CNO Financial: A Stock With 120% Upside

| About: CNO Financial (CNO)

CNO Financial Group, Inc. (NYSE:CNO) is not a household name in insurance, but for investors, maybe it should be. It operates subsidiaries such as Colonial Penn and Washington National and provides life insurance, health insurance, and a small portfolio of other insurance policies. Year to date, this stock has returned 40% and is not showing signs of slowing down.

I like CNO Financial for several reasons. First of all, it's trading at a price-to-book ratio of 0.40. That's not only low compared to similar companies, but most companies in all sectors. For those of you who may be new to P/B, the lower the better. The book value of a company is the value of its tangible assets minus its liabilities. When a company is priced below a P/B of similar companies, it typically means it's undervalued (be careful though - it could be hinting that there's something wrong in the fundamentals). The industry average P/B value for similar companies is 0.85 - which means CNO is significantly undervalued.

Earnings multiples can be a good tool to gauge how much you're paying for each dollar that the company earns. CNO is currently trading at 6.54 times earnings, which is on the low end of its spectrum. In the past five years, it has traded as high as 11.50 times earnings and as low as 5.50 times earnings. The industry has traded as high as 25.14 times earnings and as low as 5.50 times earnings.

The last ratio I'm interested in is the Price/Free Cash Flow. Free cash flow is the amount of cash a company has left over after capital expenditures (the cost of maintaining and upgrading assets). This is how much cash a company has to use towards acquisitions, product development, and dividend payments. The lower the P/FCF ratio, the less you're paying for each dollar of free cash. Companies similar to CNO are trading at an average of 9.41 times their free cash flow per share. CNO is trading at a modest 2.97 times free cash flow.

Dividend investors will like that CNO recently began paying a dividend at a yield of 0.95%. This is lower than the industry average of 1.55% but I'd like to point out that there's a lot of room for dividend growth. While the industry average payout ratio (the amount of FCF paid to shareholders) is 11.87%, CNO pays out only 1.27%. This means that CNO has a lot of room to increase dividends in the future without cutting into their cash supply to the point that growth becomes difficult.

The company is growing rapidly - which is great for long time investors. In the past five years, EPS have grown 21% compared to the industry average of 7.25%. While EPS are growing, so are profit margins, which went from 7% in 2010 to 9% in 2011. Growth investors will really enjoy that CNO is utilizing emerging markets efficiently, with an average growth rate of 10.8% in a recession.

Before investing in a company, I feel it's important to value it using the Graham valuation and the Reverse Discounted Cash Flow (RDCF). The Graham valuation shows whether a stock is undervalued or overvalued based on projected growth while RDCF shows what kind of growth the market is expecting from CNO to justify its share price.

For CNO, my Graham valuation is $20.28. I should add that I always significantly underestimate growth just to be on the safe side. I assumed a growth rate of 5% from CNO over the next feiv years. According to the Graham valuation, there's a 120% upside to this share at a current price of $9.22. The RDCF shows me that the market is expecting a growth rate of only 1% over the next five years to justify share price, which I believe is more than doable.

I also like to look at technicals for a company before investing. For CNO, all signs point up. The price is trading above the 26-day exponential moving average (NYSEMKT:EMA), which is trading above the 52-day EMA, which is trading above the 104-day EMA. The RSI and Ultimate oscillator both show we're stable in uptrend territory and not yet in overbought territory. The MACD shows that we're above the signal line and diverging upwards.

The only caveat with the technicals is that we're approaching the $9.44 resistance level. Technical investors may look for a breakthrough the resistance before investing. Here's the chart from

Click to enlarge

Based on the figures I have outlined above, I think it is safe to say the market has undervalued CNO Financial significantly and it may be looking to correct that. It's not easy to find an undervalued stock with stable growth that pays a dividend these days and this may be one of the few. What I like most about this stock is that you can invest via options. This gives you the ability to customize a trade based on how bullish you are and what kind of risks you're willing to take.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in CNO over the next 72 hours.