Financials

  • 31 Aug
    How much should value investors pay for PRU?

    How much should value investors pay for PRU?

    Every time I start evaluating a stock as a potential investment, one of the first questions I have to answer for myself isn’t just about what the stock is doing right now; it’s about what price I think the stock should be at to represent an excellent value. As a committed value hunter, it really isn’t enough for me to say that a stock has great fundamental strength, or that its trend is moving the way I want it to right now. I also need to find a compelling reason to believe the stock should be worth significantly more down the road than it is today.

    Of course, fundamental strength and a stock’s current trend do play a role in that evaluation – but not in exactly the way most investors think. Over the years, I’ve often heard people equate value investing with contrarian investing, and maybe that’s one of the reasons I’ve come to appreciate the approach as much as I do. One of the basic ideas of contrarian investing suggests that the best investment opportunities lie in the areas that the market isn’t paying attention to right now; you’re going against the grain of the rest of the market and its trends. That’s one of the reasons that downward trends don’t concern me as much as they would if I were focusing primarily on shorter-term methods like swing or momentum trading.



    The truth is that for me, downward trends represent one of the easiest ways to start spotting good value opportunities. That’s a primary reason that just about any time I write about a stock, you’ll usually see that it’s been following a downward trend for a significant portion of time. Sometimes, downward trends are driven by significant problems within a company’s business, problems that threaten the company’s well-being and ability to survive in an increasingly competitive world. Sometimes, however, those trends are driven more by external macroeconomic factors, or simply by negative investor sentiment that ignores the underlying strength of the stock’s business. Those are the opportunities that I look for, because those downward trends really just mean that the stock’s current price could be a bargain compared to where it should be.

    Prudential Financial, Inc. (PRU) is an interesting study in value analysis. Like most stocks in the Financial sector this year, the stock has struggled to form any significant upward momentum; after peaking at around $127 in late January, the stock has dropped back significantly, touching an eight-month downward trend low at around $93 in the beginning of July. That’s a decline of almost 27%, which puts the stock squarely in its own bear market territory. Lately, however the stock has been stabilizing a bit and even looks like it is starting to build some bullish momentum. That, along with the stock’s mostly solid fundamental profile creates an interesting value proposition.



    Fundamental and Value Profile

    Prudential Financial, Inc., is a financial services company. The Company, through its subsidiaries, offers a range of financial products and services, which includes life insurance, annuities, retirement-related services, mutual funds and investment management. The Company’s operations consists of four divisions, which together encompass seven segments. The U.S. Retirement Solutions and Investment Management division consists of Individual Annuities, Retirement and Asset Management segments. The U.S. Individual Life and Group Insurance division consists of Individual Life and Group Insurance segments. The International Insurance division consists of International Insurance segment. The Closed Block division consists of Closed Block segment. The Company has operations in the United States, Asia, Europe and Latin America. PRU has a current market cap of about $41 billion.

    • Earnings and Sales Growth: Over the last twelve months, earnings grew by a little over 44%, while revenue decreased almost 3%. That isn’t a great indication, but it is actually better than the results most companies in the insurance industry have reported, where earnings fell over the same period.
    • Free Cash Flow: PRU’s free cash flow is very strong, at more than $15.4 billion. This number has more than doubled over the last year, when Free Cash Flow hit a bottom at around $6 billion.
    • Dividend: PRU’s annual divided is $3.60 per share, which translates to a yield of 3.65% at the stock’s current price.
    • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for PRU is $116.53 and translates to a Price/Book ratio of .84 at the stock’s current price. The stock’s historical average Price/Book ratio is .98, suggesting the stock is almost 17% undervalued, with a long-term target price around $114 per share. The picture gets more interesting when you factor in the stock Price/Cash Flow ratio, which is currently running about 28.5% below its historical average. That increases the stock’s long-term target price to about $126.50, which puts the stock within spitting distance of the all-time peak it hit in January at around $127 per share.



    Technical Profile

    Here’s a look at the stock’s latest technical chart.

