These two life insurers are still undervalued

Donald Trump’s election to the White House has had a very strange effect on developed market equities. Even though most analysts were predicting a market crash if he was elected, stocks have done nothing but rally since the news last week. Indeed, on Friday the Dow Jones Industrial Average closed at an all-time high and the S&P 500 was just a few points off its record. 

Several groups, in particular, have benefitted from Trump’s win. In the US, infrastructure stocks have charged higher as traders speculate that the new President will usher in a debt-funded wave of public spending on infrastructure projects. This has also led to a sell-off in bonds, which is great news for life insurers such as Prudential  (LSE: PRU) and Standard Life (LSE: SL).

Fortunes linked to the bond market 

When the price of bonds fall, the yield rises and after years of sub-1% bond yields, the recent rise in yields is a breath of fresh air. Insurers such as Prudential and Standard don’t need high bond yields to survive, but a higher yield sure makes life easier for these companies. 

A higher yield means a higher return on their investment portfolios, meaning that they’re able to offer more attractive savings products to customers and generate better returns on customer savings already deposited. This is why shares of life insurers tend to be correlated to the yields on government bonds. Between the beginning of January this year and the middle of July, when government bond yields plunged into negative territory following the outcome of the UK referendum, shares in Standard and Prudential fell by 30% and 21% respectively.  

As bond yields have started to rise from their overly depressed levels, shares in Standard and Prudential have sprung back to life. In the past five days alone these insurers have jumped by more than 10%, and there could be more gains to come. 

Further gains on the horizon? 

This time two years ago, shares in Standard were trading at 500p, while the US 10-year Treasury bond yield was trading at around 2.5%. Meanwhile, shares in Prudential were on their way to 1,700p. Unfortunately, as bond yields started falling, the air was taken out of these companies’ sales as expectations fell. However, despite the negative sentiment surrounding them, both Standard and Prudential have reported steadily increasing profits. 

Indeed, since year-end 2013, Prudential’s pre-tax profit has risen from £2.1bn to £3.3bn and analysts have pencilled-in estimated pre-tax profits for the group of £4.3bn for 2017. Meanwhile, City analysts are expecting Standard to report a pre-tax profit of £640m for 2016, up from £422m for full-year 2014. Higher bond yields could lead to City revisions to earnings expectations for these companies, which would ultimately translate into higher share prices as the market reconsidered Standard’s and Prudential’s growth outlook.  

What’s more, even after recent gains and the possibility of earnings revisions on the horizon, shares in Standard and Prudential don’t look overly expensive at current levels. Shares in Standard currently trade at a forward P/E of 13.6 and support a dividend yield of 5.4% while Prudential trades at 12.3 and supports a yield of 2.3%.  

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Rupert Hargreaves owns shares of Prudential and Standard Life. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.