FIG trader_

Insurance Stocks: Shooting Down An Overwrought Valuation Metric

Spehar's argument (in his 6/28 piece) that using a DCF (intrinsic value) model would have generated higher returns (versus p/e or regressed ROE-price/book) is a bit specious. Over longer periods of time (he selected 2002 to 2006), using DCF (i.e or FCF_free cash flow or distributable dividends from insurance subs) and earnings should be the same, the difference is only a time lag between stat and GAAP earnings, for the most part. He is a card carrying member of the sellside set and one in good standing. He well knows that analysts will trot out any nonsense to justify their price targets (aggressive or too conservative), regardless of what conviction they have in the underlying assumptions. Its conviction on the stock (and management) that drives the recommendations and gets analysts to tweak the estimates and projections north or south. Who would naively believe that analysts have the know how (absent management guidance) to make detailed Statutory (i.e cash earnings) assumptions, given limited quarterly availability of data? Why he would attempt to make a point where none needs to be made is beyond me. The reason some people (I for one) like to focus on ROE/price book has more to do with potential risk/reward than trying to figure out which "supposed strategy" works better over time. The variability in book value for insurers from quarter to quarter is minimal, while a big earnings miss distorts the whole p/e measuring mechanism, without affecting the price/book materially (it does affect that quarters ROE which is why smoothed ROEs over numerous quarters are better) Lets take Ed Spehar's only ""sell" rating UNM, a rating I believe he has consistently maintained through thick and thin (from mid teens to 11 and all the way up thropugh to the current 26). It has had a low price book (for years it traded at a discount), with a modestly rising ROE, which he assumed couldn't be increased. The idea for analysts was to identify the transition point for this company, and the beginning of the ascent in the forward ROE or EPS. If you did the price/book would follow higher. Those that did were rewarded. Or lets take another favorite stock with a high price/book,uh......FMD comes to mind first. Its not that the DCF, P/E or Price/book strategies are better. Its that nobody knows where 2008/2009/2010 ROEs will be, but there is a unusually high probability that the ROE would be lower, and that the price/book would follow. Hence my January short call (historic was the way I put it)

Insurance Stocks: Wall Street's Biggest Secret

I would agree that insurers like most financials have a license (state) to steal, but I would add some caveats. First, they have had some signifinicant rough patches in which they under-earned most financials by a wide margin, based on returns on capital and equity. The real issue is timing, since most people aren't waiting 30 years to find out. Don't mean to rain on the parade, but we are currently in one of those "high risk" periods, with the stocks discounting lower returns, but not the degradation mostly likely to come down the pike. Read HIG's CEO's comments to see what I mean, and look at the historical cyclicality in earnings for the industry. Its quite possible that in 3/4 years, they will be breakeven because of the severity of the downswing and under-pricing currently. Nobody ever wants to go to the video tape, but it happens every ten years or so. You mentioned some big winners (AFL, PGR AIG) obvious, but more money will be made on the short side of BER, PHLY, and ZNT in next 5 years (just retracing last 5 years up and probably going back to book ). It looks like the "top out" parade has begun in the whole financials group, though we could have one more burst to the upside.