This P/E Suggests RSA Insurance Is a Hold

LONDON -- The FTSE 100 has risen by 25% over the last year, and many top shares are beginning to look quite expensive.

I'm on the hunt for companies that still look cheap, based on their long-term earnings potential. To help me hunt down these bargains, I'm using a special version of the price to earnings ratio called the PE10, which is one of my favorite tools for value investing.

The PE10 compares the current share price with average earnings per share for the last ten years. This smoothes out any short-term volatility and lets you see whether a company looks cheap compared to its long-term earnings.

Today, I'm going to take a look at the PE10 for RSA Insurance Group (RSA)

Is RSA Insurance Group a buy?
RSA's share price has dropped by nearly 20% since February, when the firm announced a 33% cut to its final dividend, and said that the interim dividend would also be cut by a similar percentage.

However, despite the cuts, RSA's prospective dividend yield of 5.3% is still one of the highest in the FTSE 100 -- so is it a buy?

RSA's PE10 shows that it is currently trading at 16.4 times its average earnings from the last ten years. To me, this suggests that RSA is quite fully priced at the moment, in the absence of major new growth initiatives, which aren't likely.

Based on its PE10, I think that RSA is a hold.

Undemanding valuation
RSA's average dividend yield over the last five years was 6.7%, roughly double the FTSE 100 average. As a result, RSA's share price was 16% above its book value per share at the end of 2012, despite investors' concerns about the sustainability of the dividend.

February's dividend cut brought investors back down to earth, and RSA's current share price of 115 pence is broadly in line with its most recent book value per share of 112 pence, suggesting that further falls are unlikely unless the firm releases some bad news, or the eurozone crisis takes a turn for the worse.

Income temptations
I must admit that if I didn't already own shares in Aviva, then I would probably add RSA to my income portfolio. There are not many ways of accessing a 5.3% prospective yield in today's markets, and RSA's income potential is definitely a big attraction.

Can you beat the market?
If you already own shares in RSA, then I'd strongly recommend that you take a look at this special Motley Fool report. Newly updated for 2013, it contains details of top U.K. fund manager Neil Woodford's eight largest holdings.

Mr. Woodford's track record is impressive: if you'd invested 10,000 pounds into his High Income fund in 1988, it would have been worth 193,000 pounds at the end of 2012 -- a 1,830% increase!

This special report is completely free, but availability is limited, so click here to download your copy immediately.