"Since 1926, dividends have represented over 50% of the markets total return."
The tale of the tortoise and the hare can teach us all a lesson about investing. The hare is flashy and fast, but arrogant and undisciplined. The tortoise is slow, but steady and wise. The winner of the race -- spoiler alert -- was the tortoise.
However, I wondered if there was a middle ground. A tortoise on steroids, if you will. I believe insurers like AFLAC (NYSE:AFL), ACE (NYSE:ACE)., and Chubb (NYSE:CB) have the potential to fit the bill. They're focused and steady, while also giving investors solid growth potential over time. Though, just as there was only one winner of the race, there can only be one true tortoise on steroids.
Premiums earned, or the number of insurance policies an insurer underwrites is important and would indicate a wise and disciplined business. Since 2011, ACE and Chubb have grown their earned premiums by 1.2 billion and 500 million, respectively. While AFLAC is down about 300 million. The money collected from premiums is invested, mainly in bonds, and earns interest until its needed to pay claims.
The catch, however, is that at a low enough price, selling insurance policies is easy. That's why we look at the combined ratio. This will tell us whether the company is being disciplined with its underwriting. A ratio above 100% means the insurer is paying more in claims than it receives in premiums -- obviously not a good sign for a sustainable business. Conversely, a ratio below 100% means the company is making money underwriting insurance.
As the chart below shows, all three companies have posted profitable underwriting every year for the last five years.
A dividend stock isn't worth much if you can't count on a steady payment of that dividend. For this, we use a two-pronged approach. First, do AFLAC, ACE, and Chubb have a history of reliably paying its dividend?
Absolutely: ACE has paid its dividend each quarter since 1993, while Chubb and AFLAC have increased their dividend every year for 31 consecutive years.
However, past performance doesn't predict the future. So can each company continue to pay its dividend? For that, a dividend payout ratio works perfectly: it shows how much of the company's earnings go toward paying dividends. A high, or growing, ratio could be a red flag that earnings aren't growing and the dividend may be in trouble.
The insurance business, historically, will swing with the overall economy. That's the volatility you're seeing. However, the general rule of thumb is a payout ratio over 60% could leave the dividend vulnerable if earnings falls. All three companies, even at their worst, have been well within that limit.
Supercharging the tortoise
Finally, we want to look at which business has the most opportunity for big growth -- the 'steroid' part of the equation.
Aflac sells branded health and life insurance. About 25% of AFLAC's policies are written in the U.S., the other 75% in Japan. Despite holding market-leading positions, AFLAC's CEO Daniel Amos looks content to stay within those established regions, suggesting they're "excellent platforms for future growth."
People tend to buy what they know, so the AFLAC duck -- mixed with the growing need for health insurance due to rising health care costs -- should be key tailwinds pushing the insurer higher.
Chubb and Ace, on the other hand, are more diverse in both geographic presence and product offerings. Chubb is a true property and casualty insurer, offering personal, commercial, and specialty lines. ACE seems to have its hands in just about everything, but mainly property and casualty.
Ultimately, underwriting several types of insurance could be considered a risk, but based on each companies combined ratio, they've proved more than capable. Long-term growth seems most likely to come from geographic expansion.
ACE is arguably the strongest underwriter, with a consistently low combined ratio compared to the others. It hasn't been the best every year, but it's been the most consistent. It's the youngest of the three, the most geographically diverse, and it offers the most diverse product line. Adding the lowest payout ratio and the largest dividend yield, we come out with a hands down winner as ACE being the wise and steady tortoise with the best opportunity for growth.
Are any of these three the top dividend stocks for the next decade?
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Dave Koppenheffer has no position in any stocks mentioned. The Motley Fool recommends Aflac. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.