It’s official; Retail sales and nonfarm payrolls are rebounding and the U.S. economy is back in the saddle. And knowing that, what is the natural inclination for intrepid investors? They’re likely to buy stocks, — tech, retail, consumer goods, etc — pretty much “willy nilly,” as it were.
But what investors are less likely to do is cherry pick. They’re even less likely to pick up bargains from humdrum sectors like insurance. But even boring sectors can have their cherries, such as MetLife Inc (MET), a stock that is undervalued despite its potential.
Two Pillars of Strength for MetLife
In essence, insurance stocks have two major pillars which they rely on to make money. The first is built through the insurance policies they sell, in the form of premiums. The second is created by making profits from investing the money they receive from those premiums.
Those investments are usually in bonds, mortgage papers and equities but not entirely. And on both pillars, MetLife is well positioned.
When unemployment falls and the participation rate in the work force rises, more people drive to work. Naturally, if they’re driving to work they need car insurance. The rise in the participation rate also means more people can afford health insurance. And of course, the list goes on, which will eventually translate into higher demand for retail insurance. So, it’s a very good thing that the U.S. is currently in a rising participation rate environment.
According to the MetLife financial reports, 29% of its net income comes from retail insurance in North America. In other words, this macro trend of more jobs and more demand for insurance will have a direct effect on MetLife’s own bottom line.
Of course, all those premiums feed into MetLife’s balance sheet, i.e. money available to invest, aka the second pillar. That leads to the question: Is this a source of strength for MetLife?
It absolutely is and here’s why:
The macro environment in the U.S. is looking upbeat. U.S. inflation is stabilizing, growth seems to be back on track and the job market is at its strongest in years. All of which lay the groundwork for the Federal Reserve to continue to slowly tighten monetary policy. This tends to lower long-term yields on bonds and mortgage papers.
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MetLife stock has a complicated portfolio of roughly $300 billion in varying assets, ranging from bonds to mortgage paper, stocks, etc. But what matters is the aggregate exposure, which positions MetLife to benefit from falling long term yields. For example, during 2014, long-term yields fell and MetLife’s unrealized gains (gains from open positions) jumped by $7.8 billion. During 2015, when long-term bond yields were slightly higher, MetLife’s unrealized gains fell by $4.4 billion.
That swing of billions of dollars in its portfolio value essentially moved on the back of change in the long-term yields. With yields set to fall again, given the Fed’s gradually tightening path, MetLife’s asset portfolio is set to jump back up again.
MetLife Is the Ugly Ducking
So why have investors priced MetLife at such a low valuation of $44 per share, 9.7 times its earnings? It’s because MetLife belongs to a sector that’s not particularly popular among investors. The insurance business has turned into a place where insurance policies are sold and traded like commodities.
But that is only one side of the coin; the other is that insurance companies are essentially investors in securities. And the better they do that, the more profitable they become.
In fact, MetLife does both well. Its insurance business is doing well and is well-positioned to continue to grow. Also, MetLife knows how to allocate its investments, unlike some of its peers. And just like the tale of the ugly duckling that turned into a beautiful swan, it’s all a matter of time.
Time, fortunately, is in MetLife’s favor and, eventually, cherries do get picked.
As of this writing, Lior Alkalay did not hold a position in any of the aforementioned securities.
