Prudential Financial, Inc. (PRU) is a diversified financial services company. It provides insurance (life insurance annuities, and annuities as well as P&C insurance) and investment management services worldwide. On the investment management front, it offers mutual funds, and investment management products and services. The U.S. Retirement Solutions and Investment Management division provides individual variable and fixed annuity products; and record keeping, plan administration, actuarial advisory, tailored participant education and communication, trustee, and institutional and retail investment services. It also offers brokerage services; guaranteed investment contracts, funding agreements, structured settlement annuities, and other group annuities; and investment management and advisory services to the public and private marketplace. The U.S. Individual Life and Group Insurance division provide individual variable, term, and universal life insurance products to middle affluent markets; and group life, and long-term and short-term group disability, as well as group corporate, bank, and trust-owned life insurance products to institutional clients. It also sells accidental death and dismemberment, and other ancillary coverages; and offers plan administrative services. Prudential Financial, Inc. was founded in 1875, has $813 billion in assets and made $4.3 billion ($8.96/share) last year.
Prudential has been performing well financially and that is showing up in the share price. The stock price went through a very nice consolidation from Q3-2013 to Q4-2016. After a false breakdown, the share price doubled in a years time and went into another consolidation phase. We think the charts are telling us that onward and upward is the path of least resistance. A break above the $115 level will increase the odds that buyers will push the share price higher.
Valuation is supportive of the bullish case. The shares are trading at a PE of 12.5 based on trailing 12-month earnings and about 10 based on analysts estimates of earning over the next 12 months. In a world where the median PE of a typical company in the S&P 500 is in the mid-20s, the spruce is relatively cheap. While a 20% growth in EPS seems a bit ambitious to us, we think the shares are undervalued even if earnings grow at a modest single-digit pace. The company pays a respectable 2.7% dividend and they return an additional 2.6% to shareholders through share repurchases.
We think the stock is an outright buy. If your portfolio is a bit light in financials, this could be a nice diversifying investment for your portfolio. As our readers know, we are nervous bulls and believe there is a great deal of complacency and overconfidence in the marketplace as a whole. The overall market is ripe for a selloff, so we think investors should limit their risk by using options. It is entirely possible that the share price will bounce around the upper end of the trading range before it breaks out. Since we think this is a highly likely scenario, we think selling a put spread is an appropriate structure to use. With the share price trading at $111.94, we suggest the following structure.
To initiate this trade, the investor will collect $142 upfront per put spread, which they will get to keep so long as the share price trades above $110 at expiration. The breakeven level is $108.58, which is 3% below the current price. The efficient market hypothesis suggests there is a 67% chance of success in this trade. The most one can lose is $358, which would occur if the share price traded at $105 or less at expiration, which is 6.2% below the current price. The Pru is performing well and should continue to do so, even if interest rates rise. The company, like all insurance companies, runs a matched book between its assets and liabilities. As a result, the value of the firm’s equity is immunized against interest rate shocks. All they need to do is to continue to sell insurance and run a tight ship and they will continue to make nice profits. The only wildcard is stock and real estate prices. We could get a selloff in risk assets, that would have a negative impact on the company’s financial condition at the margin and that could take the share price down. At the current valuation, we think the price contains a margin of error that should keep us safe.
