The Hartford Financial Services Group (NYSE:HIG) is a well-performing insurance company that continues to trade at a material discount to book value even though the business presented respectable business results over the last couple of years.
Strong underlying earnings trends and cyclical tailwinds in commercial insurance pricing could also justify a materially higher market valuation for this insurance business in 2014 and beyond.
Insurance companies are out of favor
Investors always seem to prefer one sector over others depending on where they believe the largest earnings momentum is going to happen.
However, this approach to investing, also called sector rotation, may not necessarily be successful, because it requires investors to be superior market timers. I don't think many investors can efficiently switch between sectors and ride temporary waves of momentum on a consistent basis.
Instead, why not buy quality insurance companies such as Hartford Financial at a sizable discount to book value?
Hartford Financial's earnings trends are very encouraging, and its results are largely driven by a well-performing property and casualty unit. All major product lines (property and casualty, group benefits and mutual funds) reported strong core earnings growth over the last 12 months.
Hartford's core earnings also jumped a whopping 26% to $1.4 billion from 2012 to 2013, and further momentum in 2014, driven by a strong commercial property and casualty business, could justify much higher share prices indeed.
Strong property and casualty business
Hartford Financial's value largely depends on its commercial property & casualty business, which accounts for roughly 50% of Hartford's core earnings.
The commercial P&C segment is doing particularly well for Hartford, and all metrics are moving in the right direction.
Hartford Financial's commercial unit raked in about $6.3 billion in written premiums in the last 12 months, and the company should well be able to exceed such volumes in 2014.
In addition, Hartford Financial's commercial P&C core earnings have materially improved to $882 million in the second quarter of 2014 (based on a "last 12 months" basis), compared to just $389 million in 2011.
Its combined ratio has also continually improved over the last couple of years, and its trend is encouraging: In 2011, Hartford Financial's commercial P&C combined ratio, a metric to gauge the underlying profitability of its policy writing, stood at 97.3 compared against only 91.2 in the second quarter of 2014 (again measured on an LTM basis).
I expect continued strong performance in Hartford Financial's commercial property and casualty business. A stronger growing U.S. economy should support higher insurance volumes as well as provide tailwinds for commercial pricing, both of which should fuel Hartford's core earnings growth for the remainder of the year.
Steep discount to book value
The third reason Hartford Financial's shares have the potential to rise relates to Hartford's apparent undervaluation as measured by its deep discount to book value.
Hartford Financial currently trades at an about 20% discount to book value. However, with a stronger performance in its core commercial property and casualty business going forward, Hartford Financial makes an extremely attractive value proposition.
Good value will not remain hidden for long. Ultimately, I expect property and casualty companies to trade at a sizable premium to book value in a cyclical economic upswing.
The Foolish bottom line
Hartford Financial has a lot of potential to increase its valuation. Its core P&C business reported strong increases in core earnings over the last couple of years, and its combined ratio development also looks promising.
In addition, Hartford Financial makes a great value proposition because of its sizable discount to intrinsic value.
Kingkarn Amjaroen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.