I’m always inspired by the story of legendary investor Shelby Cullom Davis who borrowed some money from his father-in-law to buy deeply, deeply undervalued stocks of insurance companies, eventually growing his fortune to $800 million. His thesis was that the market was unwittingly discounting the stocks by completely disregarding the huge piles of cash the companies were sitting on (which all insurance companies have…mainly by mandate). Warren Buffett did the same thing with a little insurance company called GEICO.

I’ve always liked to poke around stocks of life insurance companies. There are two reasons. First, they typically have and grow huge piles of money. Second, betting on the insurance company is the equivalent to betting on the house at a casino. It’s hard to beat the actuarial tables. Like John Maynard Keynes said: “In the end, we’re all dead.”

#-ad_banner-#But lately, I’m rethinking that for two reasons. One, lower risk interest rates are horribly low, so the huge piles of cash the life insurers are sitting on aren’t earning very much. Two, there is a ticking demographic time bomb called “Baby Boomers” looming in the near future.

I selected three large life insurers whose stocks seem to be trading and attractive levels. Then I looked under the hood. Here’s what I found:

Metlife, Inc (NYSE: MET) and Lincoln National Corp. (NYSE: LNC) look cheaper than Manulife Financial (NYSE: MFC) on a book value and forward P/E basis. However, I think MFC is a better investment. Here’s why.

Looking at company specific issues, Metlife is dealing with the most regulatory overhang. As the largest life insurer in the United States by assets, government regulators had labeled the company a systemically important institution (“Too Big to Fail”) during the Financial Crisis of 2008. The result was enhanced regulatory scrutiny. Recently, though, the federal court lifted the government designation. While seen as a positive, the government does have the right to appeal the court’s decision. To manage the risk of increased regulation in the future, the company is planning a spinoff of its variable annuity unit, which was recently hit with a $25 million fine by FINRA (Financial Industry Regulatory Authority) for inappropriate sales practices. A spinoff would definitely manage regulatory headaches, but at the same time it would remove a high quality, high margin revenue stream, leaving behind the lower yield, lower margin life insurance business. This leaves me unenthusiastic about MET’s prospects in the near to medium term, despite the stock’s attractive valuation.

Lincoln National’s challenges are caused by a one-two punch of abysmally low interest rates and volatile equity markets. LNC’s business is more heavily weighted toward the retirement/wealth accumulation channel. The result is a large number of equity (stock market related) linked products. As we all know, asset price volatility comes with the equity territory. LNC linkage to volatile equity markets could have a direct impact on earnings as gun shy consumers seek to avoid stock market related variable products.

Prolonged low interest rates will also compress product spreads, which is how the company earns its fees as well as dampening the earnings on investments in its general account. I just don’t see a whole lot of earnings catalyst with this stock.

What Manulife Financial has that the others don’t is a more diverse business and exposure to fast-growing international insurance markets. Based in Canada, Manulife’s business is almost evenly divided three ways between the United States, Canada, and Asia, the last of which is one of the fastest growing markets globally for insurance products. And the company’s offerings are tailored specifically for each market served. In the United States, the emphasis is on wealth and asset management, with its highly regarded John Hancock brand. In Asia, the emphasis is on protection, savings and wealth management products. In its home base of Canada, the company operates as more of a broadly diversified financial services company, offering Canadian consumers everything from banking services to wealth accumulation products to insurance. 

Lincoln National is poised to benefit from the demand for retirement products in the United States Manulife is primed to take advantage of growing demand on the majority of two continents. It achieves the same margin as Metlife, around 7%, on less than half the revenue, $26 billion versus nearly $70 billion, with 71% better return on equity (ROE), 12.8% versus MET’s 7%.

When you look at the difference between each company’s yields on its investments compared to its dividend yield, the difference is clear. Metlife makes the same on its investments that it pays to shareholders. Lincoln earns 95% more than it pays out. But Manulife pays shareholders nearly 19% more than its investment yield. It returns more to its shareholders AND grows the business. That’s a company I want to own.

Risks To Consider: MFC appears to be a real growth story. But, at the end of the day, a large life insurer/asset manager is a financial company and, as we’ve seen, financial stocks are not treated kindly by volatile markets. The company boasts a strong balance sheet. Canadian regulators are historically much more conservative than their American counterparts. The higher dividend yield also makes the stock more attractive to nervous investors.

Action To Take: While LNC and MET appear to have attractive valuations, the companies are either hoarding their cash or plowing it into share buybacks. It’s clear they’re not focusing on growing the business, which makes the stocks look like dead money. MFC, on the other hand, has a clear growth path that displays geographical and product diversification. They also create more value among shareholders by returning more cash in the form of dividends. A 12- to 18-month price target of $17 seems fair. Factoring in the dividend, the result would be a total return of over 25%.

​Editor’s Note: Everyone knows that dividend payers crush other stocks. It’s not a matter of opinion. You can just look at the stats. But what’s really interesting is why they do so much better. We’ve found the answer here.