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
|Gauging Valuations |
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|
The Top FourLongtime readers know that Allstate ( ALL) is a personal favorite. It's second-best in the industry behind Progressive, but it's far cheaper. Aside from State Farm, no one has a bigger database, and the name of the game today is slicing and dicing the database to more accurately predict claim activity. It will sacrifice the top line to preserve profitability, which is an admirable quality. Affirmative Insurance ( AFFM) is a nonstandard insurer working mainly in the South and the Midwest. It was spun out of Vesta Insurance three years ago; in my opinion, it was the best part of Vesta's operations, and Vesta has suffered since. It has the advantage of being both a marketer and an underwriter. In strong markets, it underwrites more. In weak markets, it originates insurance and allows competitors to underwrite the business. It's a clever strategy, I think. Why don't I own this, aside from many earnings misses? That's a question I'm pondering now. I like Safeco ( SAFC), and would buy it on weakness, say, with a "four handle." Like Allstate, it will slow growth in environments like this one and preserve the balance sheet to write in better pricing environments. Commerce Group ( CGI) is a bunch of clever guys who managed to pick the lock of the most dysfunctional personal lines insurance market in the U.S., Massachusetts. It's the big fish in that small market, and it's looking for places to grow. Where it goes next is anyone's guess, which makes me hesitant, as does the fact that management seems a little weak at present. Is this a one-trick pony?
The Bottom FourFirst Acceptance ( FAC) is a company that is new to the personal lines space; it would be a surprise if it had talent in underwriting. I'd simply stay away. The bold can consider shorting. Progressive ( PGR) is arguably the best-run company in the industry, so aside from being overvalued, I am unlikely to short it. That said, competitors like Allstate and Safeco have created pricing models that are at least close to the accuracy of Progressive's. The advantages that Progressive had in the past are being imitated by its best competitors.
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