When building wealth in the stock market, one smart move you can make is to invest in quality companies with competitive advantages and robust cash flows that can grow no matter what the economy does.
One place you can unearth hidden gems like this is the insurance industry. Insurance companies can be an excellent source of cash flow because their products are always in high demand. While these businesses aren't exciting, well-run insurers can deliver phenomenal market-beating returns with less volatility over the long haul.
Image source: Getty Images.
Established insurers are a good bet and can make an excellent addition to your diversified portfolio. Two insurance stocks you should consider buying this month are Berkshire Hathaway (BRK.A -0.76%) (BRK.B -0.69%) and Progressive (PGR -0.97%). Here's what they can bring to your portfolio.
1. Berkshire Hathaway's insurance holdings are crucial to its growing cash stockpile
When you think of insurance stocks, Berkshire Hathaway probably isn't one of the first to come to mind. However, when you dig into the conglomerate, you'll find that it owns numerous insurance companies that are a crucial component of its growing cash stockpile.
Berkshire Hathaway is the second largest insurance company in the U.S. behind State Farm, while publicly traded companies Progressive and Allstate round out the top four. The conglomerate owns several insurers, including GEICO, Berkshire Hathaway Reinsurance Group, National Indemnity, and Alleghany, which it acquired a couple of years ago for $11.6 billion.
The nature of insurance appeals to CEO Warren Buffett and his team at Berkshire. That's because insurers consistently collect premium payments from customers. Because claims costs tend to be relatively predictable, insurers sit on a large pile of cash they can put to work within investment portfolios. This cash is known as float and has been a robust source of cash for Berkshire Hathaway.
Since 1967, Berkshire's float has gone from $19 million to $164 billion, a staggering increase of 863,732%. Berkshire's insurance companies have done a stellar job of writing profitable policies over time and are "a very large chunk of Berkshire's value," according to Buffett.
Today, Berkshire is sitting on a cash stockpile of $157 billion, which it can use to invest in stocks and bonds or make acquisitions. Given its firm financial foundation, Berkshire is an excellent stock investors can confidently own for the long haul.
2. Progressive crushed the market with the help of profitable underwriting
Progressive is another high-quality insurance company worthy of a spot in your portfolio. The insurer has an excellent track record of success thanks to its commitment to underwriting profitable policies.
In 1965, Peter B. Lewis (son of co-founder Joseph Lewis) took over the company. At the time, it was commonplace that insurers would break even on their policies and that the actual returns would come from their investment portfolios. Lewis rejected this practice and prioritized earning an underwriting profit on its policies, even if it meant losing out on some customers.
In 1971, the company committed to achieving a combined ratio of 96, meaning it would earn $4 in profit for every $100 of premium earned. This goal has been a cornerstone of its success.
Progressive has maintained a prudent, disciplined approach to underwriting policies ever since. And while the company isn't very aggressive with its investment portfolio, it doesn't matter. Since 1993, the company has returned 16.4% annually to investors, well above the S&P 500's annualized return of 10%. Best of all, the insurer continues underwriting profitable policies.
PGR Total Return Level data by YCharts.
These two quality stocks can lower your portfolio's volatility
Berkshire Hathaway and Progressive are quality stocks if you want market-beating potential with less volatility. Beta measures how much a stock moves relative to the overall market. A value under 1 means a stock is less volatile than the broader market.
Berkshire and Progressive have five-year betas of 0.86 and 0.42, making these stocks a solid choice if you're looking to lower the overall volatility of your portfolio. With their well-run insurance operations that consistently produce cash flows, these two stocks can make excellent additions to your diversified portfolio this January.
