Insurance Watch List: August 13, 2012

The following is one of our personal favorite watch lists. We started tracking the insurance industry in January 2011 and we’re very impressed with the results so far.

Anyone who wishes to be successful in insurance stocks should read the book The Davis Dynasty by John Rothchild. The book starts with Shelby Collum Davis investing approximately $50,000 to $100,000 that ultimately grew to $900 million after 47 years. The strategies employed by Davis seem more accessible to average investors as opposed to Warren Buffett’s leveraged strategies and education from Benjamin Graham.

Symbol Name Price P/E EPS Yield P/B Dividend payout ratio % from low
MCY Mercury General Corporation 37.3 14.24 2.62 6.6 1.1 2.44 93.13% 3.90%
ERIE Erie Indemnity Company 63.69 22.37 2.85 3.4 4.49 2.21 77.54% 4.19%
OB OneBeacon Insurance Group, Ltd. 12.69 22.38 0.57 6.6 1.07 0.84 147.37% 5.75%
TWGP Tower Group Inc. 18.76 47.14 0.4 4 0.71 0.75 187.50% 5.87%
FRFHF Fairfax Financial Holdings Limited 385 33.64 11.85 0 1.13 0 0.00% 5.90%
UNM Unum Group 19.39 26.31 0.74 2.7 0.65 0.52 70.27% 6.07%
FSR Flagstone Reinsurance Holdings SA 6.8 - -1.3 2.3 0.58 0.16 -12.31% 6.08%
WSH Willis Group Holdings Public Ltd. 35.5 14.99 2.37 3 2.29 1.08 45.57% 7.45%
ANAT American National Insurance Co. 70.73 10.46 6.76 4.3 0.58 3.08 45.56% 7.64%
THG The Hanover Insurance Group Inc. 35.16 14.55 2.42 3.4 0.6 1.2 49.59% 8.02%
ESGR Enstar Group Limited 93.78 7.69 12.19 0 1.07 0 0.00% 8.35%
MIG Meadowbrook Insurance Group Inc. 7.07 18.51 0.38 2.8 0.61 0.2 52.63% 8.44%
UNAM Unico American Corp. 10 20.83 0.48 2 0.71 0.2 41.67% 8.58%
RLI RLI Corp. 63.37 12.34 5.14 2 1.59 1.28 24.90% 8.88%
KFS Kingsway Financial Services Inc. 1.96 - -1.02 0 0.23 0 0.00% 8.89%
AIZ Assurant Inc. 34.91 5.6 6.23 2.3 0.59 0.84 13.48% 9.09%
NSEC National Security Group Inc. 8.35 - -3.16 4.6 0.77 0.4 -12.66% 9.15%
UVE Universal Insurance Holdings Inc. 3.31 8.11 0.41 9.6 0.82 0.32 78.05% 9.97%

Watch List Summary

On top of our watch list is Mercury General (MCY).  Because we like MCY as a trade and plan to buy the stock in our partnership account, we’d like to recommend an article with a negative view to offset our current favorable perspective.  The article is titled “ "Mercury General: High Yield, And High Risk" and outlines many good reasons to avoid the stock (found here).  Our experience with stocks near a new low is that there are great articles that can counteract much of the positive that we might see in a stock.  However, we believe that the aforementioned article is a good antidote to our recommendation.

According to Morningstar.com , MCY is considered a “buy” at $31 and at fair value at $45.  Our own model suggests that MCY is significantly undervalued at $39 and a “buy” at $45. Investment Quality Trends (www.iqtrends.com) indicates that when MCY is at a yield of 4.5% or higher, the stock should be considered for purchase.  Currently, MCY has a dividend yield of approximately 6.60%.  Keep in mind that we do not buy stocks for their dividend yield.  Instead, we use the company’s consistently increasing dividend as the only proof that the company management can:

  • increase earnings over time
  • reward current shareholders

Looking at Edson Gould’s Altimeter reveals that in the short-term Mercury General is undervalued.  However, when contrasted against the long-term picture from 1990 to the present, it is revealed that MCY has undergone a massive amount of change in valuation (see inset).

image

The new reality of Mercury General’s altimeter is a far cry from what it was in the past.  We’ve had to adjust our expectations for the stock with this new reality.  For now, the buy range for the Altimeter is at 65 and below suggesting that any price below $39.65 is reasonable.  MCY should be sold when the stock trades at or above 75 or $45.75.  Based on the current price of $37.30, MCY could potentially rise 22% from the current level.

Additionally, we see the downside risk, under “normal” market conditions, to be limited to the $31-$33 price range (approximately –17% from the current level).  Again, we see MCY as a reasonable way to achieve decent gains in the short to medium-term (approximately 10%-20% in the next year).

Also of particular interest to us is the second company on our list, Erie Indemnity (ERIE).  Erie seems like the type of company that should get bought out by Warren Buffett.  The aggressive rate that the dividend has been increased over the years has pushed this stock into the bargain basement.  ERIE has absolutely no debt with $2.76 billion in cash.  While ERIE is trading at a new one year low, Dow Theory suggests the following downside targets to consider:

  • $60.77
  • $50.46 (fair value)
  • $40.13

We suspect that ERIE will eventually sell close to the fair value level of $50.46 before rebounding to higher prices.  This is a great stock where dollar cost averaging as the price declines will definitely pay off (see more of the pros and cons of dollar cost averaging here).

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