This week I have been looking at some of the ratios you can use instead of or in conjunction with price-to-book value to find undervalued stocks.
While both free cash and enterprise multiples are useful tools, there is one sector of the market where they simply do not work. You can calculate the enterprise multiples for financial service companies, but because of the way they are structured the numbers do not mean a thing. As Aswath Damadoran, professor of finance at the Stern School of Business at NYU, pointed out last year on his blog, "(t)here is a subset of the market where both assumptions break down and it is especially so with financial service companies, where debt is more raw material than source of capital and cash & marketable securities cannot be claimed by investors. With banks, investment banks and insurance companies, the only estimate of value that should carry weight is the market value of equity."
With financial, what matters most is price to book value.
While bargains are hard to find in the current market environment, there are some overlooked financial stocks that are still very cheap based on price-to-book value. Kansas City Life Insurance (KCLI) is one of those stocks that almost no one ever talks about, but is a tremendous bargain. The company is a plain vanilla life insurance company that just sticks to its business with very conservative offerings and investments. I have owned shares for years and it's one of the buy-and-add-a-little-when-the-market-pulls-back-and-just-hold stocks. Kansas City Life has been around since 1895 and the insiders have a vested interest in making sure it is around and profitable for another century or two as they own almost 70% of the stock. The stock trades at just 66% of book value and if you don't already own it, I would buy a little. As a bonus, the stock pays a dividend yield of 2.34%, so you get paid a little each year while the stock slowly chugs its way higher.
During the early days of the credit crisis, I wasn't sure Genworth Financial (GNW) was going to make it. They are one of the largest providers of private mortgage insurance outside the United States and for a while there it looked like the real estate collapse was going to drag them under. The companies placed some lines of business into run-off mode and sold its wealth management plan and has gotten back on a reasonable track. Global real estate markets are stabilizing and the mortgage insurance business is once again a profitable endeavor for Genworth. It missed estimates for the second quarter and there some concerns about the reserves needed for the long-term care portion of the business and the stock has sold off sharply in recent week. The stock is currently trading at just 50% of book value and the stock could easily double or more from here over the next several years.
Republic Bancorp (RBCAA) is a Louisville, Ky.-based bank that has been undergoing a transformation the past few years. It has shrunk the size of its tax refund lending business to more of a normal banking operation. It has 42 branches with most in central Kentucky, but also have locations in Indiana, Ohio and Florida. As the housing market has become more stable, its mortgage warehouse lending business has picked up as has the residential lending portfolio. The bank is in solid financial shape, with equity to assets ratio of more than 13 and nonperforming assets that are just.92% of total assets.
The company is going to use its strong capital position to grow via acquisition. In the last earnings release CEO Steve Trager told investors "we focused a significant amount of time during the first half of 2014 seeking an acquisition in the traditional mergers and acquisition market. We plan to continue our search until we find the right bank with which to partner and deploy our excess capital." The stock is a bargain trading and just 85% of book value and you get paid to wait with a 3.33% dividend yield.
The alternative valuation measures may not work with financial stocks like insurance companies and banks, but thankfully for us our old reliable price-to-book value measurement does a fantastic job of finding bargain issues.
