, trading at eight times forward earnings. But the stock is up 59% (including dividends) since July 2012. Shares are now above the recommended buy-up-to price of $17. KKR is a hold.