Are there any bargains in the insurance sector? Today I’m looking at Prudential (LSE: PRU), Aviva (LSE: AV) and Chesnara (LSE: CSN).
Are these firms cheap?
If we look at a few valuation indicators, we might conclude that these three firms are reasonably priced — we *might*. However, I’m cautious about Prudential, Aviva and Chesnara, but more about that later.
Compared to the FTSE 100‘s price-to-earnings rating (PER) of around 17.5 and its dividend yield of 3.8% or so, the valuation indicators for these three firms ostensibly stack up pretty well:
|
|
Recent share price |
Forward PER |
Forward Dividend Yield |
Times forward earnings cover dividend |
|
Prudential |
1497p |
12.4 |
2.9% |
2.8 |
|
Aviva |
464p |
9.2 |
5.3% |
2 |
|
Chesnara |
332p |
16 |
5.9% |
1 |
Those yields look tempting and the cost in PER terms seems reasonable, but I’m still not rushing to buy any of these firms’ shares.
City analysts following these three reckon earnings will grow in 2016 by around 9% for Prudential, 11% for Aviva, and they will decline by 14% for Chesnara. So two of the three offers forward growth, too. Surely, that’s attractive. Not to me.
Trading well, but…
All three firms offer positive-sounding recent trading updates and outlook statements. However, the ‘problem’ with insurance-based operators is that their activities have a high level of cyclicality. As well as underwriting profits and fund management profits, which are cyclical in themselves, Prudential, Aviva and Chesnara also earn high proportions of their returns from investments. When the economy tanks, the profits and share prices of firms in the insurance sector can behave with even greater extremes than other financials, such as the banks.
My pick of the bunch
That said, Prudential’s growth since the financial crisis has excelled its peers here, and the shares delivered the firm’s investors a gain of around 430% since early 2009. However, the share price displayed some aggressive volatility recently, which underlines my point about cyclicality in the sector. Speculation that macro-economic growth could soon hit the skids is what probably drove the summer market wobbles. True to form, the cyclicals led the charge south.
We currently have what we could describe as a maturing economic cycle, and that’s not the best time to be in cyclical firms such as Prudential, Aviva and Chesnara, I’d argue. There could be further investor total returns to come, but there’s also a lot of risk of profit and share-price reversal.
With the cyclicals, share prices can behave oddly, too. Perhaps staying flat or declining as profits rise, due to things such as valuation-compression and other speculative effects. The market as a whole is always trying to anticipate what will happen next in the economic environment, and nowhere is such agonising more apparent than in the performance of the cyclical firms’ share prices.