Insurance Stocks Rally: 2 To Buy, 2 To Avoid

Sammy is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Over the past few months, as shown by the chart below, the insurance sector has been hot. The primary reason for the move higher is the increase in interest rates. It must be noted that insurance companies benefit from increasing rates as it increases the amount of interest that can be earned on risk-free assets, such as Treasury bonds, that insurance companies hold. While I do not think the sector-wide advance is over, I do believe that investor focus will turn more toward individual companies, compared to the current sector-wide bullishness.

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KIE data by YCharts

Simply stated, MetLife (NYSE: MET) is my favorite insurance stock right now. With a market cap of $48 billion, MetLife is one of the largest and most diversified insurance companies in the world. MetLife divides itself into six different segments: insurance products, retirement products, corporate benefit funding, auto and home insurance, and international. As shown by the chart below, MetLife trades at an attractive price to book value ratio of 0.75, relative to historic norms. MetLife could easily trade at a price to book value of 1 without being expensive. 

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MET Price / Book Value data by YCharts

In addition to being a value play, MetLife is also a dividend play. Currently, after a recent dividend increase, MetLife yields 2.5%. Lately, investors have soured on high-yield stocks due to rising interest rates. However, given that MetLife's business benefits from rising rates, I would not expect the stock to be hurt by rising rates. 

Hartford Financial (NYSE: HIG) is my second favorite insurance stock right now. Although smaller than MetLife, Hartford is similar in that it is diversified. Hartford is a provider of investment products, property, and casualty insurance to both individuals and businesses. Like MetLife, as shown by the chart below, Hartford trades at a discount to book value. In my opinion, Hartford should trade at a minimum of 1 times book value. 

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HIG Price / Book Value data by YCharts

Hartford continues to make progress on its transformation strategy, announced in March 2012. A major part of this transformation is the run-off of Hartford's annuity business. Also, Hartford has divested its life insurance business by completing a sale to Prudential for $615 million. Finally, Hartford has announced plans to buy back as much as $500 million in stock and reduce outstanding debt by $1 billion. In short, I think Hartford is making positive changes. However, some market participants disagree. Currently, short interest stands at more than 28 million shares, or 6.4%. The high short interest is, in my opinion, a bullish factor as it indicates that, despite trading close to a 52-week high, there are many skeptics yet to be converted to the bull camp.

Two insurance stocks that I would avoid right now are Chubb (NYSE: CB) and Travelers (NYSE: TRV). I should start out by saying that these two companies, both engaged primarily in the property and casualty insurance business, are two of the highest quality insurance companies around. As shown by the chart below, during the Great Recession, both Chubb and Travelers remained profitable. Comparably, both MetLife and Hartford were forced to take significant losses in 2008 and 2009. This trait speaks to the quality of both Chubb and Travelers.  

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CB Income from Cont. Ops Quarterly data by YCharts

The reason why I am negative on these companies has little to due with their business prospects, but rather their valuations. As shown by the chart below, both Chubb and Travelers are trading well above book value and close to historic high valuations. Given this, I believe it will be difficult for either name to make a sharp move higher anytime soon. Simply put, both Chubb and Travelers are too expensive. 

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TRV Price / Book Value data by YCharts


As shown by the chart below, over the past three months, as the stock market as a whole has rallied, we have already started to see a divergence between MetLife/Hartford versus Chubb/Travelers. I expect this divergence to continue.

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TRV data by YCharts


As the bull market in insurance stocks continues, I would look to go long with MetLife or Hartford and avoid Chubb and Travelers. My main reason for this view is valuation. MetLife and Hartford trade well below book value, while Chubb and Travelers trade well above book value. Specifically, I am not looking for a big sell off in Chubb or Travelers, but rather a failure to keep pace with the move higher in names such as Hartford and MetLife. In addition to the attractive valuations, MetLife's 2.5% dividend yield and Hartford's progress on its transformation strategy make both companies solid investments.  

Sammy Pollack has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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