Dividend stocks don't get a lot of credit. Even sexy megacaps like Apple, with enough cash to buy a small country, would rather sit on that cash than return it to shareholders and risk being seen as "mature." But some stocks, such as Aflac (NYSE: AFL ) , are so boring that even dividend investors don't notice their stellar returns year after year.
Everyone knows the iconic Aflac duck, but far fewer people could tell you what the company actually does. Unlike your typical employer-provided health insurance plan with UnitedHealth Group (NYSE: UNH ) or WellPoint (NYSE: WLP ) , Aflac offers individually issued, supplementary health insurance that pays policyholders directly in cash when they get sick or injured. Aflac is the No. 1 company within this niche of the insurance world, and in Japan, where the company collects 70% of its revenue, Aflac insures 25% of households and employees at 89% of the companies on the Tokyo Stock Exchange.
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Why it's incredible
Aflac's operating business is boring. With 7.5% annual revenue growth over the last five years, it is appropriate that Aflac's mascot is a humble duck, and not, say, a thundercougarfalconbird.
But so what? Aflac sells supplemental health insurance, not Ferraris, and this part of the dividend series is called "Quietly Consistent," not "Wild Roller Coaster." While many S&P 500 companies experienced stunning losses during the financial crisis, Aflac -- a financial company dependent in part on investment returns -- stayed well in the black, and even saw modest free cash flow growth.
One aspect of Aflac is particularly exciting: insurance "float." Within certain limits, the company can take your monthly premiums and invest them in stocks, bonds, and other investments, hoping to earn a healthy return before you have an accident and need a payout. At its heart, this is how Berkshire Hathaway (NYSE: BRK-B ) operates, as well as "mini-Berkshire" Markel (NYSE: MKL ) . But if you could bet on the portfolio held by one of the three over the last 10 years, you might be surprised to find Aflac the clear and consistent winner, with average return on invested capital of 14% versus Berkshire's 7.3% and Markel's 4.8%.
Aflac's 26% payout ratio is deceptive. While Aflac may only pay out a quarter of its net income, it actually pays out just 6.5% of quarterly free cash flow. Aflac's net income is only the result of its insurance activities, and is supplemented greatly by the returns on its investment portfolio, which is mostly invested in bonds, preferred stock, and other senior, fixed-income securities.
As a result of Aflac's extremely conservative payout ratio, the company has earned itself another boring -- nay, stuffy -- title as a Dividend Aristocrat. Each year S&P releases a list of companies in the S&P 500 index that have raised their dividend for 25 consecutive years. This list has dwindled from 59 stocks in 2007 to only 42 now, after several financial stocks were kicked out during the crisis, adding to Aflac's distinction as one of the few remaining from that sector.
Aflac has not been a popular stock in recent years. As noted, much of the company's performance comes from its investment portfolio, which in 2009 was almost entirely invested in various bank securities, many of them European ones like Royal Bank of Scotland and Barclays, which required bailouts to stay afloat.
Seeing the risk to Aflac's portfolio, Morgan Stanley analyst Nigel Dally warned that Aflac could take huge losses, causing the stock to implode over several weeks. However, in a surprising show of transparency, Aflac posted intimate details of its portfolio on its website, revealing the relatively minor risk it was exposed to, and even Dally changed his mind. However, the continuing sovereign debt crisis in Europe could still pose a threat to the portfolio if countries ultimately default or restructure their debt unfavorably.
More recently, Aflac's stock has fallen 20% since the terrible earthquake and tsunami in Japan, where the company collects most of its revenue. While the damage was severe, Aflac and Prudential (NYSE: PRU ) only cover health-care costs, unlike fellow Japan giant MetLife (NYSE: MET ) , which is on the hook for property damage as well. Additionally, only about 5% of Aflac's policyholders are in the worst-affected areas, and the company quickly issued a press release reiterating previous earnings guidance.
Aflac isn't the trendiest stock you could own. While its marketing makes it one of the quirkier companies in its industry, you probably won't be showing off your insurance card at a local cafe any time soon. But when it comes to dividend stocks, boring can be beautiful. The business is consistently profitable, even in hard times, and has a rock-solid dividend that should have a place in every portfolio.