The stock market is chock-full of companies with complicated businesses and confusing revenue structures. Trying to slog through financial statements and understand what a company actually does can be difficult.
But it shouldn't be that hard to understand how a company makes its money. When searching for value stocks, an easy-to-understand business and steady earnings growth are two things you want to see. Allstate (ALL -1.32%) and Morgan Stanley (MS 0.29%) are two examples of companies with businesses that anyone can understand -- and undervalued shares that investors can buy and hold.
Image source: Getty Images.
1. Allstate
You're probably already familiar with Allstate. The company mainly provides automotive and homeowners insurance to individuals and businesses.
The company underwrites insurance policies, taking in premiums from customers and paying out claims from the funds it collects. Allstate invests its extra cash between the time it receives the funds and pays out the claims.
The best insurance companies make more in premiums than they pay out in claims, and Allstate is one of the best. The company has a stellar combined ratio, a key measure of profitability that simply shows claims plus expenses divided by premiums. A ratio below 100% means profitability, and the lower the better. Through nine months last year, Allstate's combined ratio was 94.8% -- a stellar measure for those writing auto insurance policies. Even better, the company's combined ratio has been 93.2% on average since 2012 and hasn't gone above 96% in any year since then.
Insurance stocks can be great for conservative investors because they constantly generate cash flow. This is one reason why Warren Buffett loves to invest in insurance stocks. Even better are the companies that can consistently turn a profit the way Allstate does.
Allstate is currently trading at a price-to-earnings ratio around 11.5, placing it just below its 10-year average. However, this ratio gets a lot lower when adjusting for the businesses it sold off in early 2021, which hurt its bottom line. The company has recently expanded its commercial automotive insurance policies, which should spur further growth in the company's total premiums received over time.
Image source: Getty Images.
2. Morgan Stanley
Morgan Stanley is a financial services firm that seems complicated at first, but when it boils down to it, the company makes money in four primary ways:
- Investment banking
- Trading
- Asset management
- Commissions and fees
While the business may seem complicated on the surface, it really is set up quite simply and smartly to make money in a variety of market conditions. Morgan Stanley previously relied on investment banking for revenue -- typically helping other companies launch initial public offerings or issue bonds. The problem was the company would have periods of fantastic earnings followed by periods of lackluster earnings, depending on demand.
That's why Morgan Stanley spent $20 billion in 2020 to acquire Eaton Vance and E*TRADE. Eaton Vance gives it a stellar asset management segment, which will provide the company with a steady stream of revenue through investment management fees. E*TRADE helps boost earnings commissions and can benefit when markets become volatile. That's because volatile markets can lead to increased trading activity, which leads to more commissions for the firm.
Morgan Stanley trades at a P/E ratio of 13.2, which is below its 10-year average. Its forward-looking P/E ratio is just a little higher, at 13.4. Its closest competitor, Charles Schwab, which has a similar business model, is trading at a P/E ratio of 36.1 and at 25.8 times forward earnings. You could make the argument that Morgan Stanley warrants a valuation closer to that of Charles Schwab, given its recent acquisition, making this a solid value stock to add to your portfolio.
