Buy the Financials Trading Below Book Value
Mark is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
After the financial crisis, numerous financial-related stocks traded at prices below book values due to the fears in the accuracy of the reported balance sheets. In the years since the crisis, most of those fears have disappeared, yet many financial stocks haven’t regained the valuations suggested by the improving asset bases.
A prime example exists in the insurance and retirement services sector where both Hartford Financial Services Group (NYSE: HIG) and Lincoln National Corporation (NYSE: LNC) still trade at roughly 50% of asset values. In both cases, the stocks have surged to 52-week highs, yet significant value still exists.
Book valuations aren’t perfect
As with any financial measurement, book value can be an imperfect calculation. The valuation can include intangible assets, risky investments, or any number of assets or liabilities that might be calculated according to flawed estimates or accounting methods. Regardless, book value provides a solid basis for starting research on an investment. Any stock trading substantially above or below such a valuation should be questioned as to whether the market has become too bullish or conversely bearish. Remember that these very insurance stocks traded at multiples of book value back prior to the financial crisis.
With the insurance sector of the financials, one has to wonder when investors will finally conclude that the fear of rising rates won’t impact the companies as much as expected. The lower-for-longer interest rate environment hurts the investment income these firms need to pay claims and support retirement commitments, but the companies have all adjusted to this environment by now.
The below table highlights the price to book values of the insurance stocks:
Solid earnings growing book value
The extremely perplexing part about this selection of stocks is that earnings have been solid and consistent over the last few years. In fact, the book value continues to grow each and every year. Rarely will a company trade below book value that is growing book value and has the potential to keep growing it.
As an example, the book value of Hartford has grown from the mid $20s at the low of the financial crisis to over $52 now. Not only does that question why investors remain so fearful, but why is the stock currently trading around the book value at the lows of the crisis. The stock should be nowhere near $24 if the worst period wasn’t that low. In fact, the book value quickly sprang to around $40 by the beginning of 2010. Three years later the stock continues to languish.
See below chart highlighting the book values over the last 10 years:
In general, my favorite stocks are the ones trading at the lowest price to book value. At this point, there's no reason to make the investment selection more complicated. Both Hartford Financial and Lincoln National trade right around half of book value.
Hartford trades at the lowly 0.46 of book value. After earning $1.94 per share in 2011, analysts expect the company to earn $2.59 in 2012 and $3.26 in 2013. On top of those earnings, the company is now able to repurchase shares at these extreme discounts. Hartford spent most of the 2000s above the $60 level and even touched $100.
Lincoln National trades right at half of book value as well. The stock trades at roughly 6x the expected earnings for 2012 and 2013. The company is also repurchasing shares at these extremely low book value values. The combination should cause the book value to continue appreciating. As with the other stocks, Lincoln now has a higher book value per share than prior to the crisis. The stock though spent most of the early 2000s above the $50 range or almost double the current price.
Investors could probably spend months analyzing the best-positioned stock in the sector. At the end of the day, most sectors trade in unison so the sector movement rather than any individual stocks will influence the majority of any future gains. Investors need to own these stocks in a portfolio as the group continues to languish under book value. The fundamentals suggest investors remain too bearish on the sector.
Mark Holder and Stone Fox Capital Advisors, LLC own shares in both Hartford Financial Services and Lincoln National Corporation. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!