Although insurance businesses aren’t always easy for investors to understand, in my experience they can be very profitable investments.
Today I want to look at two dividend stocks in the insurance sector, one of which I own myself — and both of which are owned by top fund manager Neil Woodford.
The specialist choice
Lancashire Holdings Limited (LSE: LRE) is a specialist insurer which provides insurance against assets such as aircraft, ships and oil rigs.
This year’s damaging hurricane season has brought to an end a run of quiet years without major payouts. The group’s return on equity for the third quarter has fallen to -10.4%, from +3.1% during the same period last year.
These losses aren’t unexpected. The group’s loss estimate of $106m-$212m is described as “comfortably within our expectations” by chief executive Alex Maloney.
For shareholders, there’s good news and bad. In the short term, the bad news is that the bumper special dividends paid in recent years will be stopped. Management believes that market conditions in 2018 will allow it to put fresh capital to work, so it won’t be returning spare cash to shareholders.
This means that the dividend yields of 7-10% enjoyed by shareholders will come to an end for now, at least. Instead, shareholders will get Lancashire’s ordinary dividend, which gives a yield of about 1.5% at current prices.
The good news is that the company believes that this year’s string of major catastrophes mean that insurance rates are likely to rise. Rivals who have been under-pricing risk could run into problems and securing higher rates now should support profit and dividend growth in the future.
During the years I’ve been following this company, management commentary has always been consistent and accurate. I’m not surprised that Lancashire shares have risen by 20% since late September and investors are pricing in a more profitable future.
I suspect we may get a chance to buy the shares more cheaply when market enthusiasm calms a little. In any case, I rate this stock highly as a quality business.
I’m not selling yet
One of the oldest holdings in my own portfolio is currently Aviva (LSE: AV). This stock has been a great income investment for me and has delivered a healthy capital gain to date. But I’m not in any rush to sell just yet.
Chief executive Mark Wilson has been consistent in his focus on cash flow, profitability and balance sheet strength. The success of this approach seems clear to me. During the first half of this year, cash generation rose by 56% to £1,170m, while operating profit rose by 11% to £1,465m. The group’s Solvency II coverage ratio, a key regulatory measure, improved from 189% to 193%, putting the group on a level with key rivals.
Although Wilson has now delivered several years of consistent progress, the market has remained cautious and Aviva’s valuation still seems quite modest to me.
At around 515p, the shares trade on just 1.2 times their book value of 412p per share. The stock’s forecast P/E of 9.5 is lower than many rivals, and the forecast yield of 5.1% is above average for this sector. I’m seriously considering buying more for my portfolio.