One Stock That Finally Grew Up

How Universal Insurance Holdings grew up, and rewarded its shareholders, with two simple changes.

Mar 24, 2014 at 2:53PM

Money Pic

Photo: JDR

It was almost like finding $20 in a pair of old jeans.

I recently stumbled on an old find -- Universal Insurance Holdings (NYSE:UVE). We reunited after I first found it in 2010. Back then, Universal Insurance Holdings was a rare breed. It wrote homeowners policies in Florida. And it had a shareholder base that was content to make it a proxy for hurricane predictions.

Every fall, it seemed, Universal Insurance Holdings would trend up as the prospect for a costly hurricane trended down. Those who had the guts would hold it through a full year, collecting a dividend yield which regularly ventured into double digits.

But what made it truly unique was its love for risk. Universal Insurance Holdings had one of the most questionable investment portfolios in the insurance industry. Whereas its peers would have invested primarily in high-grade debt and a small stock portfolio, Universal Insurance Holdings had a preference for precious metals.

In 2009, a full 20% of its investments were in metals-related equities. Sinking a fifth of the portfolio in one industry is bad enough. Sinking it in one of the most volatile industries in all of finance is just downright stupid -- something a doomsday prepper would do. 

An irrationality discount
I quickly balked from an investment in Universal Insurance Holdings after discovering its investment portfolio. If gold or silver plunged at the same time a hurricane struck Florida, Universal Insurance Holdings would invariably take a dive.

But like many stories, this one has a happy ending. Universal Insurance Holdings has grown up. It hired Deutsche Bank to manage its investment portfolio. The 2014 annual report states:

"Working with the investment advisor, we transitioned the composition of our portfolio to a more traditional insurance company investment portfolio."

Cash now makes up about 25% of its investments. Debt securities made up about 61%. The scars of the old investment portfolio are still visible on its income statements, however. Millions of dollars of realized losses appear in their respective 2011, 2012, and 2013 columns.

Meanwhile, Universal Insurance Holdings has also sized up its reinsurance. The 2014 annual report reveals reinsurance that limits Universal's exposure to $27.5 million of the first, second, and third wind event in Florida. For reference, the loss limit is about one-tenth of Universal's premium revenue.

Universal Insurance Holdings has evolved and prospered, escaping what would have been catastrophic losses from several sizable hurricanes had they happened in the summers of 2010 through 2013. Luckily, they didn't.

Since 2010, Universal Insurance Holdings has more than tripled. Shares traded from a low of $4 in 2010 to nearly $15 in 2014.

Looking back
I missed out on a big winner. But what is most important here is the lesson learned -- some companies can change. Often, change happens for the better.

Betting on change, however, comes often with undue and uncertain risks (in this case, what the price of gold or silver would be, and when the next big hurricane would strike Florida). While it's easy to look back and imagine all the money that could be made on the little insurer of Florida, it requires some perspective.

Looking backward, it's easy to make the right call. But finance is a game of looking forward. Those who first looked at it in 2010 saw an insurance company with an insane investment policy. Those who first crack its annual reports in 2014 see a completely rational insurer making money hand over fist. The difference of opinion is split only by time.

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Jordan Wathen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.

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