NEW YORK (TheStreet) -- If you believe, like Warren Buffett, that boring insurance companies are one of the best paths to profits, then buy fast-growing HCI Group (HCI) - Get Report now. With a price-to-earnings ratio of just 8.31 and an even more favorable price-to-earnings-to-growth ratio (PEG), this undervalued stock won't remain cheap for long. Currently trading around $45, buy HCI up to $50.
In addition to a targeted return of 11% in the next few months, shareholders of record on May 15, 2015 will collect a 30 cents per share dividend (2.6% annual yield).
In order to do that, HCI has developed a proprietary risk-measurement tool that allows it to selectively choose which polices it will underwrite and which it will not. That has resulted in HCI being ranked as the third largest underwriter of property and casualty premium dollars in the state of Florida, yet it ranks only 15th in total dollar risk exposure (by way of comparison, the top two largest underwriters of premiums are also the two highest ranked for risk exposure).
It is that type of intelligent management that ultimately is reflected in the financial performance that our proprietary stock-picking model measures, and in this case it has now identified HCI as one the ten most attractive stocks to own now.
A Peter Lynch-Style Investor Would Also Like HCI
While Buffett is well-known for his love of insurance stocks, in this case it is superstar mutual fund manager Peter Lynch's investing profile that has identified HCI Group as undervalued based on its exceptional performance. See how HCI fares against some of Lynch's criteria:
1. PEG ratio: What made Lynch famous was his "PEG Ratio," which compares a company's price-to-earnings ratio to the rate of growth in its earnings over the previous five years. It was Lynch's belief that a PEG ratio of less than 1.0 indicated that a company is growing its earnings at a higher rate than the market is valuing them. In this case HCI has a very low PEG ratio of 0.17, meaning it has been able to grow its earnings at a rate greater than five times the value the stock market is placing on them.
2. Earnings-per-share growth rate: Lynch also believed that there is an optimal range of earnings growth between 20%-to-50% annually, as anything less than that isn't exceptional and anything more than that isn't sustainable. In this case HCI has been growing its earnings at a 49% rate, which is at the top end of Lynch's range. But even if that rate dropped in half, its PEG ratio would still be well within tolerance.
3. Equity-to-assets ratio: In addition, Lynch wanted to know that a company was not using too much leverage (debt) to achieve earnings growth, so he would only own a stock with an equity-to-assets ratio of more than 5%. HCI easily surpasses this standard with a ratio of 30%, or six times Lynch's minimum requirement. He also assigned a "bonus point" to a stock if it had a net cash-to-price ratio above 30%. HCI beats that with a ratio of 37%, indicating it has plenty of liquidity to handle a sudden spike in claims from an unexpected natural disaster.
4. Return on assets (ROA): Lynch used ROA as a way to measure a financial intermediary's profitability. HCI's ROA of 11.1% is well above the minimum 1% that he looks for.
5. Net Cash Position:Another bonus for a company is having a net cash-to-price ratio above 30%. Lynch defines net cash as cash and marketable securities minus long term debt. According to this methodology, a high value for this ratio dramatically cuts down on the risk of the security. The net cash-to-price ratio for HCI of 37.4% is high enough to add to the attractiveness of this company.
For more on why Peter Lynch would recommend you buy HCI Group up to $50, watch this short video.
This article is commentary by an independent contributor. At the time of publication, investors at Baton Investing, the author's company, held HCI. As is normal with the Baton Investing system, HCI will likely be sold in the next few months as its valuation grows.