     

    • Current Price Action/Trends and Pivots: The red diagonal line measures the length of the stock’s upward trend until January of this year; it also provides the basis for the Fibonacci retracement lines shown on the right side of the chart. The stock’s downward trend from January to this point is easy to spot, and its stabilization range between support around $96 and resistance around $102 is well-illustrated by its price activity over the last few weeks within the 38.2% and 50% retracement lines. This a good early indication the stock’s current downward trend could be about to reverse; the longer that range holds, the more likely a strong move back to the upside becomes. In the same sense, a break at any point above the $102 level, accompanied by strong buying volume would provide a visual confirmation that the stock is actually in the early stages of a new upward trend. A break below support at $96, however should put investors on notice that the downward trend remains in force, with a push below $92 acting as a signal that trend should extend into an even longer timeframe.
    • Near-term Keys: If you like the stock’s value proposition at its current price, and are willing to hold the stock for the long-term, you could do much worse than to buy a high-dividend paying stock at the kind of discount PRU is offering right now. If you’re looking for a way to work with shorter-term strategies, you would need to wait for a break above $102 to buy the stock or start working with call options, or a drop below $92 to short the stock or start using put options.


  • 17 Aug
    MET looks like a value trap

    MET looks like a value trap

    There’s a popular saying that you might have heard in a lot of different settings outside of the stock market: “If it looks like a duck, walks like a duck, and smells like a duck…then it’s a duck.” It’s interesting to me that I haven’t heard or seen the saying used when talking about stocks, given how often I’ve heard it throughout my life in common, everyday settings. The more time I spend paying attention to the market, though, the more I think there’s a reason for that. The truth about stocks – and, quite frankly, one of the things that makes most people simply toss their hands in the air when it comes to active investing – is that very often, the reality about a stock, or the underlying company, is quite different than the perception.

    One of the dangers of value investing is that sometimes you’ll start paying attention to a stock that looks, at least at first blush, like it could be a good bargain. It might be a very well-known and respected company, and so sometimes when people realize the stock has dropped off of recent highs, they’ll automatically assume it’s a great opportunity to buy the stock cheap. This kind of situation is often called a value trap, meaning that it looks good enough to get you interested, and perhaps even to go ahead and put your hard-earned capital into it. The trap is that sometimes there are very good reasons the stock has been dropping – and the risk is that it could go even lower.



    My own investing style can put me at risk of running into these kinds of value traps. To be clear, the risks I’m talking about aren’t just about the fact the stock might already be in a long, sustained downward trend; they often aren’t readily visible unless you’re willing to open the hood and really start probing around the guts of the business. That means analyzing a lot of the company’s fundamentals and being able to accept when you see a significant amount of problematic data that can act as an early warning that there is more trouble ahead.

    I believe MetLife, Inc. (MET) is a pretty good example of what I’m talking about right now. The company has great public visibility and presence, and a strong, long-standing position of leadership in the Life & Health Insurance industry. Since the beginning of the year, the stock is also down more than 20% as of this writing, putting it in clear bear market territory, and near to its 52-week low prices right now. There are some indications of good fundamentals in place, and some basic valuation measurements like the Price/Earnings and Price/Book ratios that look attractive at first glance. If you dig a little deeper, though, you’ll find that there are also some things to be concerned about, and that should give investors ample reason to think twice before buying the stock.



    Fundamental and Value Profile

    MetLife, Inc. is a provider of life insurance, annuities, employee benefits and asset management. The Company’s segments include U.S.; Asia; Latin America; Europe, the Middle East and Africa (EMEA); MetLife Holdings, and Corporate & Other. Its U.S. segment is organized into Group Benefits, Retirement and Income Solutions and Property & Casualty businesses. Its Asia segment offers products, including life insurance; accident and health insurance, and retirement and savings products. Latin America offers products, including life insurance, and retirement and savings products. Life insurance includes universal, variable and term life products. EMEA offers products, including life insurance, accident and health insurance, retirement and savings products, and credit insurance. MET has a current market cap of about $45.3 billion.

