It's been a tough year for equity investors, as evidenced by the bear market. The widely-followed benchmark indexes, the S&P 500 and Nasdaq Composite, are down 22% and 31%, respectively, from their recent highs.
Investors are concerned about inflationary pressures and the Federal Reserve's aggressive response using multiple interest rate hikes. However, Federal Reserve Chair Jerome Powell reiterated the central bank's strict policy, saying, "we have got to get inflation behind us."
The Fed's interest rate increases could continue to wreak havoc on the stock market and keep it in bear market territory for a while longer. If that's the case, you'll want to own stocks in high-quality companies that can do well in any environment and generate strong cash flows. Three quality companies on my radar are Visa (V -0.83%), Kinsale Capital Group (KNSL -0.91%), and Progressive (PGR 0.14%).
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Visa: Robust payments network drives strong profit margins and steady cash flow
Visa leads the world when it comes to payment processing. Through its debit cards, credit cards, and other payment methods, Visa processed nearly $9 trillion in payments in 2020. Mastercard was a distant second with $4.7 trillion in payments volume.
What's appealing about Visa is the network effect it has built up over the years. Visa spent years coordinating payments between banks, consumers, and merchants, giving it a powerful competitive advantage.
Visa's business is relatively asset-light, meaning it doesn't have to invest much capital into equipment or inventory, helping it generate relatively high profit margins and strong cash flows. Over the last decade, Visa's net profit margin averaged 44%. The payments giant pulled in over $16 billion in free cash flow -- or net cash from operating activities minus capital expenditures -- over the last 12 months. This is cash that the company can use to make acquisitions, pay dividends to shareholders, or buy back shares during the current bear market.
Data by YCharts.
Because Visa earns fees on a percentage of the payment volume that goes through its network, it should remain resilient in the face of inflation. For this reason, Visa can perform well in a bear market and will do even better when economic conditions eventually stabilize.
Kinsale Capital: Paid well to write insurance policies others won't take on
Kinsale Capital Group writes insurance policies on hard-to-measure risks that other insurers don't cover. The company operates in the excess and surplus (E&S) insurance market, writing policies on small businesses, construction, product liability, and professional liability.
Kinsale fills a gap in the market, writing policies many other insurers won't touch, helping it produce high profit margins and strong cash flows. The insurer measures this risk well and produces lower loss ratios than its peers.
One way to see this advantage is through the company's combined ratio. The combined ratio is the total expenses plus claims divided by premiums taken in. The lower the ratio, the more profitable the policies. Over six years, Kinsale's combined ratio was 82%, beating the industry average combined ratio of 99% during the same time.
Data sources: Company filings and National Association of Insurance Commissioners. P&C = Property & Casualty. Chart by author.
This year Kinsale has grown its net written premiums by 47% from last year. Lackluster investment performance dragged its net income down 13%. However, the company posted a stellar combined ratio of 78%, showing that its core business continues to outperform, making it another solid stock that can do well if the bear market continues.
Progressive: The auto insurer is pricing policies with precision
Progressive was the first auto insurer to price its policies using driving behavior, known as telematics. Telematics is a technology that records a driver's behavior while behind the wheel, collected through a mobile app or a device installed in a car. With that data, Progressive can gain insight into a customer's speed, braking time, and miles driven. Customers can win by getting discounts for good driving, and Progressive wins by being able to price policies with precision.
For over a decade, the insurer has leveraged the technology, translating into industry-beating profitability. Since 2011, Progressive's combined ratio has averaged 92.7%, beating the industry average of 100%. This strong underwriting has helped Progressive grow its free cash flow at 15% compounded annually over the last decade.
In the first half of the year, the company's net premiums earned, or the premiums it has made based on how much time has passed on a policy, increased by 12% -- an excellent sign that the company can continue outperforming even in a bear market.
