Even after substantial gains this year, a whole slew of financial stocks still trade below book value. As written about back in January, a good portion of the insurance stocks traded close to half of book value. While the fears from the financial crisis have mostly dissipated, the stocks continue to meander below book value even with strong earnings profiles.
Investors continue to fear that either the balance sheet isn’t clean or that a rapidly rising interest rate environment will hurt the vast bond portfolios of the firms. Either scenario appears unlikely as the balance sheet should be as clean as ever following the scrubbing after the financial crisis and the firms have had years now to hedge against rising interest rates. Neither scenario should be ignored, but investors should be willing to pay closer to historical book value multiples as these fears are no greater than normal stock market risks.
Insurers still trading below book value
The insurance and retirement services stocks of Hartford Financial Services Group Inc (NYSE:HIG) and Lincoln National Corporation (NYSE:LNC) continue to trade at the low end of the valuation spectrum at levels close to 0.7 times book value. The perplexing part of the equation is that analysts expect strong earnings into the future. Profitable stocks continuously growing book value shouldn’t trade at a level below the value of the net assets of the stock.
Even the other insurance stocks of Metlife Inc (NYSE:MET) and Prudential Financial Inc (NYSE:PRU) continue to trade at decent levels below book value at around 0.8 times. In both cases these stocks have gained 20-25% during the five months since the last article, but gains in the book value per share during that span have kept the multiple significantly below historical multiples.
10-Year book value chart
As the below chart highlights, the book value was typically closer to 1.5 times prior to the financial crisis. The typical stock in this group would need to double in order to reach that pre-crisis normalcy.
Earnings potential to grow book value
The interesting dichotomy in this group of insurance and financial services stocks is that the earnings potential remains strong. All of the stocks have strong earnings generation with solid, but not spectacular growth into 2014. The question is how a stock can trade below book value that generates continuous profits that will grow that value each day.