Cincinnati Financial (CINF -0.65%) has grown its dividend payout annually for over six decades, earning it the rare designation of a Dividend King. Only eight public companies have increased their dividend over a longer time, affirming that this is one of the most reliable dividend stocks you could buy.
After a record profit in 2021, Cincinnati Financial posted an annual lost of $486 million in 2022. Despite this, the stock price is up 6.9% since the start of 2022, while the S&P 500 index is down 14.8%. Here's why investors shouldn't fret over Cincinnati Financial's net loss and why it will bounce back as the stock market recovers.
Swinging from a profit to a loss
Cincinnati Financial's main business is writing insurance policies, including automotive, property, and homeowners insurance. Last year its insurance business performed well, growing its premiums by 11%. Despite this, the insurer posted a $486 million loss during the year, a significant decline from its $2.9 billion profit in 2021. This swing was due to lackluster performance on its investment portfolio.
To understand this, let's first dive into how insurance companies operate. Insurers collect customer payments upfront and provide their service of resolving claims at a later date. Because there is a period between collecting payments and paying out claims, insurers invest this held cash in stocks and bonds to earn extra income. When an insurance period lapses, the insurer keeps that leftover money and can invest it as it sees fit (assuming its policies were profitable).
Entering 2022, Cincinnati Financial had a $24 billion investment portfolio spread across fixed-maturity investments, like bonds, and equity investments, like stocks.
Data source: Cincinnati Financial 10-K filing. Chart by author.
Last year, the Federal Reserve raised interest rates multiple times to bring down inflation. The rapid increase in interest rates affected bonds because interest rates and the price of bonds are inversely related. So when interest rates rise, the fair value of its bond holdings falls. In addition, the S&P 500 fell 19.4% during the year, its worst annual return since 2008, weighing on Cincinnati Financial's equity investments. As a result, Cincinnati Financial posted a $1.6 billion investment loss last year after posting a $1.9 billion investment gain in 2021.
Cincinnati Financial investors shouldn't overlook this
Cincinnati Financial had a solid year in its primary business of writing insurance policies. The company did a solid job adapting to inflationary pressures and raised its premiums -- continuing its streak of profitable underwriting for the 11th consecutive year.
One positive aspect of higher interest rates is that insurers can put incoming cash into higher interest-earning assets, which should boost future investment income. However, the insurer will face short-term headwinds, especially if interest rates continue to rise.
According to the CME Group's FedWatch tool, investors project that the Federal Reserve will gradually increase its benchmark interest rate by about 1% by July. Rising rates could continue to pressure its bond investments, reducing their fair value and resulting in more investment losses. Its equity investments face the same fate if stock markets remain turbulent.
Another potential scenario that could hurt Cincinnati Financial would be if it were to post an underwriting loss during the year that could require it to sell some of its investments to cover losses. The company aims to hold its investments long-term, so if it's forced to sell, it could realize losses on some of those investments. Given its strong position with over $1.2 billion in cash and cash equivalents and a history of profitable underwriting, this scenario isn't too likely. However, this is still something a potential investor must consider.
A solid dividend stock with a long history of payouts
Cincinnati Financial posted a net loss last year, but its insurance business performed well and is well-positioned to keep growing over a long time horizon. It'll likely face near-term headwinds on its investment portfolio, but as long as it doesn't have any outsized losses, it can take advantage of higher interest rates with new money flowing in.
Cincinnati Financial displayed an impressive history of growth and capital management and has increased its dividend payout for 63 consecutive years. Given its resilience in the face of inflation, and its ability to take advantage of higher interest rates, Cincinnati Financial is a dependable income stock investors can consider adding today.
