Prudential Financial (NYSE: PRU ) appears to be a great bet on increasing valuation multiples over the next couple of years. In addition, Prudential Financial, an industry leader in the life insurance space, could profit from further premium growth in both the U.S. and Japan as well as from a solidifying economic recovery.
I have been an outspoken bull on insurance companies for a long time and I still cannot help but like them. This is even more true when market leaders are concerned that have a lot of potential to grow earnings as the economy continues to improve.
To some extent, it is really an old song that is being played here: Financial businesses are top beneficiaries of an economic expansion as compared to defensive businesses such as telecoms or utilities which face a rather stable cash flow stream across business cycles. Consequently, I expect insurance companies to do extraordinarily well over the next two to three years. Of course, no one has a crystal ball, and even these bullish indicators may not be enough to cause the stock to rise -- other events could intervene. That said, let's dive right in.
1. Earnings growth and high profitability
Prudential has already benefited from stronger earnings over the last couple of years as well as higher profitability measures and I expect this trend to continue.
While past performance records are not necessarily to be extrapolated, good records suggest that a company will be able to continue to perform equally well in the future.
With a return of equity of more than 15% in 2013, Prudential Financial has materially improved the efficiency of its operations since 2010 which should serve the company well going into an expansionary phase of the business cycle.
If Prudential Financial sees further premium growth over the next couple of quarters, the insurance company might be able to deliver quite a few handsome surprises on the earnings front which should help boost its stock price and company valuation.
2. Strong growth opportunity in Japan
Particularly noteworthy is Prudential's strong market position in the second largest market for life insurance companies: Japan.
Japan is a very attractive market for Prudential as well as other life insurance companies, and poses significant growth potential. According to information from insurance company Swiss Re and Bloomberg, Japanese life insurance premiums stood at a whopping $524 billion in 2012: a huge growth opportunity for Prudential.
Moreover, Prudential Financial has been growing strongly over the last couple of years as it sought to capitalize on growth opportunities presented by the Japanese market.
As a result of its sales efforts, Prudential actually outperformed industry growth. And a lot of it has to do with the extraordinary consumer trust the insurance brand has earned over the last couple of years.
According to information from J.D. Power Asia Pacific, a market research firm, Prudential Japan achieved top customer satisfaction ratings in its life support insurance segment for four years in a row.
A reputation like this should certainly help further sales growth.
Prudential Financial isn't cheap -- on a comparative basis -- but that doesn't mean the insurance company can't see further valuation growth. As one of the largest insurance companies in the United States and worldwide, Prudential Financial trades at the highest book value multiple when compared to MetLife and American International Group.
When it comes to market-leading insurance companies, and Prudential Financial is certainly among them with a market capitalization of $41 billion, so a buy-and-hold approach might be a good way to benefit from a Prudential investment.
Looking at the big picture, Prudential Financial has historically traded at much higher valuation multiples, and this is especially true in periods of market exuberance when investors rotate their funds into cyclical sectors such as financials.
The Foolish bottom line
Prudential Financial is an excellent bet on book multiple expansion over the next couple of years thanks to its low valuation compared to its own historical standards. Premium growth opportunities and momentum in the attractive Japanese market only add to the appeal of a Prudential Financial investment.