Is the Financial Crisis Over Yet for Financial Equities?

seventh article For A Healthier Portfolio – Look Here.

As a refresher, my focus in this and all subsequent articles will be on identifying fairly valued dividend growth stocks within each of the 10 general sectors that can be utilized to fund and support retirement portfolios. Therefore, when I am finished, the individual investor interested in designing their own retirement portfolio should find an ample number of selections to properly diversify a dividend growth portfolio with.

This article will look for undervalued and fairly valued individual companies within the general sector 40-Financials.  Within this general sector, there are several subsectors, which I list as follows:

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Screening the Financial Sector Universe

The following screenshot shows that I initially produced a list of 318 takers in the financial sector that paid a dividend.  As I have done in all previous articles, I went through each of these 318 selections one company at a time utilizing the earnings and price correlated F.A.S.T. Graphs™ research tool.  Much to my chagrin, I was only able to come up with 16 companies on my conservative list, and only another 16 companies that I was willing to include in my aggressive list:

Conservative Financials

As I looked for candidates in the Financial Sector that I felt were worthy of further scrutiny, I received quite an education on this sector.  Not only is this industry very diverse, I was disappointed by how few opportunities I was able to find that fit my personal criteria.  When looking for investment opportunities, I covet consistency and above-average growth.  But even more importantly, I insist on sound valuation.

The following group of companies either met my criteria, or was very close to meeting it.  Furthermore, since my screen included Canadian exchanges, the reader will discover a predominance of Canadian banks on the list.  Since Canada did not participate in the lax lending practices, Canadian banks fared much better through the Great Recession of 2008 than most of their US counterparts did.  Later I will feature the The Bank of Nova Scotia (TSE:BNS) as an example.

Aflac Inc. (AFL)

Not only is AFLAC Incorporated (NYSE:AFL) my featured company from the conservative selection, it is also my favorite company in the Financial sector, and has been for some time (For full disclosure, I have been long Aflac since January 2005).  Since I have a long experience with Aflac, the reader should also assume that I have conducted comprehensive research on this name.  Consequently, in addition to featuring it in this article, I also consider it a sound and attractive long-term investment.

Furthermore, I believe that AFLAC Incorporated (NYSE:AFL) is currently undervalued with a blended P/E ratio of 10.3, and a current dividend yield of 2.2%.  I might also point out that prior to the Great Recession of 2008 Aflac had generated a very consistent record of earnings growth.  However, as a result of the Great Recession, Aflac took several actions, including the de-risking their portfolio, which added some cyclicality to their earnings record.  Nevertheless, earnings growth has continued at an above-average rate.  Moreover, during the Great Recession-induced cyclicality of their earnings, their dividend has continued to grow at an average rate of 16.8% since the beginning of 2007.  However, their dividend growth rate has slowed to between 6% and 9% over the last 3 to 4 years.

The long-term performance associated with the above Earnings and Price Correlated F.A.S.T. Graphs™ on Aflac demonstrates that in spite of its current low valuation, their strong operating history has rewarded shareholders in excess of the S&P 500 on all levels, capital appreciation and cumulative dividend income.  Additionally, Aflac is a Dividend Champion and has increased their dividend for 30 consecutive years.

This next graphic looks at Aflac’s year-end price earnings ratios since 1999 (the blue line with black squares) overlaid with 10-year Treasury bond interest rates (the red shaded area).  The important takeaway here is that Aflac’s P/E ratio has been in steady decline and even closely correlated to the drop in the interest rate of the 10-year Treasury.

This is counterintuitive, because in theory, the P/E ratios of common stocks should expand as interest rates decline, on the concept that bonds become less competitive to stocks when the interest rate they offer declines.  I believe this simply reflects a negative bias towards equities, especially equities in the Financial sector, on the part of investors who were traumatized by the Great Recession of 2008.

The following Estimated Earnings and Return Calculator shows that 21 analysts reporting to Standard & Poor’s Capital IQ estimate Aflac to continue growing earnings at the rate of 8.5% per annum over the next 5 years.  However, there are 2 additional estimates on this graph.  Earnings growth for fiscal 2013 is only expected to average 1%, and growth for fiscal 2014 is estimated at 5%.  I believe this partially explains the low valuation that “Mr. Market” is applying to Aflac shares currently.  However, longer run I believe the patient dividend growth investor will be well-rewarded by investing in Aflac on a total return basis.

In addition to rewarding their shareholders through dividend increases and capital appreciation, Aflac has also been using its prodigious cash flows to purchase shares and reduce share count.  Fewer shares outstanding support their ability to grow earnings per share to the benefit of shareholders.  Common shares outstanding have fallen from 531 million shares in fiscal 1998 to 466 million shares in their most recent quarter (MRQ).

Additional insights into the financial strength of Aflac can be seen by reviewing their free cash flow per share, the light blue line on the FUN Graph below (Fundamental Underlying Numbers). Free cash flow per share (fcflps) has grown from $1.26 per share in 1998 to $30.67 a share by fiscal year-end 2012.  This metric supports Aflac’s ability to pay dividends, as it is calculated after dividends have been paid.

In addition to being a prodigious generator of cash flow, Aflac has also accumulated $20.93 of cash and equivalents per share (cashps).  I believe these important fundamental metrics indicate that Aflac is a financially strong and healthy company.

Additional strengths supporting Aflac’s business model can be found by reviewing their common equity or book value (ceq), the lime green line on the following graph, in comparison to