A well run insurance company generates a predictable cash flow with an appropriate level of risk management in place. Insurance stocks can therefore be a solid core holding for any portfolio. Picking insurance stocks that pay good dividends will help create a dividend based cash flow in your portfolio, that you can use to make more strategic investments. [Read my discussion on mixing cash cows with question marks in your portfolio].
The 3 stocks listed below have been picked for great dividend yields. At the same time, I have been careful to make sure the stocks may represent a good value. For example, the following screen was used
- Dividend Yield = Top 20% in the industry
- Dividend Growth Rate (5 yr Average) = Highest 60%
- P/E = Lowest 60%
- Book Value Growth (5 yr avg) = Highest 60%
As it so happens, all 3 of these stocks are Property and Casualty insurers. These stocks do not give you the most undervalued insurance companies. They also do not give you the fastest growing insurance companies. Rather, these insurance companies are great performers with high yields that can become a core that you can build your portfolio around. As the companies do well, the stock should do well as well, since at the current prices you are likely NOT overpaying for the stock.
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1. Validus Holdings, Ltd (VR)
The company started in 2005 and has been profitable every year since. As a P&C insurer, it insures an eclectic mix of risk, including crop insurance, terrorism, marine, war, aviation, etc. It also has extensive reinsurance operations and strong focus on risk and active capital management, returning $2 Billion to the shareholders between 2007 and 2013 through dividends and share repurchases. Since 2006, the company has achieved a 13.2% compounded growth in Diluted Book Value per Share.
Currently the stock values the company at $3.75 B in market capitalization. Currently the stock yields 3.3% in dividends and the dividend has grown at a 25% average over the last 5 years. A 7.7 P/E ratio indicates the stock can be bought at a reasonable valuation today, at roughly 1 times the book value. Overall, this stock looks very attractive and a definite candidate for the VSG Watch List.
2. Safety Insurance Group Inc (SAFT)
Safety Insurance Group provides auto insurance in Massachusetts and New Hampshire. It also provides homeowner’s policies and limited inland marine insurance (water crafts). The stock is slightly more expensive at around 15 P/E and 1.16 times the book value, however it pays a 4.6% dividend and carries no debt on the books. It has also grown its dividend an average of 8.45% over the last 5 years and its book value by 5.18% on average in the same period.
3. Baldwin and Lyons Inc (BWINB)
Founded in 1930, Baldwin & Lyons specializes in marketing and underwriting insurance for the transportation industry. They operate three domestic property and casualty insurance companies that provide both admitted and excess and surplus lines platforms, a Bermuda-based captive solution (reinsurance), a fully licensed Canadian branch and two brokerage firms.
The stock is reasonably undervalued at 10 times earnings and 1 time book. A 4.2% dividend yield adds to the attractiveness.
Tips to Value an Insurance Company
Take these ideas and do your research to determine if any of these are good investments for your portfolio. When valuing an insurance company, you need to review certain profitability metrics that are unique to the industry. Essentially, you break down the overall profitability in 2 parts – one that measures the underwriting discipline and the other one measures the operational costs in the company. The Combined Ratio under 1 indicates a profitable insurance operation. This is made up of Loss Ratio which measures insurance payouts versus premiums earned and Expense Ratio which measures operational expenses in underwriting and payout administration versus the premiums earned. There are other unique considerations that you need to keep in mind. Ultimately, traditional valuation techniques such as P/E or Book Value Growth can only take you close, but are not sufficient to make a reasonable valuation judgment. Also keep in mind that most insurance companies manage their risk by re-insuring a portion of their policies (which has an expense as well).
To learn more about analyzing and valuing insurance companies, refer to this paper by Doron Nissim at Columbia Business School
Analysis and Valuation of Insurance Companies (pdf – will open in a new window or tab)