William Blair's 7 Favorite Financial Stocks for 2012

Bank of America/Merrill Lynch's top financial stock pick added to this update

BOSTON ( TheStreet) -- William Blair's financial stock picks for 2011 were a disaster, trailing the broader market by a wide margin, as the industry suffocated under tighter regulations and lower interest rates.

But the Chicago-based investment bank, which manages more than $45 billion in assets, is looking to recover in 2012 with financial stocks like MasterCard ( MA), which has soared 66% this year, and Aon Corp. ( AON), up 13%.

William Blair every year offers the top stock picks from individual sectors. In 2011, the firm's selections in the financial sector had the worst performance, falling 25% from Nov. 26, 2010, through Nov. 25, 2011. That compares to a slide of 18.7% on the S&P 500 Financials Index.

William Blair analysts last year highlighted five stocks in the financial sector, four of which were big losers. Morgan Stanley ( MS) and Och-Ziff Capital Management ( OZM) each dropped 46%, Evercore Partners ( EVR) slumped 22%, and Affiliated Managers ( AMG) fell 8%. Only IntercontinentalExchange ( ICE) made investors money.

Given the dismal performance in the financial sector over the past year, why should investors come back to William Blair for more? For one, the firm is looking more closely at financial technology and specialty finance, which is much different than the big, beleaguered banks.

"Leading financial-services providers to the 2.5 billion underbanked consumers as well as the growing number of unhappily banked consumers should drive strong growth," William Blair analyst Adam Klauber wrote in a research note Tuesday. "New technologies and services such as online lending and prepaid cards are examples."

William Blair isn't the only investment banking firm out with a list of favorite financial stocks. Earlier this week, Bank of America/Merrill Lynch analysts posted their top stock picks for 2012, selecting Lincoln National ( LNC) as the best stock idea from the financial sector.

Klauber and William Blair's team of financial analysts see opportunities in other names, saying companies with high barriers to entry, long-term secular growth, international exposure, and visible operating leverage should remain core holdings for investors. The analysts have selected seven financial stocks that they're banking on in 2012, which are outlined below and on the following pages.


Visa ( V)

Company Profile: Visa is the global credit card company.

Share Price: $95.69 (Dec. 6)

2011 Return: 36%

Investment Thesis: "Visa is well-positioned to continue to capitalize on the electronic payments secular growth trend," William Blair analysts write of Visa, noting that secular growth of electronic payments is expected to average 10% to 12% globally over the next several years.

The analysts also say that Visa also enjoys very high incremental margins, which contributes to the company's attractive margin profile (59% in fiscal 2011) and strong free cash flow.

"Visa has a strong balance sheet and generates strong cash flow," the analysts write. "Visa had about $4.1 billion of cash and investments, $2.9 billion of litigation reserves, and no debt on its balance sheet as of Sept. 30, 2011. Guidance calls for more than $4 billion of free cash flow in fiscal 2012."

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MasterCard ( MA)

Company Profile: Like Visa, MasterCard is a global payments processor. The company says its worldwide network processes more than 23 billion transactions each year.

Share Price: $371.45 (Dec. 6)

2011 Return: 65.8%

Investment Thesis: Analysts at William Blair say MasterCard, like Visa, will continue to gain from electronic payments. They note that MasterCard's business, like Visa's, faces substantial barriers to entry and that high incremental margins should drive operating margin expansion for MasterCard over time.

Also like Visa, William Blair analyst say MasterCard's guidance for the coming year could prove to be conservative.

"Management recently affirmed its 2011 to 2013 objectives of growing constant-currency revenue and EPS at a compound annual rate of 12% to 14% and more than 20%, respectively, while maintaining operating margins at a minimum of 50%," the analysts write. "We anticipate long-term sustainable EPS growth of 15% based on the secular tailwinds, modest margin expansion, and capital redeployment."


Aon Corp. ( AON)

Company Profile: Aon is a provider of risk-management services, insurance and reinsurance brokerage and human capital and management consulting. In July 2010, the company announced a merger with Hewitt Associates, an HR consulting and outsourcing company.

Share Price: $46.30 (Dec. 6)

2011 Return: 0.7%

Investment Thesis: William Blair analysts see several catalysts for Aon Corp. in 2012, the most notable of which is the merger with Hewitt, which should reap rewards next year. The analysts forecast a 100-basis-point improvement in pretax margin for 2012 and a 250-basis-point improvement for 2013.

"The margin in the brokerage segment has finally begun showing progress," the analysts write. "With forecast organic growth remaining solid (our estimate is 3% for 2012), the segment should be able to secure additional margin expansion for the next few years. We forecast 40 basis points of pretax margin improvement during 2012 and 2013."

