I’m always on the hunt for cheap companies, and one of the means of identifying “cheap” that I like to use is the Graham number. Its formula is pretty straightforward: Multiply earnings per share by book value per share, then multiply that by 22.5, and finally take the square root. The result, in dollars, is the Graham number. As with any valuation, the Graham number only tells part of the story, and it’s important to look at the story behind the numbers to see if there are underlying reasons why the company appears so cheap.
Last week, I discovered that the financial sector is among the cheapest sectors out there when it comes to the Graham number. The reasons for this are varied, so I will be taking a deeper look at the 27 financial companies that currently trade below their Graham valuations to see if there is real value in the company, or if there is an underlying reason investors should avoid the stock in question. I will then make a CAPScall regarding the future performance of the company. Up first is Genworth Financial Inc (NYSE:GNW).
Genworth Financial Inc (NYSE:GNW) has been around in some capacity since 1871, when it wrote its first policy as The Life Insurance Company of Virginia. It maintains its headquarters in Virginia to this day, but it offers a variety of insurance products to customers in 25 different countries. The bulk of its revenues come from its U.S. Life Insurance segment, which made up 62% of its revenues in 2012.
Its life insurance business has been fairly robust over the past few years, with the majority of revenues generated by the sale of long-term care insurance. With the continued aging of America, more people are opting for this insurance, which helps cover some of the costs of extended nursing home stays and other services that are typical toward the end of life. However, Genworth Financial Inc (NYSE:GNW) also has a sizable business insuring mortgages, both in the U.S. and abroad, which could be a driving factor in making the company appear so cheap.
How cheap is it?
When compared to some other life insurance companies, Genworth Financial Inc (NYSE:GNW) comes out on top, though the industry at a whole appears to be greatly undervalued, at least according to the Graham number:
| Company | EPS (TTM) | Book Value per Share (MRQ) | Graham Number | Recent Price |
|---|---|---|---|---|
| Genworth Financial | $0.65 | $33.62 | $22.17 | $8.84 |
| Reinsurance Group of America (NYSE:RGA) | $8.52 | $93.47 | $133.86 | $57.34 |
| Primerica | $2.71 | $22.62 | $37.14 | $30.94 |
| Symetra Financial | $1.49 | $26.29 | $29.69 | $13.07 |
| Protective Life | $3.66 | $59.06 | $69.74 | $32.09 |
Source: Yahoo! Finance and author’s calculations.
Why does a company like Genworth have over 150% of upside from its current price to its Graham valuation? One reason could be its unprofitable mortgage insurance business mentioned above. Though the combined domestic and international mortgage insurance segments have generated $10.7 billion in revenues since 2008, they have resulted in a loss of $60 million during the same time frame. The U.S. mortgage business has been especially ugly, responsible for nearly $2 billion in losses alone since 2008.
It is easy to see why an announcement to separate out its mortgage business back in January led to a 14% jump the same day. If this divestiture happens, it won’t be completely smooth sailing for the company in the short term. The international mortgage insurance business is one of the most profitable parts of its current business, so the loss of revenue will be felt almost immediately. That said, the cost-savings from jettisoning the currently underperforming domestic mortgage insurance business should help bridge the gap and allow Genworth to focus on life insurance, its core competency.
Though Genworth Financial Inc (NYSE:GNW) is the cheapest of the companies on the list, a couple of others could be attractive given their current valuations. As its name implies, Reinsurance Group of America is primarily focused on reinsurance, or the insurance purchased by insurance companies to mitigate risk in their insurance portfolio. It is a favorite of our CAPS community, and its recent poor performance could have been driven by poor results from the third quarter last year.
Accountability time
A stock’s valuation, regardless of the method used, only tells part of the story when evaluating a company. However, by going beyond its Graham number valuation, it is easy to see why Genworth Financial Inc (NYSE:GNW) might appear so “cheap” at its current price. With plenty of room to grow into its current Graham valuation, as well as plans to streamline its business to focus on its core competencies, I think Genworth Financial should continue to beat the market.
The article Genworth Financial Is Cheap According to Ben Graham originally appeared on Fool.com and is written by Robert Eberhard.
Fool contributor Robert Eberhard has no position in any stocks mentioned. The Motley Fool recommends American International Group. The Motley Fool owns shares of American International Group and has the following options: Long Jan 2014 $25 Calls on American International Group.
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