Aflac Is a Buy Today -- Overcome Your Japanese Economy Fears and Profit

Aflac stock has a low price-to-earnings ratio of just 11. See how this company continues to grow despite a sluggish Japanese economy.
By Ben Reynolds ,

Everyone knows the Japanese economy is in trouble. The nation has a declining population, a debt-to-gross domestic product ratio of more than 200% (yes, really) and a stock market that hasn't gone up in around 30 years.

But there's one company with a huge business in Japan that is doing quite well. Free-thinking investors should take a deeper look at Aflac (AFL) - Get Report .

AFL data by YCharts

Forget about those goofy duck advertisements in the U.S. Aflac is a Japan-focused business. Aflac generates about three-quarter of its premium revenue in Japan, with the other quarter coming from the U.S. Another interesting fact: the company's Japan business was built on cancer insurance.

The insurance industry is responsible for several phenomenal fortunes. Warren Buffett's Berkshire Hathaway has a significant insurance business. The lesser known (but unbelievably successful) Shelby Davis made $900 million investing almost exclusively in insurance stocks. In short, the insurance industry can offer investors tremendous returns. That's because the economics of the insurance industry are so favorable.

Insurers take in premiums. They pay out claims. The most important metric in insurance is the combined ratio. The combined ratio is calculated as follows:

(claims paid + all other expenses) / premiums received

When the combined ratio is less than 100%, an insurer is making money from its insurance policies before investment gains.

The real money in insurance comes from investing the float. The float is premiums earned that have not yet been paid out as claims. It is money the insurance company gets to temporarily control.

When an insurance company's combined ratio is less than 100% that means in essence the company is getting negative interest rate investable loans. That is very powerful -- it's how Warren Buffett went from being a multimillionaire to being a multibillionaire.

Aflac's combined ratio for the last four years is listed below:

  • 2014 combined ratio of 96%
  • 2013 combined ratio of 95%
  • 2012 combined ratio of 95%
  • 2011 combined ratio of 94%

As you can see, Aflac's insurance operations are very profitable.

But Won't Japan's Struggling Economy Hurt Aflac?

Japan's economy didn't start struggling today.

From 2005 through 2014, Aflac's annual premiums in force in Japan grew at an average of 5.2% a year. According to World Bank data, average growth of Japanese GDP over the past decade has been less than 1%. Clearly, Aflac can grow while Japan stagnates.

Of course, there is one aspect of the Japanese economy that should worry Aflac investors: Japanese government bonds.

More than 38% of the debt that Aflac holds consists of Japanese government bonds. If Japan experiences significant inflation from its loose monetary policy, Aflac could realize very significant investment losses.

The potential for temporary investment losses does not detract from Aflac's favorable insurance operations as a whole. The company will continue to reap the benefits of profitable insurance policies even if Japan is hit with inflation.

Aflac's Expected Total Returns

Despite weakness in the Japanese economy, Aflac stock has solid expected total returns going forward.

The company is expected to grow premium revenue (on a constant-currency basis) at between 2% and 5.5% a year over the next several years.

In addition to this growth, Aflac has a 2.5% dividend yield and is expected to repurchase between 3.0% and 4.5% of shares outstanding each year going forward.

The company's total returns by source are broken down below:

  • Dividend yield of 2.5%
  • Organic growth of 2.0% to 5.5% a year
  • Share repurchases of 3.0% to 4.5% a year

In total, investors in Aflac should expect total returns of between 7.5% and 12.5% a year going forward.

Aflac Stock Is a Bargain Today

The S&P 500 is currently trading at a price-to-earnings ratio of 21.6. Aflac is trading at a price-to-earnings ratio of 11.1. Aflac's earnings are trading at nearly 50 cents on the dollar as compared to the overall market.

This is unusual for a company with average to above average expected total returns (such as Aflac). Over the long run, the S&P 500 has returned around 9% a year. Aflac's average expected total returns are 10%. There's no reason Aflac stock should be trading at such a discount to the overall market.

Final Thought: Aflac Is a Buy Today

Aflac stock has a low price-to-earnings ratio. It has favorable growth prospects. It has an above-average 2.5% dividend yield.

Better yet, the company has highly profitable insurance operations, is shareholder friendly, and operates in the slow changing insurance industry.

All of the above factors help Aflac to rank highly using The 8 Rules of Dividend Investing. Serious dividend growth investors looking for exposure to the insurance industry should consider adding Aflac to their portfolios.

This article is commentary by an independent contributor. At the time of publication, the author was long AFL.

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