Manulife Financial Corp. handed investors a complex accounting lesson when it reported its fourth-quarter results last week, and the subsequent head-scratching will likely weigh on the stock's valuation.
On Thursday, the insurance company announced a profit of just $63-million, or a mere 1 cent per share, in the fourth quarter, which sounded dismal to anyone who relies on reported results to analyze stocks.
But wait a minute: After making a few adjustments, Manulife said that its adjusted or "core" profit was much better, at nearly $1.3-billion, or 63 cents a share.
That's a massive gap between the two quarterly figures. And given the stock's muted response over the past three trading days – the price fell slightly two days before rising a little on Monday – many investors may be taking a wait-and-see approach.
No wonder. Without some consistency between reported and adjusted profits, valuing Manulife rests largely on siding with the accountants.
Many companies report adjusted profits that differ from their actual reported results to provide a better understanding of their operations. But these differences are often slight or simple to understand. They can involve, say, the sale of a division or the cost of layoffs.
In the case of Manulife, though, the difference in the fourth quarter was neither slight nor simple. It rested on mark-to-market accounting, which are standards that require a company to report the fair market value of its assets.
In the fourth quarter, Manulife took a total of $1.2-billion in charges related, in part, to the impact of rising interest rates on its insurance liabilities and interest-rate hedges.
By ignoring these charges as a one-time accounting detail that has little bearing on Manulife's operating performance – which is fair – fourth quarter results can look a whole lot better: The company's per-share profit zooms from a penny to 63 cents, and its return on equity jumps from 0.3 per cent to 12.9 per cent.
Manulife's dividend policy apparently rests on these sunnier adjusted numbers: The company raised its quarterly dividend by 11 per cent, to 20.5 cents a share, reflecting management's confidence.
The problem: When profits are difficult to understand – let alone predict – it can be hard to figure out an appropriate valuation for a stock.
"We are not expecting such a quarter to be repeated any time soon and accept management's explanation that almost everything moved against it in the quarter and has a low probability to repeat again soon," Darko Mihelic, an analyst at RBC Dominion Securities, said in a note following the release of Manulife's financial results last week.
Nonetheless, Mr. Mihelic stressed that it can be difficult to explain the results, which may hold back investors from awarding the stock with a more robust valuation.
In some ways, the stock looks cheap relative to peers. Manulife shares trade at 1.3-times book value, compared to 1.7-times book value in the case of Sun Life Financial Inc. In terms of estimated profit, Manulife shares have a price-to-earnings ratio of 11.3, versus a higher P/E ratio of 13.5 for Sun Life.
Given the quiet reaction to Manulife's fourth quarter results, investors seem to be in no rush to close this valuation gap: Since Thursday morning, the share price has risen all of a penny, to $24.59, which is essentially flat on a percentage basis.
Perhaps investors are waiting for strong reported profits rather than a complex accounting lesson. After all, the shares had risen as much as 30 per cent in November and December in the belief that rising bond yields will provide a nice tailwind to most banks and insurers, including Manulife.
Now investors are going to have to wait until the insurer's first quarter results, in May, to find out if this headwind is real. One thing is for sure: They're probably not going to be in the mood for another accounting lesson.