VALUE INVESTING
Shares For A Market Recovery

By Stephen Bland (TMFPyad)
March 14, 2003

Last October, I wrote a feature on value amongst insurers, since when many have fallen further with the bear market. Following my look at banks last week, I thought it would be useful, considering their depressed state, to continue with the financial sector theme. Insurers are split into two official sectors, being life and general, though there may well be some overlap. It is in the main emphasis of their trade that the distinction lies.

Here are the 15 companies listed in the FTSE 350.

                               Cap£b    Price    Yield    P/E   P/TBV
                                         (p)       (%)

Aviva (LSE: AV.)               L 7.6     335      7.0     7.0     0.7
Prudential (LSE: PRU)          L 5.6     281      5.7     6.7     2.5
Legal & General (LSE: LGEN)    L 3.9      60      8.2     7.0     1.2
Old Mutual (LSE: OML)          L 2.8      72      7.0     5.1     3.0
Jardine Lloyd (LSE: JLT)       G 1.1     558      3.7    14.3    16.7
Friends Provident (LSE: FP.)   L 1.1      64     11.5     5.9     0.6
Royal & Sun (LSE: RSA)         G 0.8      56     12.7     2.2     0.2
BRIT Insurance (LSE: BRE)      G 0.5      72      0.0     8.4     1.2
Amlin (LSE: AML)               G 0.4     112      2.2     7.9     1.9
Hiscox (LSE: HSX)              G 0.4     144      2.6     9.5     2.1
Wellington Under. (LSE: WUN)   G 0.4      78      0.0     7.2     2.0
St James's Place (LSE: STJ)    L 0.3      75      3.7     5.9     0.7
Britannic (LSE: BRT)           L 0.3     130      0.0     4.1     0.3
Cox Insurance (LSE: COX)       G 0.2      81      0.9     9.3    -3.0
Beazley (LSE: BEZ)             G 0.2      92      1.6    16.5    -0.2

Note that yield and price to earnings (P/E) figures are consensus forecasts while price to tangible book value (P/TBV) data is from the last annual accounts. The latter will have probably altered dramatically in many cases given the market fall, depending when the last annual report was made. For those firms with December 2002 year-ends though, there may not be a huge difference.

Of the fifteen shares shown, seven are classed as life and eight as general and I have indicated the distinction in the market capitalisation column. Many of the generals, such as Amlin, often described as Lloyds brokers, are not known to the general public, sort of wholesale if you like compared with the retail insurers that are household names like Prudential.

It can be seen that Royal & Sun sticks out on all the three value criteria I show. Royal has been a share widely discussed by value investors and repeatedly crops up in all sorts of value trawls such as my recent FTSE 100 value feature. Since then, it has been dropped from the blue chip index as its value shrunk, but it offers staggeringly attractive gearing upon a market recovery, assuming it survives that long (and I live that long which at my age is most definitely questionable). Were it to recover merely to book value for example, it would multiply several times. If the book rises, as it will in a recovery, then we are into even further multiplication. The reverse occurs in a fall, which is one reason that Royal has had the living shite beaten out of it in recent years.

As I have written many times, banks and insurers are geared plays and thus will over-react on the downside to a market fall but will in my view outpace the market upon a recovery. Any purchase therefore must be viewed as a share to hang on to until the market puts in a recovery. Moreover, portential insurance investors have to be able to live with potentially large falls should the market go down further because of the inability of investors to appreciate bottoms. Understand that serious bear markets, in a mirror image of serious bull ones, always go much further and longer than most will expect and there are no reasons for this other than human nature, though the chatterers will offer all sorts of spurious reasons.

Ultimately, share prices are driven by earnings per share (EPS) in the long run but in the shorter run they are driven by the constant flux of human nature, call it emotion, irrational exuberance or gloom, whatever, and we now happen to be in such a phase of excessive gloom.

Incidentally, it is interesting to note that since insurers have got shot of a lot of their equity holdings in the bear market, their market gearing may well be slanted to the emotional rather than arithmetical to a much greater extent than hitherto. Good contrarian sign I'd say. When insurers -- the financial retards of the institutional investment world judging by, for example, their assassination of enormous numbers of pension and endowment investors' savings over recent years -- start dumping shares then it must be time to think of doing the opposite.

Cushioning the process of waiting, for insurance share investors, are the fat yields available on many of them, even if there are some dividend cuts, giving an income way above that on cash. For most investors who wish to play insurance, it may be best to buy a small selection so as to spread the risk a bit, and as always with value, have the nerve and patience to see it through.

I have always liked the financial sector, though I'm normally unemotional on shares and always on deep value PYAD shares. One reason for my liking is the gearing factor, second is the sheer volatility. Some of these shares are very sensitive to market conditions and can demonstrate really sharp movements at times, both up and down. I like that, particularly when they're going my way, which has not been the case over the last few months.

The author owns shares in Royal & Sun Alliance