Additionally, William Blair expects Aon's free cash flow growth to remain robust and their forecast assumes 30 million of share repurchases over the next two years, which they argue could be a conservative number if the cash flow from the merger with Hewitt. accelerates into 2012.

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Wright Express ( WXS)

Company Profile: Wright Express provides fleet charge cards and information services for car, van and truck fleets throughout the U.S.

Share Price: $53.25 (Dec. 6)

2011 Return: 15.8%

Investment Thesis: Wright Express plays on one of William Blair's investing trends for 2012: Prepaid cards.

"Wright Express appears to be gaining good traction with its prepaid card initiative," the analysts write. "We believe prepaid could be a significant new growth area for Wright Express given the cross-selling opportunity it has with its core customer base. We believe Wright Express's scalable infrastructure and closed-loop network gives it a sustainable competitive advantage."

The analysts expect Wright Express's other payments solutions segment, which accounted for 23% of third-quarter revenue, to continue to be strong.

"Wright Express accelerated international investment over the past several years and completed a highly accretive acquisition in Australia in 2010," the analysts write. "Wright Express is working on many new growth initiatives, which gives us confidence in the long-term outlook. We believe an accretive acquisition, likely international, is possible in the near term."


Higher One Holdings ( ONE)

Company Profile: Higher One offers integrated financial aid disbursement services for universities. The company provides services to about 5.8 million students, ensuring they receive financial aid refunds quickly, can pay tuition and bills online, make on-campus and community purchases.

Share Price: $19.99 (Dec. 6)

2011 Return: -1.2%

Investment Thesis: William Blair analysts say they like Higher One because the company has an attractive, predictable business model with high incremental margins and solid cash flow conversion. It also helps that management recently said that the company's pipeline "remains extremely robust."

"We believe there could be upside down the road from the company increasingly being viewed as a true bank alternative (e.g., more direct deposit), through acquisitions, by monetizing the graduate opportunity, and as a takeover candidate," the analysts write.

However, there is high short interest in Higher One's stock -- William Blair analysts say it would take about 30 days to cover. That's due to a number of unresolved headwinds, including competition, fees, potential cuts in Pell grants, slowing enrollment growth in the U.S. and a bank partner.

While finding a bank partner is the biggest question market, William Blair analysts say that a positive announcement, which could come in the next three months, would be a huge catalyst, especially considering the massive short interest.

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DFC Global ( DLLR)

Company Profile: Formerly known as Dollar Financial, DFC Global offers financial services to unbanked and under-banked consumers and small business owners, many of whom receive income on an irregular basis or from multiple employers.

Share Price: $18.87 (Dec. 6)

2011 Return: -1.2%

Investment Thesis: William Blair analysts don't mince words when talking about DFC Global; They argue the market opportunity is "significant" and that business trends are strong and accelerating in the U.K. and Europe and remain solid in U.S. and Canada.

"We believe DFC is well positioned to provide alternative financial services to the 2.5 billion underserved/underbanked consumers worldwide (about 60 million in the United States) given its diverse product offering, geographic diversity, and strong balance sheet," the analysts write.

They add that DFC's recent acquisitions provide platforms for growth. "We believe DFC's acquisition pipeline remains active and that DFC will focus primarily on using its recent U.K. and Scandinavian pawn acquisitions as platforms for expansion in existing and adjacent European markets," they add.

Shares of DFC have fallen hard in recent weeks due to regulatory concerns in the U.K., although William Blair analysts say the selloff is overdone. "A November 2011 review published by HM Treasury increases our conviction that the U.K. government wants to make sure consumers have access to high cost loans with proper disclosures," they add.


Crawford & Co. ( CRD.B)

Company Profile: Crawford & Co. is the world's largest independent provider of claims management solutions to insurance companies and self-insured entities.

Share Price: $5.87 (Dec. 6)

2011 Return: 72.7%

Investment Thesis: William Blair analysts argue that Crawford "is a classic example of an underutilized marquee franchise."

"Jeffrey Bowman, CEO since 2008, has a track record of success at the company, turning the international property and casualty insurance segment into a profit driver for the firm," the analysts write. "We believe that current management has the ability to significantly turn the company around."

The analysts say the company should benefit from improving claims trends and that a return to secular growth is possible over the next several years. They also argue there is potential for significant upside to 2012 estimates thanks to the potential for a faster rebound in Broadspire.

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>>To see these stocks in action, visit the William Blair's 7 Favorite Financial Stocks for 2012 portfolio on Stockpickr.

-- Written by Robert Holmes in Boston.

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Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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