Elevated Valuations Could Cause Problems for Cowen Stock

Cowen (NYSE:COWN) is a U.S.-based financial services firm. COWN stock had a tremendous run throughout late 2020 and into 2021 after the pandemic’s stock market craze.

Cowen stock has grown by more than 260% since March 2020, but it’s time for a reversal as markets seek stability.

The notion is that financials will do well during a rising 10-year yield, which is likely to persist in 2022 due to a shift towards contractionary monetary policy. I agree with the general consensus, but I think there will be a divide in financial sector performance based on core business activities.

Cowen may well end up on the losing side of it all. Here’s why.

Key Segments

Cowen relies heavily on asset management, underwriting, and brokerage activities. The firm’s asset management fee-based revenue has grown by 56% since last year during an equity bull market. There’s a strong case for a market correction, and based on 2019’s (pre-pandemic) fee-based growth rate of 9.95% I find it hard to believe that its recent success is sustainable.

Brokerage commissions could well stay elevated (31.8% from a year ago) if we enter a bear market as much of the stock that got bought through the firm’s brokerage may get sold through the same vehicle.

Cowen’s investment banking services will definitely take a hit. The segment has experienced year-over-year growth of 102% due to an increase in mid-market deals and SPAC offerings. The SPAC craze has cooled down a tad and this could drag down Cowen’s revenue from underwriting activities.

Bond Yields and Valuation

Banking stocks usually gain when bond yields are anticipated to move higher, and this is because bond yields are positively correlated to interest rates. When interest rates are higher the banks usually have better margins on their credit investments/loan offerings. This scenario will benefit the likes of Citigroup (NYSE:C) and Morgan Stanley (NYSE:MS) dearly. But Cowen’s loan origination only makes up for a small amount of its business. Its over-reliance on asset management and underwriting will cause for disbenefit from a rising yield.

I anticipate investors to realize the differences between Cowen and a depositary bank when yields rise, and the stock could sell off dramatically as a consequence. With Cowen’s earnings-per-share anticipated to shrink by 48% by December 2022, we could well witness its stock price reach the $23 handle according to the justified forward price-earnings metric.

Shareholder Compensation

I think the second quarter was a final hurrah for Cowen in terms of beating earnings estimates. Its second-quarter report beat revenue estimates by $27.32, but that’s a 30.8% decrease from last year. Shortly after the announcement, Cowen announced that it would only buy back an additional 900,000 shares during its current buyback program; a much larger number was expected. 

With a cash dividend payout ratio of 30.1% higher than its five-year average, I certainly believe that Cowen’s dividend payouts will reduce moving forward. Investors are currently seeking high dividend stocks to substitute a potential market drawdown, and Cowen just isn’t an attractive option for it.

Bottom Line on COWN Stock

Cowen has outperformed significantly due to abnormal growth across its key segments. The likely outcome is that these segments will cool down for now, and the stock being overvalued will sell-off as a consequence.

If you own Cowen, you may want to think about hedging your position or cashing out on your profits. Market timing is essential when it comes to financial sector stocks.

On the date of publication, Steve Booyens held a short position in COWN. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.  Steve Booyens co-founded Pearl Gray Equity and Research in 2020 and has been responsible for equity research and PR ever since. Before founding the firm, Steve spent time working in various finance roles in London and South Africa, and his articles are published on various reputable web pages such as Seeking Alpha, Benzinga, Gurufocus, and Yahoo Finance. Steve’s content for InvestorPlace includes stock recommendations, with occasional articles on crowdfunding, cryptocurrency, and ESG.