Manulife Financial: Stock Growth Hinges On Rate Outlook, Asset Management Division
Geoff Considine, Ph.D | Aug 30, 2021 08:52
Manulife Financial (NYSE:MFC) is the largest insurance company in Canada by Investing.com
Market-Implied Outlook for MFC
I have analyzed call and put option prices at a range of strikes and two expiration dates. The options expiring on Jan. 21, 2022 provide a market-implied outlook for the next 4.74 months and those expiring on Mar. 18, 2022 provide a market-implied outlook for the next 6.57 months. I analyzed options with these two expiration dates to provide a view to early 2022 and then to check for consistency in the market implied outlook for a slightly longer period.
The standard presentation of the market-implied outlook is a probability distribution of price return, with probability on the vertical axis and price return on the horizontal.
Source: author’s calculations using options quotes from eTrade
The market-implied outlook for the next 4.74 months is significantly tilted to favor positive price returns. The peak probability corresponds to a price return of 5% over this period. The median price return from this distribution (50% probability of having a return above / 50% probability of having a return below) is 1%. The annualized volatility derived from this market-implied outlook is 24%. This is quite low for an individual stock. This market-implied outlook is significantly bullish.
To make it easier to compare the probabilities of positive and negative returns of the same magnitude, I rotate the negative return side of the distribution about the vertical axis (see chart below).
The negative side of the distribution has been rotated about the vertical axis (Source: author’s calculations using options quotes from eTrade)
This view shows that the probability of having a positive return is substantially higher than for a negative return for a range of the most probable outcomes (returns in the range +/-10%), which supports a bullish view. For large-magnitude returns (+/-15% or larger) the probability of negative returns is higher than for positive returns but these are, overall, low-probability outcomes.
One limitation in interpreting the market-implied outlook for MFC is that the option trading on this stock is light. This reduces confidence in the meaningfulness of the outlook. When I analyzed the options expiring in March, however, the outlook is qualitatively the same, with a strong tilt in probability towards positive price returns.
The negative side of the distribution has been rotated about the vertical axis (Source: author’s calculations using options quotes from eTrade)
Over this longer time horizon, the peak probability is for a price return of 5.6% and the annualized volatility is 23%. This bullish market-implied outlook is reassuring, but the overall confidence in the results is modest due to the light options trading.
Summary
Recent years have been challenging for insurance companies, largely due to low interest rates. MFC has responded to this business environment by focusing on expanding Wealth and Asset Management (WAM), a group of business lines with higher margins.
The shares are cheap compared to current earnings but higher multiples rely on evidence for faster earnings growth. As yet, the market appears unconvinced.
The consensus opinion of the equity analysts who follow MFC is remarkably bullish, however, with expected 12-month price appreciation above 20%. The market-implied outlook for MFC to early 2022 is also bullish, with the peak probability price return at 5%-6% over the next six months. The annualized volatility derived from the options is about 24%.
Taking the analyst consensus price target at face value, MFC has expected price return of 20%+ with volatility of 24%. I consider expected return for a stock that is greater than ½ the volatility to be attractive, so MFC looks like a strong buy.
Tempering that bullish view, however, there is considerable uncertainty in when interest rates will rise. The market-implied outlook is also bullish, stock has moderate expected volatility and, let’s not forget, a 4.5% dividend yield. I partially discount the market-implied outlook due to low levels of options trading activity. I am bullish overall, but I don’t expect a price return as high as the analyst consensus.
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