Why Insurance Stocks Will Outperform
Summary
The overall insurance industry group has very attractive valuations - especially on a revenue basis - which is tough to find in an otherwise expensive market.
Expect MetLife to lead the industry group over the next twelve months, with all of the outperformance coming from its relative undervaluation.
FBL Financial is another attractive pick, as it combines an attractive valuation with a strong growth profile.
A) Introduction
With the prospect of rising interest rates on the horizon, insurance stocks look poised to reap higher returns on their float and profit accordingly. This article will be a statistical top-down analysis of the industry group, highlighting stocks that should outperform the market in the upcoming 12 months. Our algorithms estimate the alpha a stock will generate in the next 12 months by looking at the stock's strength in a variety of valuation, price momentum, and profit growth factors. The algorithms use the average excess returns generated by these factors in the past to estimate the alpha a stock will generate in the future.
B) Industry Overview
Before identifying individual insurance stocks that should outperform, we'll first analyze how the overall industry group is performing against other industry groups in the financial sector. The table below shows how the insurance group is doing on a growth basis, relative to the other sub-groups in the financial sector:
The insurance industry group has an attractive valuation profile relative to other groups in the financial sector. On a revenue basis, the insurance group has the most discounted valuation of all the other groups with its sales yield (inverse of Price/Sales ratio) of 74%. This means that the average insurance stock would give its investor $0.74 of sales for every $1 they invest, which is much higher than all of the other financial industry groups. The same can't be said for earnings, as the insurance group's earnings yield (2.95%) trails every other group but the Thrifts & Mortgage Finance group (1.8%). This is true for the dividend yield (2.15%) as well, which is also the second-lowest among the Financial groups. Insurance stocks look undervalued on a price-to-book ratio (1.74) and overvalued on price-free cash flow ratio (46.22). Overall, our algorithms expect the average insurance stock to generate 5.37% of alpha that is attributable to valuation over the upcoming 12 months. Next, we'll analyze the industry's growth profile:
The insurance industry's growth metrics aren't as strong as its valuation stats, resting in the middle of the pack within the Financial sector. The industry group's price momentum has been moderately positive, with the average insurance stock gaining 2.3% in the last six months, and 5.8% in the last twelve. Profit-wise, insurance stocks are leading the sector, growing an average of 52% on annual EPS basis. Insurance stocks have had average profit efficiency compared to the sector, returning 2.4% on assets and 10.7% on equity. Overall, our algorithms expect the average insurance stock to generate 0.24% of outperformance attributable to growth over the upcoming 12 months.
C) Group Leaders
As we just outlined above, the overall industry group looks strong on a value basis and average on a growth basis. We will now delve into specific stocks that look poised to lead the industry group over the following 12 months. As we did before, we focus our analysis on the growth and value metrics that have been repeatedly shown to predict stock returns. The table below shows the top ten insurance stocks based on value:
As you can see, there is a surplus of high-quality insurance stocks that can be bought at very attractive valuations. Only three of these stocks - AFLAC (NYSE:AFL), FBL Financial Group (NYSE:FFG), and Principal Financial Group (NYSE:PFG) - have sales yields below 100%. Assurant (NYSE:AIZ), Unum Group (NYSE:UNM), and AFLAC all have earnings yields above 10%, which is very cheap when the average earning yield in the market is below 4% and 10-year treasuries currently yield below 2.5%. Although there are no true dividend leaders in the space, only one of the stocks - Navigators Group (NASDAQ:NAVG) - pays no dividend at all. The group looks very attractive on a book value basis as well, with MetLife (NYSE:MET), Assurant, Unum Group, and Prudential Financial (NYSE:PRU) all trading below their book value. On a free cash flow basis, only State Auto Financial (NASDAQ:STFC) and Infinity Property and Casualty Corp. (NASDAQ:IPCC) trade on double-digit multiples. Our algorithms are most bullish on MetLife, expecting them to generate 11.9% of alpha attributable to value over the upcoming 12 months. With that being said, each of the ten stocks looks relatively undervalued compared to the market.
Next, we'll analyze the top ten insurance stocks based on growth metrics:
While insurance stocks aren't expected to generate their outperformance from superior growth metrics, it is still helpful to analyze the growth leaders. As you can see, most of the stocks leading the group on a growth basis were not listed as valuation leaders, with only FBL Financial appearing in both lists. In terms of price momentum, Erie Indemnity (NASDAQ:ERIE), Marsh & McLennan Companies (NYSE:MMC), FBL Financial, and Platinum Underwriters (NYSE:PTP) are the only stocks that have returned over 20% in the last twelve months. Safety Insurance Group (NASDAQ:SAFT) started the year off badly, but has returned 22% over the last six months, bringing its total 12-month gain to 18.3%. Argo Group International Holdings (NASDAQ:AGII) is the EPS growth leader of the group, having grown annual EPS numbers by 181% last year, while the next best - Amerisafe (NASDAQ:AMSF) - grew at 47%. Because of their immense asset float, none of the insurance stocks have great ROAs, with the best being Marsh & McLennan at 8.5%. It is different for equity, though, with Erie, Marsh & McLennan, Progressive (NYSE:PGR), and Aon Corporation (NYSE:AON) all sporting +15% ROEs. Overall, our algorithms expect Erie to generate the most alpha attributable to growth (3.11%) in the next twelve months.
Next, we'll highlight five insurance stocks with the best track record of beating analyst expectations:
Not surprisingly, most of the stocks listed in the growth leader list have been releasing the best earnings numbers relative to expectations. Progressive tops the list, having beat Wall Street EPS estimates nine times in a row after beating last quarter by 16%. Assurant, Aon Corporation, Lincoln National Corp. (NYSE:LNC), and Principal Financial have each beat EPS estimates a minimum of four times in a row as well, while Assurant has beaten revenue estimates ten straight quarters.
D) Conclusion
Now that we've analyzed the growth and value leaders of the Insurance group, it's time to see which stocks come out on top overall. The table below shows the top five stocks in the insurance group, ranked by expected price outperformance in the next twelve months:
MetLife tops the list, with its extremely attractive valuation making up for a slightly weak growth profile. Overall, our algorithms expect MetLife to generate 11.8% of alpha over the next twelve months, with all of it coming from its relative undervaluation. To come up with a 12-month price target, we need to estimate the amount of market-based return the stock will generate as well. To do this, we simply multiply MetLife's beta (1.87) by the expected return the market will generate over the next twelve months (we assume 7.5%, the market's historical return) to get 14%. Then, we multiple the current price by the sum of the market-based return and outperformance expected, to come up with a 12-month price target:
$50.65 * (1 + 11.8% + 14%) = $63.77 (+26% from current price)
You can repeat this process using different assumptions for what the market will generate (an inherently speculative process), and for the other stocks listed. We recommend avoiding Navigators Group, though, as the stock's extremely weak earnings strength rating means it is very likely to continue disappointing investors come earnings release. FBL Financial may be an even better stock pick, as investors would be getting a stock with an attractive valuation showing strong price momentum.