Insurance companies don't offer nearly the same pizzazz that other high-beta sectors have. They don't even offer the same enticement that banks have, so you can often see why investors usually roll their eyes when the discussion of insurance stocks comes up. But they shouldn't.
Insurance companies can often be purchased at a discount to other sectors despite the fact that they normally offer a steady stream of cash flow. Part of this stems from the idea that investors are discounting against the losses that could be incurred from future natural disasters. The other part of the story is that most investors really don't understand insurance companies.
The goal here today is not to get to know every company out there, but to highlight two that have done a reasonable job at increasing shareholder value through dividends, while also pinpointing one that looks like a suckers bet.
Insurers don't get much better than Cincinnati Financial. The company began paying a quarterly dividend to shareholders in 1954 and hasn't lowered its quarterly distribution since 1960. Currently yielding 5.4%, Cincinnati Financial is one of the highest-yielding dividend aristocrats and one of the more secure dividends in the sector. Let's take a closer look at how it's able to sustain this tantalizing dividend.
If you base everything just on last quarter's results, you'd be sorely disappointed. Last quarter marked the second highest catastrophe losses the company has seen in the past 12 years and is the primary culprit as to why its combined ratio -- essentially a measure of how profitable it was for an insurer to underwrite policies -- was in excess of 100 in most of its business segments. A figure over 100 indicates that it was unprofitable to write policies during that period. However, if you look at Cincinnati Financial's historical performance, this is an anomaly.
The real gem behind this dividend growth story is the company's aggressive, yet still prudent, approach to investing. With $12 billion on its balance sheet, Cincinnati Financial has taken to putting 26% of its portfolio -- a figure far and away higher than many of its peers -- into dividend-paying equities. The remaining cash is predominantly divided among high-rated bonds. While this is an approach that could be problematic if the market suffers a meltdown like we saw in 2008, its portfolio should easily outpace many of its peers' based on investment returns.
I know you're probably getting tired of hearing me tout Tower Group, but the recent growth in its dividend is unparalleled. Already a personal choice in my 10 small caps to rule them all series, and a second-quarter dividend champion, Tower Group offers the perfect balance of value and dividend rewards.
From a value perspective, being the biggest doesn't always mean being the best. Take, for example, three of Tower's closest rivals, which also happen to dwarf Tower in market value: Hartford Financial Services
5-Year Compounded Dividend Growth Rate
|Hartford Financial Services||0.59||1.50%||(24.2%)|
Source: Yahoo! Finance.
On paper, all four companies have very similar P/E ratios, but Tower's dividend growth rate, current yield, and price-to-book ratio are in combination significantly better values than its larger peers.
Having recently hiked its quarterly payout by a whopping 50%, Tower is now yielding north of 3%. Looking back five years, Tower's dividend has jumped by a cool 652% -- yet its payout ratio sits at a minuscule 20%, meaning it's only paying out 20% of its earnings in the form of a dividend. Usually a 652% five-year jump in quarterly distributions might signal a slowing is ahead, but with a payout ratio this low, it looks like Tower's dividend momentum could continue for years to come.
Perhaps Primerica's first day of trading was an omen. A spin-off of Citigroup
Primerica isn't lacking in name recognition or licensed agents. Selling term-life insurance and targeting middle-income America, the company made a name for itself over the past decade -- but middle-class America isn't what it used to be. Primerica's revenue saw a steep decline in 2010 and is projected to tumble by another 20% in 2011. In its most recent quarter, term-life revenue dropped off a cliff, falling 69%, while its corporate products segment revenue dropped 47%.
Currently yielding a paltry 0.5%, Primerica is paying out only $0.12 per year in distributions for a payout ratio of just 1%. I've heard of playing it safe, but a payout ratio of 1% is a slap in the face to current shareholders. I'll give the company some leeway since it has only been publicly traded for just beyond a year, but I think the trend of falling revenue is really the worry here, and management isn't hiking that dividend potentially because of the uncertain nature of its revenue stream. I'd keep my distance from Primerica.
Insurance companies aren't going to offer you double-digit growth rates or fancy new products, but they can provide steady enough cash flow and above-average dividend yields that would allow most of us to sleep better at night. While the sector is littered with dividend-paying companies, Cincinnati Financial and Tower Group appear to be two standouts that could pay handsome rewards for current and future shareholders.
Do you think the insurance sector is worth a second look? Tell me by posting your thoughts in the comments section below. Also consider adding Cincinnati Financial, Tower Group, and Primerica to your watchlist to keep up on the latest happenings within the insurance sector.
Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy that is guaranteed to survive all natural disasters.