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This Small Insurance Company Has High Growth Potential

By Courtney Carlsen - Feb 25, 2021 at 8:25AM

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Goosehead Insurance has grown premiums 36% compounded annually for 10 years, but valuation metrics indicate it is expensive. Is this growth stock a buy?

When it comes to growth stocks, you probably wouldn't consider the insurance industry a place to look. But then you'd miss Goosehead Insurance (GSHD -2.02%), a small insurance agency that's relatively young and has grown rapidly since it went public almost three years ago.

Goosehead is a personal lines insurance agency, focusing on coverage for things like home, auto, and floods, and it underwrites personal lines and commercial lines for about 100 insurance companies. Its business includes a franchise model, which has resulted in stellar growth on the top and bottom lines. But like many growth stocks, it's sitting at a hefty valuation, so let's see if it's worth its high price.

A differentiated business model

Goosehead, which was founded in 2003, focuses on providing personal lines of insurance by entering into contracts with insurance carriers that include things like terms of engagement and compensation. Goosehead receives commissions every time customers sign up for insurance; the average rates are 15% for new signups and 13% on renewals.

The company operates two segments, its corporate channel and franchise channel. Corporate was the primary channel at first, and includes Goosehead's corporate headquarters, where employees are hired and trained by the company itself. This channel generates revenues from commissions from new or renewed policies, and from agency fees.

The franchise channel was created in 2012 and is the faster-growing of the two. It generates revenues from initial franchise fees and royalty fees -- which include royalty fees for new or renewed policies. Because the corporate channel handles renewals, Goosehead receives 50% royalties on premiums for renewals, versus 20% of royalties on new signups. This structure creates a step-up in revenues after first policy term and is part of why the company has grown so quickly. This payment structure helps align incentives, so that the franchise channel focuses on new business generation only -- which is what will ultimately drive long-term growth.

Hands signing paperwork.

Image source: Getty Images.

The insurance agency has done a great job of growing the top and bottom lines over the years. In the first nine months of 2020, revenue grew 29% compared to the same period last year, to $82 million, with diluted earnings per share up 33%, to $0.36 per share. Since 2017, it has seen great growth in both channels, with the corporate channel's premiums growing at a 30% compounded annual growth rate and its franchise channel's premiums growing 58% compounded annually.

Its franchise model is a competitive advantage

Goosehead seeks out entrepreneurial individuals from independent agencies to head its franchises. The corporate channel helps lift franchises through training. Franchisees also have access to Goosehead's processes, systems, and back-office support team to sell insurance. Because the corporate channel provides important renewals, risk management, accounting, legal, and finance functions, franchisees are able to focus on acquiring new clients.

As of Sept. 30, Goosehead had over 1,261 franchisees, a 33% growth in franchisees compared to 2019. There's also a strong demand for insurance agents interested in joining Goosehead's franchise network -- with 114,000 potential franchise candidates in the pipelines.

Competition and growth prospects

Goosehead competes across the U.S. personal lines insurance distribution industry. The company's ultimate stretch goal is to become the largest U.S. personal lines distributor. However, this would require catching up to the leader State Farm, which wrote nearly $60 billion worth of premiums. In comparison, Goosehead just passed $1 billion worth of premiums in 2020. Clearly it has a long way to go to achieve this goal.

But the industry is fragmented, and it thinks its technology and business model can be disruptive. Working with over 100 carriers ensures Gooesehead can find the best insurance coverage to fit its customers' needs, and that's one reason why it scores highly on customer service -- with a net promoter score of 91 in 2020, 2.4 times the property and casualty insurance industry average.

High valuation may be worth it

Goosehead is expensive by any valuation metric, with a price-to-earnings (P/E) ratio of 476, a price-to-forward-earnings ratio of 175, and a PEG of 7.92. These metrics make Goosehead one of the most expensive companies in the insurance industry. In general, a high P/E ratio is indicative of higher earnings expectation, but it can also sometimes be a sign that a stock is overvalued. While this can sometimes stay high for a while, a ratio that's too high can be a warning sign -- unless you believe the company can grow into its multiple.

For Goosehead stock, growth is an important factor to consider. In the past 10 years, to October 2020, the company grew premium revenues by 36% compounded annually, and 45% in the past five years. While the stock is expensive, the company has a habit of impressive growth -- a testament to its business model.

A great stock to buy and hold long-term

Goosehead is a relatively young company with consistent, strong growth. While its valuation is high, I think it's a business to buy and hold for the next decade. The company reports earnings on March 11, something I will be paying attention to. 

One final note: If you purchase this stock, you may want to consider putting in a limit order, which lets you determine the maximum you're willing to pay for shares. The reason is because the stock is more lightly traded, and market orders can rocket stock prices higher on these types of stocks, causing you to end up paying more than you anticipated.

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