Cincinnati Financial Value Propped Up By Generous Dividend
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Over the last seven months – through the end of February – shareholders in Cincinnati Financial (NASDAQ: CINF) have experienced the pleasant result of an almost linear 40% share price gain. Other insurance companies with similar product lines, such as Selective Insurance Group (NASDAQ: SIGI), The Travelers Companies (NYSE: TRV) and Chubb Corporation (NYSE: CB) all gained value during the period, but the share gains of these stocks were in a range of 12% to 16% – in line with the overall stock market. What information has caused the stock market to set Cincinnati Financial apart from its peers?
Cincinnati Financial is a insurance company that primarily sells commercial property and casualty insurance. The company uses independent agencies in 39 states to market the lineup of insurance products. Of the annual premium collected, 70% comes from commercial lines, 23% from personal lines – home, auto and umbrella insurance -- and 5% from life insurance products. The remaining 2% is from excess and surplus (E&S) lines.
Property and casualty insurers measure their annual results using a metric called a combined ratio. The ratio is the total of an insurance company's claims paid plus corporate expenses divided by the premiums collected. Insurance companies shoot for a combined ratio of less than 100%. Cincinnati Financial aims to keep the ratio between 95% and 100% to meet its value growth goals. Catastrophic events such as hurricanes and floods will often push insurance company ratios above 100% for the year when the events occur. The excess claims expenses are covered by reserves set aside specifically to cover claims and earnings form the large investment portfolio each insurance company manages. With several high claims events in 2011, Cincinnati Financial reported a combined ratio of 110% for 2011.
Two additional factors have made recent years tough for property and casualty insurance companies. The low interest rate environment makes it difficult to earn enough from a portfolio to cover the extra costs when the combined ratio exceeds 100%. Many insurance companies were involved in mortgage backed securities and took large write downs when that market collapsed during the financial crisis. Cincinnati Financial has maintained a conservative management policy with its bond portfolio and was not forced into the write down path. Still the company is earning low interest rates on its bonds. Second, premium rates in the property and casualty business have been depressed as insurance companies have competed on price to earn or maintain market share in the slow economy. Cincinnati Financial has been working to generate more premium by signing up new agencies and working to earn a larger portion of the total business written by the contracted independent insurance agencies.
The factors discussed so far highlight Cincinnati Financial as a company as good as or slightly better than its peers in accomplishing the management goals of an insurance company. But these items aren't enough to cause a stock to appreciate by 40% in the face of a 110% combined ratio and a very competitive pricing market. Two more factors seem to have set this company apart.
First is the dividend, Cincinnati Financial has a 50-year history of steady dividend payments and usually increases the payout each year. The current dividend yield is 4.5% based on a $1.64 annual payout. Competitor Selective Insurance Group yields 2.9%, The Travelers yields 2.8% and Chubb yields 2.4%. When Cincinnati Financial was at $25 a share, the dividend yield was 6%, too high for a quality insurance company. Much of the share price increase can be attributed to market forces pushing up the share price to bring the yield more in line. For 2011, the dividend paid was higher than net and operating income due to the catastrophic claims. In typical years Cincinnati Financial pays out 45% to 50% of net cash flow. There is little debt and plenty of cash on the balance sheet to cover the occasional high claims year.
Another factor probably helping the share value is the fact that Cincinnati invests 25% of its investment portfolio in common stocks. Most insurance companies put less than 10% into stocks. The stock market has moved steadily upward over the last six months helping the value of the insurance company's portfolio – pushing up assets and book value. The equity portion of the portfolio balances the other 75% in bonds and provides capital appreciation.
In the property and casualty insurance sector, companies are starting to see positive trends in pricing. Low interest rates remain a drag on portfolio earnings, something Cincinnati Financial counteracts with its stock market investments. After the recent price gains, the stock price may be due for a pull back. Cincinnati Financial would be a very attractive long-term investment if the share price dropped to the point where the yield exceeds 5%. With the current dividend rate that price is $32.80 per share.
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