Like most private investors, I drip-feed money from my earnings into my investment account each month. To stay fully invested, I need to make regular purchases, regardless of the market’s latest gyrations.
However, the FTSE 100 is up 82% on its March 2009 low, and the wider market is no longer cheap. It’s getting harder to find shares that meet my criteria for affordability.
In this article, I’m going to run my investing eye over Direct Line Insurance Group (LSE: DLG), to see if it might fit the bill.
The triple-yield test
Today’s low interest rates mean that shares have become some of the most attractive income-bearing investments available.
To gauge the affordability of a share for my portfolio, I like to look at three key trailing yield figures –the dividend, earnings and free cash flow yields. I call this my triple yield test:
| Direct Line Insurance Group | Value |
|---|---|
| Current share price | 261p |
| Dividend yield | 4.7% |
| Earnings yield | 9.5% |
| Return on tangible equity | 17.3% |
| FTSE 100 average dividend yield | 2.8% |
| FTSE 100 earnings yield | 5.7% |
| Instant access cash savings rate | 1.5% |
| UK 10yr govt bond yield | 2.8% |
A share’s earnings yield is simply the inverse of its P/E ratio. Direct Line’s 9.5% trailing earnings yield equates to a P/E of 10.5 and looks appealing, especially alongside its above-average dividend yield of 4.7%.
Return on tangible equity (RoTE) is a useful measure of profitability for insurance companies, and Direct Line’s adjusted RoTE, which excludes discontinued/run-off businesses, rose from 11.5% at the end of 2012 to 17.3% on an annualised basis during the first half of 2013. That’s an impressive figure, but even Direct Line’s own CEO, Paul Geddes, was moved to admit a degree of luck, saying that “these are a good set of results, even allowing for the benign weather in the period”.
That benign weather hasn’t continued, and a recent report by Bank of America Merrill Lynch analysts suggests that the firm may experience a £145m loss as a result of the recent flooding. Although some of these losses may be booked in 2014 figures, rather than hitting last year’s earnings, some impact is still expected.
Is Direct Line a buy?
Direct Line’s share price has risen by 40% since the firm’s shares commenced trading on the LSE in October 2012.
Although the Direct Line’s dividend yield remains one of the most attractive in its sector, I believe there is a risk that the 2013 results could fall below expectations. Given this, I would wait until after Wednesday’s full-year results announcement to decide whether the insurer’s shares remain a buy, or not.