3 Undervalued Financial Stocks with High Margin of Safety to Buy Now

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  • Financial stocks are finally starting to catch their wind as $4T in Fed stimulus and the forthcoming $2T stimulus package from the federal government is likely to be passed by the end of the week. That’s a lot of money that is being supplied as the Covid-19 closures continue. The effects of the significant stimulus have caused the U.S. Treasury yield curve to steepen, which is generally pretty beneficial for banks and other financial companies. However, some of the uncertainty that has been holding them back may be starting to diminish.

    There are a number of ways to determine valuation for a company. Some of the most popular measures involve taking ratios like P/E, P/B, P/S and EV/EBITDA and comparing them to the company’s history or to their peers. At times, it’s clear when is a value opportunity, but it doesn’t provide a sense of how undervalued company is. It’s also complicated comparing valuation of companies that have different earnings growth rates.

    Discounted cash flow (DCF) is a method of evaluating whether a stock is trading at a discount from what the company is projected to be worth. The discount that you are measuring is called the margin of safety (MOS). The value of the company is estimated by taking the present value of future projected cash flows. This accounts for the current level of cash and the growth rate in the cash being generated.

    The following are three financial stocks that are trading with a significant MOS in both earnings and cash flow.

    Discount Stock #1: Reinsurance Group of America Inc (RGA)

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  • RGA is currently trading with a margin of safety of 79% using a discounted cash flow model and at a 62% discount using earnings. That means that the stock is theoretically trading 79% or 62% less than its current projected price. Discounts of 30-50% are typically significant.

    As you evaluate the valuation ratios for this company, its P/E ratio is near the lowest over the past 10 years along with its P/B and P/S ratios. Its EV/EBITDA is close to its 10-year low as well and is lower than 67% of companies in its industry. The company also pays a 3.42% dividend yield, which is also just off of its 10-year high of 4.29% and significantly above its median value of 1.38%.

    The share price surged 18.41% on Wednesday and substantial volume as investors and short covering pushed this stock quickly. It’s also been a company that others have recognized for its value as hedge funds have added it to their portfolio in recent quarters.

    RGA has a $107 near-term price target.

    Discount Stock #2: First American Financial Corp (FAF)

    FAF is currently trading with a margin of safety of 78% using a discounted cash flow model and at a 72% discount using earnings. That means that the stock is theoretically trading 78% or 72% less than its current projected price.

    As you evaluate the valuation ratios for this company, its P/E ratio is near the lowest over the past 10 years while its P/B and P/S ratios are trading around its median value over the past 10 years. Its EV/EBITDA is close to its 10-year low as well and is lower than 80% of companies in its industry. The company also pays a 3.77% dividend yield, which is lower than its 10-year high of 4.83% and significantly above its median value of 2.48%.

    FAF traded 10.28% higher on Wednesday on above average volume. The price closed above its highs over the past week near $40.

    FAF has a $53 near-term price target.

    Discount Stock #3: Credit Acceptance Corp. (CACC)

    CACC is currently trading with a margin of safety of 76% using a discounted cash flow model and at a 72% discount using earnings. That means that the stock is theoretically trading 76% or 72% less than its current projected price.

    As you evaluate the valuation ratios for this company, its P/E ratio is near the lowest over the past 10 years. Its P/B is trading near 10-year lows and P/S ratios is still well below its median value over the past 10 years. Its EV/EBITDA is slightly below its 10-year median value and is lower than 59% of companies in its industry.

    CACC attempted to breakout strongly on Wednesday as the price reached a high of nearly $316 intraday before pulling back. The stock still finished 7.86% higher on the session.

    CACC has a $350 near-term price target.

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