Time to Get Personal With Insurers
This column was originally published on RealMoney on March 27 at 3:34 p.m. EST. It's being republished as a bonus for TheStreet.com readers.
I favor financial companies with strong balance sheets and high business quality. Over a full market cycle, they will usually outperform the average lower-quality company.
There is an exception, though: When credit spreads are abnormally high (as from October 2002 to January 2004), and the credit cycle turns, it pays to buy low-quality companies that have survived the crisis. This would be one of the few times I would be tempted to lever up and buy all the momentum I can.
Simple screening techniques aren't generally applicable to financials, for the reasons that I outlined last week in the first part of this two-part series. Two relatively similar institutions may write business with decidedly different risk profiles. The one writing the more risky business will typically trade at lower price-to-earnings (P/E) and price-to-book (P/B) ratios, though free cash flow, could it be fairly measured, might show the company writing the higher quality business to be the cheaper one. Also, earnings quality will be higher for the company writing better-quality business and the likelihood of negative surprises will be lower.I use screens as a starting point. Typically, I use a metric that compares P/B to prospective return on equity (for more on my screening methods click here). This works best when comparing companies in very similar industries. I have nine models like this screening the subsectors of the U.S.-traded insurance universe.
Graphing price-to-book vs. ROE for the companies in the personal lines sector gives a sense of relative valuations
|Source: David Merkel|
|Personal Property and Casualty Insurers
|Symbol||Name||Market Cap||P/E||P/E (next year)||Est. ROE||P/B||Est. P/B||Possible Gain/Loss|
|HMN||Horace Mann Educator||795.7M||11.10||10.84||13||1.36||1.55||14|
|IPCC||Infinity Property and Casualty||871.5M||8.21||12.73||11||1.38||1.48||7|
|STFC||State Auto Financial||1.372B||10.91||10.32||17||1.77||1.84||4|
|TW||21st Century Insurance||1.376B||15.79||16.04||10||1.66||1.53||-8|
|Source: David Merkel|
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