Several years ago, Henry Carstens of Vertical Solutions and I did a study on stocks in the S&P 500. We found that those stocks in the index that traded below book value and had solid balance sheets outperformed the overall market by a wide margin. I have kept track of this approach, and the results have continued to be solid in practice as well as theory. This morning, I sat down and ran the screen to see what turned up as we head toward the end of the year.
The first and most obvious conclusion is that life insurance stocks remain very cheap. These companies have seen net interest margins pressured by the semi-permanent low long-term interest rates. To compound the problem, the weak economy has made it difficult to increase sales and profits. Like many banks, life insurers have had to work their way through troubled assets in the wake of the credit crisis. Although most credit issues are in the rearview mirror, they have weighed on profitability and on stock prices.
Looking at the list, my favorite life insurance stock remains MetLife (MET). The shares are cheap at 70% of tangible book value, and I am a huge Snoopy fan -- that is an unbeatable combination in my eyes. The company is moving forward with plans to sell its bank units and get out from under the thumb of the Fed's capital restrictions. Completing the transaction would allow the company to consider dividend increases and buybacks, which are restricted at the moment.
MetLife is seeing decent growth in its domestic retirement products divisions and from international markets. It is also bringing its insurance products to Asian markets such as Japan and China, and that should provide a source of earnings growth. This is probably not going to turn MetLife into a highflier anytime soon, but it is a leader in its field at a very cheap price. And as a bonus, you get Snoopy as the spokesperson for one of your stocks.
The picture is pretty much the same over on the Rock. Prudential Financial (PRU) shares currently sell at 60% of tangible book value. In addition to the problems that face all life insurers, the company has to take charges to strengthen reserves in the annuity business and to cover losses in a real estate fund. The company should see strong results from its purchase of American International Group's (AIG) Japanese operations as also expand into Asian markets. The company is expected to close soon on the purchase of the life insurance book of The Hartford (HIG), a deal that would add $135 million of insurance in force to the books. The life insurance business faces some stiff headwinds, but Prudential's stock is cheap enough and its prospects bright enough for long-term investors to consider the shares.
The cheapest non-financial stock on the list is WPX Energy (WPX), which trades at 60% of tangible book value. The company faces the same problems that every other domestic driller has this year. Natural gas in the U.S. is extremely cheap, as drilling technology advancements have produced a surplus of gas, pushing prices lower. WPX has been focusing on the more profitable natural gas liquids and oil, but more than 75% of the company's reserves are natural gas.
WPX was spun off from Williams at the end of last year, and the stock has not done much since that time. From a long-term perspective, it is only a matter of time before the reduction in coal usage by utilities and industrial companies and the increased export of gas put a floor under natural gas prices and even push them higher. At that point, this stock should rise to more fully reflect the value of the assets. I am bullish on fossil-fuel energy stocks because they are pretty cheap across the board, and this stock is a good fit to an energy portfolio.
As I look at the list of undervalued S&P 500 stocks, there is one other obvious conclusion. Most of these stocks have done the December Santa dance along with the index and have risen sharply in the last few weeks. I do not believe that buying into an uptrend works very well for value-conscious, long-term investors, so I would be a hesitant buyer of even the cheapest index components. The stock market is up almost 7% in December alone, so I would wait for some of the froth to come off the top before plunging in. Having said that, conservative long-term investors should have these stocks near the top of their buy list.