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?
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.