From respected reader:
Just did a quick calc based on NWLI earnings and thought I would pass onto you as I know you at least used to hold it as a double weight. Let me know if you think there are major holes in this theory:
From the Annual Report:
“The yield on debt security purchases to fund insurance operations rebounded somewhat to 3.53% in 2013 from 3.37% in 2012 but was still below the 4.18% yield attained in 2011.”
So, investment yields improved, but are still down. Their unrealized gains in securities dropped from $541 million to $146 because of this, so this part of the “hidden value” in the shares went down.
But if rates can get back up to that 4.18%, a quick calc says that would cause annual earnings on their $9 billion investment portfolio to increase $58 million. If 2/3’s of this is credited to annuity holders, it leaves $19.5 million before tax for shareholders. 32% tax from 2013 gives after tax earnings increase of $13 million or $3.57 increase in earnings per share.
If we could get yields back up to 5.5% like they were a few years ago, using the same calc would give an increase in EPS of $9.38, or a 1/3 increase in earnings.
It is still a double-weight here. It is not as cheap as it once was, but it is still cheap. Financial stocks should always be valued on a combination of price-to-book and price-to-expected-earnings.
Why? Because accrual items in the accounting can either be aggressive, fair or conservative. If aggressive, earnings will be overstated, and book value understated. If conservative, earnings will be understated, and book value overstated. For the most part, the two measures balance the squishy accounting.
Now as for the disclosures in the NWLI 10K, we need to note that more than 2/3rds of the bonds that they hold are “held to maturity.” That’s unusual, as is their policy where they don’t buy high yield bonds. Held to maturity means the value of the bonds amortizes over time, but price moves don’t affect the accounting, unless default is likely. Thus if interest rates rise, book value will not be affected much, but earnings will rise on a GAAP basis.
NWLI has a conservative investing culture, and in the present aggressive environment that is a *good thing.* Adjusting for the held to maturity securities, the adjusted price-to-book is 55%, and my estimate of future earnings is one-ninth of the current price. It is rare to find stocks trading at a significant discount to book and a single-digit P/E.
Full disclosure: long NWLI