    • Earnings and Sales Growth: Over the last twelve months, earnings have been flat, while revenues increased nearly 23%. In the last quarter, earnings declined by about 4.5% while revenues increased 43%. This is a pattern that I think shows the company is becoming more and more inefficient. In addition, the company’s margin profile shows that Net Income as a percentage of Revenues dropped from a little over 6% over the last twelve months to 4.2% in the last quarter. That might not sound like a big drop, but to put it in perspective, in the last quarter, 1% of Revenues equaled about $212 million. That means the company has seen its profit margin erode by roughly $425 million.
    • Free Cash Flow: MET’s free cash flow is healthy, at more than $13 billion. The warning signal about Free Cash Flow – and something that I think helps to put the erosion of Net Income/Revenues in perspective – is that it has declined from from about $19 billion over the last year.
    • Debt to Equity: MET has a debt/equity ratio of .29. This is a very manageable number, and since the company has more than twice the amount of cash (more than $34 billion) than it does long-term debt (about $15.5 billion) there is no concern about their ability to service, or even to liquidate their debt if necessary.
    • Dividend: MET’s annual divided is $1.68 per share and translates to a yield of 3.68% at the stock’s current price.
    • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for MET is $54.11 and translates to a Price/Book ratio of .84 at the stock’s current price. That’s pretty attractive at first glance to value investors, who generally like to see Price/Book ratios below 1. However, the stock’s historical average Price/Book ratio is only .88, which puts a target price for the stock at only about $47.50 per share, or only about 4.2% higher than its current price. This is also where I’m seeing one of the biggest and most persuasive reasons to be concerned: the stock’s Book Value has been declining steadily for the last two years, from a high at $72.25 in mid-2016 to its current level. I read that as an erosion of the company’s intrinsic value. Warren Buffett likes to think of Book Value as a reflection of the per share amount of money a shareholder can expect to see if the company suddenly decided to pay off its debts and close up shop. Would you want to buy a stock that has seen the value of its basic business operations erode by more than twenty percent?



    Technical Profile

    Here’s a look at the stock’s latest technical chart.

     

    • Current Price Action/Trends and Pivots: The red diagonal line measures the length of the stock’s longer-term upward trend, and also informs the Fibonacci trend retracement lines shown on the right side of the chart. The stock’s downward trend dates back to November of last year after the stock hit a 52-week high at around $56 per share. Since February of this year, the stock has hovered in a mostly sideways range between about $48.50 on the high side and $43 on the low end. That range has been narrowing since July, with resistance at around $46.50, with support looking steady at between $43 and $44 per share. At the bottom of a downward trend, a sideways range can often point to signs the stock is getting ready to rebound; however the narrowing of that range over the last month looks to me like a deterioration of the stock’s ability to sustain its current price levels.
    • Near-term Keys: The stock’s Fibonacci retracement lines are a pretty good reference point to use to look for clues that the stock could be finding some strength and might actually reverse its downward trend. Look for a break above the 38.2% retracement line at $48 as a first signal that a new upward trend is in the offing; until that happens, any kind of bullish bet on the stock is purely speculative, with a very low probability of success and not a lot of upside potential to offset the downside risk. A drop below current support at $43 could be an opportunity to look for a bearish trade, however, with a short-term target between $35 and $38 looking very possible.


  • 10 Jul
    PFG could be a winner if Financial stocks come back into favor

    PFG could be a winner if Financial stocks come back into favor

    Since the beginning of the year, the Financial sector has lagged the rest of the market; as measured by the SPDR Financial Select Sector Fund (XLF), as of this writing it is down about 10% from its late January highs, and while the broad market appears to be recovering some bullish momentum this week, financial stocks remain mostly lower, constrained by the downward trend they’ve been following for the last six months. While interest rates have been rising for the last year or so, those gradual increases have kept rates near historically low levels, a fact that puts pressure on a variety of asset management offerings from savings accounts to certificates of deposit, bonds, and interest-bearing insurance products like annuities. I believe that fact has played a role in the sector’s underperformance. Insurance companies have also suffered not only from narrow margins resulting from low interest rates, but also from tepid revenues; that is a trend that could change, but is mostly expected to do so gradually.

    The best opportunities in the Financial sector for investors, I think come from companies that can offer a balanced mix of products between asset management (including investment, savings and retirement) services and insurance services. Principal Financial Group (PFG) is a good example of one of those kinds of companies. The other fact is that a lot of stocks, like PFG in the Insurance industry have really been beaten down over the last six months, far more than the -10% I referred to at the beginning of this post. PFG, for example is down about 38% from its late January high, and that is a level that I think is starting to offer a pretty nice value proposition. Let’s take a more detailed look.



