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.
HIG Price / Book Value data by YCharts
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.
Hartford Financial Services Group Inc (NYSE:HIG) is expected to grow earnings from $2.88 last year to $3.54 next year. The stock trades at the highest forward multiple in the group at 8.9 times those estimates.
Lincoln National Corporation (NYSE:LNC) is expected to grow earnings from $4.47 in 2012 to $4.94 in 2014. Even on an earnings multiple basis, the stock trades at 7.4 times those forward numbers.
Metlife Inc (NYSE:MET) is expected to grow earnings from $5.28 in 2012 to $5.73 in 2014. The stock trades at roughly 7.8 times those forward earnings estimates. The stock also has a solid 2.6% dividend yield.
Prudential Financial Inc (NYSE:PRU) is expected to grow earnings from $8.31 this year to $8.87 next year. On an earnings multiple basis, the stock trades at 7.9 times those forward estimates.The stock has a 2.4% dividend yield.
Bottom line
As mentioned back with the original article, investors could probably spend months analyzing the best-positioned stock in the sector. In the end, these stocks will all generally trade in the same pattern. Investors can purchase Metlife Inc (NYSE:MET) due to the higher 2.6% dividend yield or Lincoln National Corporation (NYSE:LNC) for the lowest book value and forward earnings multiple.
Either way, investors need to own this sector along with other financials that continue to trade below book value even after the financial crisis is long over.
The article Buy the Financials Still Trading Below Book Value – Part 1 originally appeared on Fool.com and is written by Mark Holder.
Mark Holder and Stone Fox Capital Advisors, LLC own shares of Hartford Financial Services (NYSE:HIG) and Lincoln National. The Motley Fool has no position in any of the stocks mentioned. Mark is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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