Almost a third of the way into the year, stocks haven't recovered much from their lows -- at Friday's close, the S&P 500 was down 10.4% so far in 2022.
One stock that has performed well to start the year is Progressive (PGR -0.77%); the auto insurer finds its stock up 5.5%. However, if you glanced through its first-quarter earnings report and noticed that its net income fell almost 80%, you might have wondered why investors weren't running away instead.
As a holder of Progressive stock, I'm not too concerned. Here's why.
Image source: Getty Images.
Progressive's primary business continues to grow
In the first quarter, Progressive saw net income drop 79% to $314 million after putting up nearly $1.2 billion in profit in the same quarter last year. What happened?
The problem isn't Progressive's primary business: writing good insurance policies. Progressive's net premiums earned were up 13% from last year to $11.8 billion during the quarter. What dragged Progressive down in the quarter was investment losses of $445 million.
Progressive, like many other insurers, brings in cash when customers pay their policies and then uses those funds to pay out customer claims. In the time between the receipt of cash and the payment of claims, it can invest that cash, also known as float.
Progressive invests 92% of its investment portfolio in bonds, like U.S. Treasuries and corporate debt. In the first quarter, the iShares 20+ Year Treasury ETF lost 10% while the iShares Trust-iShares iBoxx $Investment Grade Corporate Bond ETF lost 8%, dragging down Progressive's investment returns. Last year, the insurer saw investments drive a gain of $585 million. This $1 billion swing in investment results was the primary driver of its loss in the quarter.
Progressive is used to seeing a swing in investment gains and losses. Over the last four years, the company has seen investment losses in three different quarters, including the last one.
Data source: Progressive quarterly filings. Chart by author.
The company benefited from strong investment returns in the quarters following the initial market shock from the pandemic in March 2020. However, Progressive's investment results were lackluster, with bonds and stocks off to a slow start in 2022.
As a shareholder, I'm not concerned. That's because investment gains and losses and investment income make up such a small portion of Progressive's overall earnings.
To put it in perspective, here's that same information alongside investment income and earned premiums. As you can see, investment gains or losses tend to fluctuate and make up a minimal source of its revenue.
Data source: Progressive quarterly filings. Chart by author.
Here's how I like to gauge the business
I pay closer attention to how premiums grow and how well Progressive is doing at writing policies. Over the last 10 years, Progressive has grown its premiums earned at an 11.5% compound annual growth rate. Not only that, but the company has consistently written profitable insurance policies.
One measure that helps measure profitable underwriting is the combined ratio, a measure of profitability for insurers that's the ratio of the claims paid out plus operating expenses to the total premiums collected. A measure below 100% means a company is writing profitable policies, so the lower the ratio, the better. Progressive's goal is to keep this ratio below 96%, which it has done for 20 years.
Data source: Progressive annual and quarterly filings. *2022 data through the first quarter. Chart by author.
Progressive's primary business is not investing, and fluctuations in gains or losses on its investments are expected -- which is why I'm not selling the stock as long as Progressive continues to underwrite profitable insurance policies.