    Fundamental and Value Profile

    Principal Financial Group, Inc. is an investment management company. The Company offers a range of financial products and services, including retirement, asset management and insurance. Its segments include Retirement and Income Solutions; Principal Global Investors, Principal International; U.S. Insurance Solutions, and Corporate. The Company offers a portfolio of products and services for retirement savings and retirement income. The Company’s Principal Global Investors segment manages assets for investors around the world. The Company offers pension accumulation products and services, mutual funds, asset management, income annuities and life insurance accumulation products. The Company’s U.S. Insurance Solutions segment provides group and individual insurance solutions. It focuses on small and medium-sized businesses, providing a range of retirement and employee benefit solutions, and individual insurance solutions to meet the needs of the business owners and their employees. PFG has a current market cap of $15.7 billion.

    • Earnings and Sales Growth: Over the last twelve months, earnings increased about 10%, while sales decreased almost 6%. Growing earnings faster than sales is difficult to do, and generally isn’t sustainable in the long-term; however it is also a good indication of a management’s ability to maximize their business operations. The company’s Net Income versus Revenue was almost 14% in the last quarter, which indicates their margins are pretty healthy.
    • Free Cash Flow: PFG’s Free Cash Flow is strong, at about $4.2 billion. This number has improved from a little under $3.5 billion a year ago.
    • Debt to Equity: PFG has a debt/equity ratio of .26, which is conservative. The company has more than $4.9 billion in cash and liquid assets, which means they they have plenty of liquidity, against only about $3.2 billion in total long-term debt. Cash and liquid assets have improved over the past year from about $3.3 billion.
    • Dividend: PFG pays an annual dividend of $2.08 per share, which at its current price translates to a dividend yield of about 3.8%.
    • Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for PFG is $42.79 per share. At the stock’s current price, that translates to a Price/Book Ratio of 1.27. The average for the Insurance industry is 1.2, while the historical average for PFG is 1.54. That might not sound like much of a discount, but it actually indicates the stock is a little more than 17% below the $66 level that a rally to par with its historical average would provide. That’s pretty attractive and offers a nice opportunity from a value-oriented perspective if the Financial sector comes back into favor as I’ve seen some analysts suggest should happen soon. If the stock’s downward trend continues, that proposition is only likely to improve.



    Technical Profile

    Here’s a look at the stock’s latest technical chart.

    • Current Price Action/Trends and Pivots: The red diagonal line on the chart highlights the stock’s downward trend since January, and also provides the range needed to calculate the Fibonacci retracement lines shown on the right side of the chart. The stock’s gradual, but consistent stair-step pattern since February is a good indication of the downward trend’s strength. It’s also pretty easy to the stock’s recent bullish strength as it has rebounded from a trend low at around $52 per share to its current price level. The downward trend will remain in place until and only if the stock can break the $61 level marked by the 38.2% retracement line. A push above that point would likely mark and important reversal point. If the stock breaks below its current support around $52, its next most likely support level would be around $49; continued bearish momentum beyond that point could push the stock as low as $45.
    • Near-term Keys: If the stock’s current bullish momentum holds, and the stock can break above immediate resistance around $56, the stock should have little trouble rallying near to $61 per share; that could be a decent opportunity for a bullish short-term trade by buying the stock outright or using call options. A drop below $52 could act as a good signal for a bearish trade using put options or by shorting the stock.


  • 06 Oct
    Analysts Love This Metric. Here’s Why You Shouldn’t.

    Analysts Love This Metric. Here’s Why You Shouldn’t.

    • EV/EBITDA is a widely used metric these days, so every investor should understand what it is.
    • We’ll discuss how EV/EBITDA is calculated and how you can manipulate it.
    • There are some pros to using it, but also some cons.



    Introduction

    When I was just starting with investing, I remember that the beta coefficient was popping up everywhere, next to almost every stock price or price to earnings ratio.

    The beta coefficient has faded in the last two decades as it was clear that markets aren’t efficient and that there is no real usage of the metric. Now a new metric has emerged lately and is used by most analysts. More →

  • 25 Oct
    The First Two Weeks Of Earnings Season Are In. Warnings Ahead.

    The First Two Weeks Of Earnings Season Are In. Warnings Ahead.

    • Don’t be fooled by earnings growth in financials and utilities. The underlying risks are growing too.
    • Lower margins are the first indications of a recession being around the corner. Global government and monetary stimulus make it impossible to know if one will be coming sooner or later.
    • Without buybacks earnings would be terrible.

    The Earnings

    The first two weeks of earnings season have passed and, according to FACTSET, the combined earnings released so far are better than expected but still negative. 23% of the companies in the S&P 500 have reported earnings and their aggregate earnings decline for Q3 2016 is -0.3%. More →