Property and casualty insurance is one of the true wonders of the stock market. Companies that exemplify sound underwriting and grow policies have handily crushed the performance of the broad market.
Property and casualty insurers write policies against the most basic risks including damages and loss to your property (hence property in the name), as well as the liability (casualty) for potential damages you might cause another person. Car insurance is one of the best examples, as it insures your property from loss, while shielding you from liability in the event you cause loss to someone else's property. Insurance companies, particularly P&C insurers, may be the most attractive group among the financials industry, which includes everything from banks to real estate investment trusts.
Markel (NYSE:MKL), Safety Insurance Group (NASDAQ:SAFT), and Berkshire Hathaway (NYSE:BRK-A)(NYSE:BRK-B) are some of the very best P&C insurance stocks on the market today. Here's why buy-and-hold investors should wait for a fat pitch in these three well-run insurers.
Bank on Buffett
The Oracle of Omaha's masterpiece isn't a P&C insurer in pure form -- it also happens to own a railroad, an airplane-parts manufacturer, and a reinsurance operation, too -- but it has recently offered investors the chance to buy at some of the lowest multiples in recent history. That may happen again.
Berkshire Hathaway's core property and casualty insurance units include the likes of GEICO, which, despite having a rough 2015 as low gas prices encouraged Americans to log more miles, will almost certainly grow to become the No. 1 company in car insurance. The company benefits from a model that eschews agents, allowing it to pass on low costs and grow to become the second-largest car insurer in the country.
Berkshire Hathaway currently trades for just under 1.35 times book value, a measure that Warren Buffett uses to value the growing conglomerate. He has previously stated that the company would repurchase shares at any price under 1.2 times book value. Shares nearly traded that low during the stock market rout in January.
Should the market give you a second chance, investors would be wise to snap up the company's stock. At 1.2 times book value, Berkshire will be in the market buying its own stock. Investors would be wise to follow.
The Baby Berkshire
Markel Insurance has an excellent record as a specialty P&C insurance company. From horses to boats and weddings, Markel will insure just about anything at the right price.
Markel's best assets are its discipline -- the company earned an underwriting profit in all but two years from 2003 to 2015 -- and its chief investment officer, Tom Gayner, who has been an excellent steward of the company's growing wealth. Over the past 20 years, Markel has compounded book value at 14% annually. From the relative peak in 2007, book value per share compounded at an annual rate approaching 10% per year -- far better than the stock market as a whole.
Shares of Markel, however, rarely come cheap. The insurer trades for about 1.6 times book value, not particularly compelling for a company whose earnings may have hit a recent peak on the back of impressive reinsurance results in 2015.
Short-term pressures could present a buying opportunity for those of us on the sidelines. The company's outsize profits from reinsurance are unlikely to continue, as Gayner spoke to the pricing difficulties in the industry at the annual meeting of shareholders. Buffett spoke similarly about the reinsurance industry's dismal outlook just days earlier.
History shows that Markel has the discipline to forgo profits in the near term for larger wins in the future. That prudence could shake out investors who bid up the company's stock on its short-term successes in 2015.
If we assume that the company can produce returns on equity of 12% over the long haul -- the midpoint of its post-crisis and 20-year historical growth in book value -- a better price may be in the neighborhood of 1.2 to 1.3 times book value, more than fair for an above-average compounder with plenty of growth still ahead of it.
The Massachusetts Dividend
A small East Coast insurer has built a big name as a dividend payer. Safety Insurance Group, a P&C insurer that specializes in automobile and homeowner lines, could prove tantalizing for yield-focused investors.
The company faced a short-term hiccup when record snowfall plagued Massachusetts in the first calendar quarter of 2015. The resulting losses culminated in the company's first-ever annual loss in its 35-year history.
Rest assured that 9-foot snowfalls are not the norm, and Safety Insurance capitalized on the losses by seeking approval for rate increases, which could buoy profits going forward. The company has proved to be a capable underwriter, historically pricing policies so that it can generate an underwriting profit.
Safety Insurance Group's simple business model has an important embedded earnings driver in the form of rising rates, as most insurance stocks do. Though it may be difficult to predict the timing or direction of interest rates, one thing is certain: Rising rates would be very good for Safety Insurance.
The company noted in its filings that it earned a meager 3.2% yield on its investment portfolio in the most recent quarter, dragged down by its preference to hold short-term bond investments that average 4.1 years in duration. Should rates tick higher, Safety will be a quick beneficiary, as the maturing securities in its portfolio can be quickly rotated into higher-yielding investments.
Somewhat ironically, Safety's high dividend yield of 4.4% helps keep shares elevated when interest rates dip, as income seekers buy dividend stocks as a yield alternative. At about 1.45 times book value, it's hardly cheap, but you'll be adequately compensated for normality in its underwriting performance and doubly rewarded if higher interest rates help juice its yield-starved investment portfolio.
Winning with insurance stocks
One of the smartest investors I know once told me that the secret to market-beating returns in insurance isn't as complex as many might want you to believe. The recipe is simple: Seek out insurers that reward managers for multi-year returns and underwriting profits, that hire people who are obsessively risk-averse, and that backstop losses by purchasing reinsurance against the very worst events. His overarching point: Great insurers play better defense than offense.
Managed well, this is an industry in which participants can and should print money for their shareholders as a steady stream of premiums exceed insurance losses and retained earnings are compounded by the insurer's investment results and growth in policies. These three insurers share many of these traits, making them the perfect building blocks for an opportunistic watchlist of insurance stocks to buy and hold forever.