Why Prudential Is Telling Me to Buy Aviva

LONDON --  Prudential  (LSE: PRU  ) (NYSE: PRU  )  is the flavor of the month.

Its share price hopped and skipped almost 10% on Wednesday and jumped another 5% on Thursday morning. Which is great news for me, because I bought this FTSE 100-listed insurance behemoth three years ago, and it has doubled in value since then.

I shouldn't brag about my stock-picking abilities, because around the same time I sank an even bigger sum into its troubled rival Aviva  (LSE: AV  ) (NYSE: AV  ) . It is down 18% over three years, wiping out a good chunk of my Prudential profits.

We have one winner, one loser. The question is, which one should you buy next?

Mob rule
Let's take the good news first. Prudential rocks.

But it wasn't always that way. When I bought the stock, chief executive Tidjane Thiam had just made a complete Horlicks of his 36 billion-pound attempt to buy AIA Group, the Asian arm of American International Group, and was nearly pitchforked out by upset shareholders.

I always thought the takeover was risky, and was glad it fell through. The market thought differently, and handed me a great buying opportunity. Who doesn't like buying good companies on bad news?

Since then, all the headlines have been happy. Indeed, Prudential's latest full-year results thrashed the sector generally, and Aviva in particular.

Highlights included a 25% increase in operating profits to 2.53 billion pounds, of which nearly 1 billion pounds come from its target Asian market, notably Indonesia, Singapore and Malaysia.

Asia now contributes more cash to Prudential than any other region, a mighty 341 million pounds in 2012, up from 40 million pounds just three years earlier. Prudential did pretty well in the U.S. as well, adding 200,000 new policies.

The firm has also continued to plump up its financial cushion, which now represents three times its solvency requirements. Best of all, Prudential whacked up its dividend by a whopping 16%.

Strong stuff
The turbulent Indian life-insurance market, challenging conditions in China, uncertainties over EU Solvency II requirements and the wider economic malaise are all worries, but given the jubilant market response to Prudential's progress, they are clearly minor concerns.

This is a company that is even throwing off cash in the U.K. Is there anything Prudential can't do? No wonder analysts are nailing it has a strong buy. I decided that three years ago.

Lifeless
And so to Prudential's whey-faced rival, poor, sickly Aviva.

I've just checked Aviva's past share-price performance, and it has pointy-down red arrows all over it.

Aviva has "red-arrowed" over five, three, two, one years... just about every timescale you can name.

The price is down 14% over the past 12 months, against a 10% rise for the FTSE 100 as a whole. The group's market cap has sunk to a lowly 9.5 billion pounds, against 30 billion pounds for the chubby-cheeked Pru. When Aviva announced its results last week, its share price fell 13% in moments. Bleh.

Just about everything Prudential has done right, Aviva has done wrong.

Aviva reported a pre-tax loss of 3.1 billion pounds, down from a profit of 60 million pounds last year, although in mitigation, that was mostly down to a 3.3 billion pounds writedown in the value of its disposed U.S. business.

While Prudential gains ground in Asia, Aviva is on the run in France, Italy and Spain, thanks to a sharp drop in long-term savings rates. Even foreign-exchange movements are against it, knocking 65 million pounds off its adjusted operating profit, which fell 4.3% to 1.78 billion pounds.

That's what happens when your luck runs out.

Finally, the one thing still in Aviva's favor, its 7%-plus yield, went under the knife. The final 2012 dividend was cut by a mighty 44%, leaving the full-year payout down 27%. That wasn't a nip and tuck, it was an amputation. Hence the share-price punishment.

Buy what?
Prudential rocks, Aviva sucks.

Prudential is cash-rich, has a strong balance sheet and an 11.6% operating margin. It's Asian strategy isn't a vague intention, it's a lucrative fact on the ground.

Aviva is Prudential's cash-poor cousin, financially weaker, embarrassed in Europe, strategically confused and overly complex, with a feeble operating margin of just 5.5%. So which stock should you consider? It's a no-brainer for me: Aviva.

I feel you should consider Aviva for the same reason I bought Prudential three years ago: The market hates it, and the share price reflects that.

If you're patient, you might just be buying a bargain. The recent dismal results could be a turning point for Aviva. The bad news is well and truly out there.

But that 3.3 billion-pound U.S. writedown is out of the way. Management is now simplifying the business, slashing costs, reducing debt, and plumping up its capital cushion.

Given the insurer's problems, Aviva knows it must take aggressive action to restore its fortunes.

Yes, the dividend is down, but it still yields 5.9%, more than double Prudential's 2.6%. So you should be rewarded for your patience. And you won't be surprised to hear that Aviva is a lot cheaper, trading at 9.24 times adjusted earnings, while Prudential is a more fully priced 14.6 times earnings.

Buying great companies on great news is perfectly acceptable thing to do. But buying good companies on terrible news is far better. But you will need to be patient...

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