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Thinking about Financial stocks? These 2 insurance stocks are value traps

Thinking about Financial stocks? These 2 insurance stocks are value traps

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There’s a popular saying that you might have heard in a lot of different settings outside of the stock market: “If it looks like a duck, walks like a duck, and smells like a duck…then it’s a duck.” It’s interesting to me that I haven’t heard or seen the saying used when talking about stocks, given how often I’ve heard it throughout my life in common, everyday settings. The more time I spend paying attention to the market, though, the more I think there’s a reason for that. The truth about stocks – and, quite frankly, one of the things that makes most people simply toss their hands in the air when it comes to active investing – is that very often, the reality about a stock, or the underlying company, is quite different than the perception.

One of the dangers of value investing is that sometimes you’ll start paying attention to a stock that looks, at least at first blush, like it could be a good bargain. It might be a very well-known and respected company, and so sometimes when people realize the stock has dropped off of recent highs, they’ll automatically assume it’s a great opportunity to buy the stock cheap. This kind of situation is often called a value trap, meaning that it looks good enough to get you interested, and perhaps even to go ahead and put your hard-earned capital into it. The trap is that sometimes there are very good reasons the stock has been dropping – and the risk is that it could go even lower.

If your approach to the markets leans towards value-based methods, you’re at risk of running into these kinds of value traps. To be clear, the risks I’m talking about aren’t just about the fact the stock might already be in a long, sustained downward trend; they often aren’t readily visible unless you’re willing to open the hood and really start probing around the guts of the business. That means analyzing a lot of the company’s fundamentals and being able to accept when you see a significant amount of problematic data that can act as an early warning that there is more trouble ahead.

Over the last month or so, I’ve noticed an increasing amount of chatter from talking heads on popular financial news media pointing to the financial sector as a place that could provide some good value opportunities right now. And the sector has responded positively; as measured by the SPDR Select – Financial Sector ETF (XLF), financial stocks have rebounded about 6.5% since late June. That’s pretty impressive, and it looks like the sector could be poised to keep moving higher, as it has broken above its long-term trend line and appears to be reversing its intermediate downward trend. Even so, you should be cautious, because there are traps lying in wait. Here are two stocks that appear to have more reason to go down – and could be at risk for even bigger drops than they’ve already seen – than to go up.

MetLife Inc. (MET)

Current Price: $45.57

MET’s downward trend dates back to November of last year after the stock hit a 52-week high at around $56 per share. Since February of this year, the stock has hovered in a mostly sideways range between about $48.50 on the high side and $43 on the low end. That range has been narrowing since July, with resistance at around $46.50, with support looking steady at between $43 and $44 per share. At the bottom of a downward trend, a sideways range can often point to signs the stock is getting ready to rebound; however the narrowing of that range over the last month looks to me like a deterioration of the stock’s ability to sustain its current price levels. A drop below support at around $43 could see the stock drop quickly to as low as $35 to $38, with two-year lows at around $32 not far distant from that point.

Perhaps more indicative of the fundamental danger of working with this stock right now are some troubling fundamental measurements that, put together outweigh the stock’s other positive fundamentals, such as very healthy liquidity and low debt. Over the last twelve months, earnings have been flat, while revenues increased nearly 23%. In the last quarter, earnings declined by about 4.5% while revenues increased 43%. This is a pattern that shows the company is becoming more and more inefficient. In addition, the company’s margin profile shows that Net Income as a percentage of Revenues dropped from a little over 6% over the last twelve months to 4.2% in the last quarter. That might not sound like a big drop, but to put it in perspective, in the last quarter, 1% of Revenues equaled about $212 million. That means the company has seen its profit margin erode by roughly $425 million.

From the standpoint of value analysis, there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for MET is $54.11. This is also where I’m seeing one of the biggest and most persuasive reasons to be concerned: the stock’s Book Value has been declining steadily for the last two years, from a high at $72.25 in mid-2016 to its current level. I read that as an erosion of the company’s intrinsic value. Warren Buffett likes to think of Book Value as a reflection of the per share amount of money a shareholder can expect to see if the company suddenly decided to pay off its debts and close up shop. Would you want to buy a stock that has seen the value of its basic business operations erode by more than twenty percent?

Lincoln National Corporation (LNC)

Current Price: $65.13

LNC’s downward trend hasn’t extended quite as long as MET’s has; their trend coincides with the Financial sector’s decline beginning in late January of this year. Like MET, however, LNC has mostly failed to follow the sector higher in the past month; after initially surging from around $62 in late June to about $68, it has dropped back to its current level, and is well below its own long-term trend line. Since hitting its all-time high in January at about $86, the stock has dropped nearly 24%. The stock’s current support is only about $3 away from its current price, and a drop below that level points to even greater downside than what MET is at risk for: LNC could easily drop without much hesitation to test previous pivot levels as low as $44 to $48 per share. That is continued downside risk, from a strictly technical perspective right now of an additional 26%.

LNC is also showing some of the same fundamental warnings signs as those I just described for MET. Over the last twelve months, earnings have increased about 9, while revenues increased a little over 12%. In the last quarter, earnings still managed to increase, but by only 2.54%, while revenues increased 11%. This is the same pattern – revenues growing faster than sales that indicates the company is becoming more and more inefficient. The company’s margin profile shows that Net Income as a percentage of Revenues dropped from a little over 13.3% over the last twelve months to 9.5% in the last quarter. Neither of those numbers are horrible by themselves; but the red flag is the deterioration of Net Income as a percentage of Revenue, not the amount. To put the question in perspective, in the last quarter, 1% of Revenues equaled about $40 million. That means the company has seen its profit margin erode by almost $160 million.

The stock’s Book Value also reveals a troubling risk, since LNC’s Book Value has declined by about 11.5% in just the last two quarters, from an all-time high at $79.16 to its current level of $70.04. That may not be as severe as the decline in MET’s Book Value, but it also covers a much shorter time frame.

Value traps generally manage to hide themselves pretty effectively; both of these stocks have some excellent core fundamental measurements that indicate they are quite strong in many respects. The problem comes when those strengths don’t translate to a good reason the stock should move higher. If they don’t, you’re probably looking at a value trap, which means the best move is to leave those stocks alone and look for better candidates to work with.

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