Why First American Financial is an Undervalued Niche Insurance Player

First American Financial should benefit nicely from increased transaction activity in the housing market and has become an attractive dividend income play.

Jul 14, 2014 at 5:52PM
G

Source: Company

First American Financial Corporation (NYSE:FAF) is a relatively small insurance company with a market capitalization of $3.0 billion, that specializes in title insurance and related services. The insurance company has a strong market position in title insurance and has substantially increased its free cash flow over the last three years.

In addition, management has successively increased its dividend, which adds to the appeal of First American Financial as a niche insurance and dividend income play.

Background
First American Financial looks back on 125 years experience in the insurance industry and has a leading market position in residential and commercial title insurance.

Title insurance is a special form of insurance, that protects buyers of real estate from losses sustained from  title-related issues such as fraud, forgery and liens. Insurance services are usually offered to (home-)buyers, sellers, real estate agents, developers, mortgage lenders and legal professionals.

First American Financial's title insurance services are complemented by a host of related services that facilitate low-risk real estate transactions such as escrow and settlement services.

It is straightforward to see, that the demand for title insurance is high during periods of buoyant activity in the real estate market: The more purchases and sales are being conducted, the higher the demand for title insurances and the need for smooth real estate transactions.

The collapse of the U.S. housing market in 2008 also led to a serious decline in mortgage originations and, by extension, to a bad title insurance business as evidenced by record low title insurance margins. A more dynamic housing market, on the other hand, will certainly help First American Financial on the revenue and on the margin side of the business.

G

Source: First American Financial KBW Mortgage Conference Presentation, June 3, 2014

Strong market position in title insurance
The title insurance market clearly is a niche market and not as fragmented as other markets for insurance products such as worker compensation or property- and casualty.

G

Source: First American Financial KBW Mortgage Conference Presentation, June 3, 2014

As mentioned above, title insurance is what drives First American Financial's business.

The insurance company has 800 offices throughout the U.S. with over 6,000 employees which support 7,800 agencies in order to capitalize and build on its leading market position in title insurance.

First American Financial has a roughly 27% market share in the market compared to roughly 33% of Fidelity National Financial, Inc.

Its strong market position in an insurance market niche is also what will drive First American Financial's cash flow and earnings when the U.S. housing market continues to recover.

Generally speaking, if the residential real estate market recovers, First American Financial should benefit from both better title insurance pricing and higher sales activity which should underpin its dividend and free cash flow growth.

Dividend and free cash flow growth
Over the last three years, First American Financial has produced a strong dividend and free cash flow growth record.

G

Source: First American Financial KBW Mortgage Conference Presentation, June 3, 2014

First American Financial uses its free cash flow generally for three purposes: Dividends, share buybacks and the pursuit of selective M&A opportunities.

First American Financial has substantially hiked its dividend from $0.18 per share in 2010 to $0.48 per share in 2013 and the insurance business is now well on its way to pay out $0.96 per share in 2014 (based on an annualized Q2 2014 dividend of $0.24 per share).

As a result, First American Financial currently yields 3.45% and further dividend hikes may be just around the corner if mortgage originations experience a meaningful uptick in 2014 or 2015.

Underpinning First American Financial's dividend growth is its free cash flow, which has increased dramatically from $67 million in 2011 to $346 million in 2012 and $291 million in 2013 giving the company enough room to both reward shareholders and invest in the expansion of its title insurance business.

Valuation
The strong market position in title insurance and First American Financial's solid dividend yield contribute to a premium valuation in the marketplace.

The insurance company currently trades at a 21% premium to book value. The valuation still seems low relative to its earnings prospects which could be meaningfully fueled by a recovery in residential real estate.

The Foolish Bottom Line
Title insurance is a cyclical business. With more mortgage originations and higher transaction activity in the housing market, demand for residential and commercial title insurance should grow.

With its 27% market share in the title insurance market, First American Financial should be able to capitalize on its existing relationships and technology platform to further increase cash flow and dividends for shareholders.

How to get even more income during retirement
Social Security plays a key role in your financial security, but it's not the only way to boost your retirement income. In our brand-new free report, our retirement experts give their insight on a simple strategy to take advantage of a little-known IRS rule that can help ensure a more comfortable retirement for you and your family. Click here to get your copy today.

Kingkarn Amjaroen has no position in any stocks mentioned. The Motley Fool recommends First American Financial. 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.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers