3 Reasons Why The Travelers Companies' Stock Could Rise

The Travelers Companies convinces with consistently high profitability and a focus on shareholder remuneration. Going forward, the insurance company has a lot of potential to build on premium growth and further cash distributions.

Aug 25, 2014 at 8:00AM
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Source: Company

Three reasons in particular stand out why The Travelers Companies (NYSE:TRV) could see rising stock prices throughout the remainder of the year and beyond: Premium momentum should continue to benefit the insurance company in the short- and medium term, returns on equity could further improve and raise The Travelers Companies' intrinsic value and it could deploy more cash in the future toward repurchasing its own shares and hiking its dividend.

Background
The Travelers Companies is a leading insurance company specializing in comprehensive property and casualty product offerings in home, business, and auto. With a market capitalization of almost $32 billion, The Travelers Companies is one of the largest insurance operations in the United States.

I am generally bullish on The Travelers Companies as well as on other insurance companies thanks to their business cycle sensitivity and high potential to increase premium volume when U.S. economic activity is improving.

Ultimately, The Travelers Companies, like other financial businesses, is a bet on higher growth going forward which should serve the insurance company well.

1. Encouraging premium trend
Insurance companies like The Travelers Companies increase their intrinsic value by growing premium volume (that is, by writing more insurance policies), selecting 'good insurance risks' and controlling costs.

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Source: The Travelers Companies Investor Day Presentation

If you looked at The Travelers Companies historical net written premium growth, you might be tempted to dismiss the 1.4% compound annual growth rate over the last nine years as too low (see chart on the left-hand side).

However, you need to consider that the financial industry, including insurance businesses, had to overcome extreme adversity as the financial crisis unfolded and many companies in the industry were on the brink of failure.

Moreover, the property and casualty business is traditionally competitive with a lot of pressure on policy prices and a tendency to seduce insurance companies into inferior underwriting.

In any case, putting The Travelers Companies' premium growth in context to the operating environment and literal collapse in economic activity in 2008 and 2009, the insurance company actually did quite a good job overall.

For the foreseeable future I expect further premium momentum, which should contribute to higher returns on equity as well as continued book value growth.

2. High returns on equity
The underlying performance of a property and insurance company can quickly be evaluated by looking at its underwriting gains or losses.

Underwriting gains signals that the insurance business did a great job in selecting insurance risks in the past and achieving a series of underwriting gains is certainly in an indicator of a well-run insurance company.

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Source: The Travelers Companies Second Quarter Investor Presentation

Two things stand out in the chart above: 1. The Travelers Companies has historically achieved high double-digit operating returns on equity (with the exception of 2011).

2. Underwriting gains, for the most part, contributed positively to company performance (with the exception of 2005 and 2011).

The Travelers Companies achieved an average operating return on equity of more than 13% annually since 2005, which is a respectable accomplishment given the distressed market conditions during the financial crisis.

3. Shareholder remuneration
Companies that face difficult markets, either because of fierce competition or because of macroeconomic shocks, often resort to alternative measures to create value for shareholders instead of expanding market share or increasing earnings.

At the top of the list: Share repurchases and dividend payments.

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Source: The Travelers Companies Investor Day Presentation

I particularly like that The Travelers Companies seriously stepped up its shareholder remuneration when investors freaked out in 2008-2010. Though total shareholder remuneration has dropped subsequently as investors regained confidence in the financial sector and internal capital deployment opportunities emerged, shareholders can reasonably expect that the company will continue to repurchase its own shares on an opportunistic basis in the future.

The Foolish Bottom Line
The Travelers Companies is a solid insurance bet on premium momentum and convinces with a great record of achieving high levels of profitability.

In addition, The Travelers Companies remains committed to repurchasing its own shares and offers investors a promising, initial dividend yield of 2.40%.

All of these themes laid out above could lead to higher share prices for The Travelers Companies in the years ahead.

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Kingkarn Amjaroen 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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