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Torchmark (NYSE:TMK) is an insurance company that has grown consistently over its 32-year lifetime. Insurance companies have been Warren Buffett's favorites since his very beginning in investing because they receive the cash upfront and can invest it in the most profitable way according to their projections. The legendary investor has an appreciable stake in Torchmark (2,820,000 shares) on account of Berkshire Hathaway (NYSE:BRK.B) because he appreciates its conservative, long-term strategy and its consistently high underwriting margins ("The Warren Buffett Stock Portfolio", by Mary Buffett, 2012).

Torchmark invests only in investment-grade corporate bonds and has no risky products, such as collateralized debt obligations (CDOs). Thanks to its strong cash flow, it can hold all the securities till they mature and thus secures a guaranteed yield on its investments. For instance, in the financial crisis of 2008, Torchmark was able to meet its obligations without liquidating any of its securities and hence it did not write any losses.

As per the available data for the period 1995-2012, Torchmark has demonstrated an almost linear, consistent growth of earnings per share. In the last 9 years, the company has grown its EPS at an annual rate of 9%. Moreover, despite the very low current interest rates, only 2%-3% of Torchmark's securities will be maturing every year in the next 5 years and hence the company projects that it will maintain its streak of excellent results for at least 5 more years.

Torchmark currently distributes a dividend of $0.60, which corresponds to a low yield (1.2%). However, the distinguishing feature of the company is its aggressive rate of repurchases of its own shares. During the last 9 years, Torchmark has reduced its outstanding shares from 177.40 million to 100.58 million (data from investing.money.msn.com). This 43% reduction in the number of shares has resulted in EPS growth 122% during these 9 years even though the net earnings increased only 35% during this period.

To understand the above more clearly, let's go through a simple calculation. Torchmark has achieved annual earnings greater than $500 M in the last 3 years and has announced that it will be spending more than $400 M for share repurchases every year (the amount for 2012 is ~ $430 M). Therefore, the company is capable of purchasing about 8,000,000 shares per year and hence it can reduce its outstanding shares by 80% in 10 years, which will send the stock price to the… sky. Indeed, if the company purchases 80,000,000 shares in the next 10 years, its EPS will quintuple even if its net earnings remain constant (the latter is very unlikely)! In its earnings conference, the company reassured its investors that it will maintain its aggressive share repurchase program, with no end in sight. In another article, the author suggested avoiding some housing stocks because they repeatedly issue new shares in order to raise cash, thus punishing their shareholders with a strong dilution effect. Well, Torchmark is the completely opposite side of the coin.

The above calculation depicts why Warren Buffett is so interested in companies that purchase their own shares. Particularly when a company has greatly reduced its share count beyond a point, the effect of spending a fixed annual amount on share repurchases becomes increasingly effective in boosting EPS. Not only does this strategy raise the EPS over time, it also reassures the investors that the company believes in the value of its stock at the prevailing market price.

Surprisingly, very few investors have Torchmark in their sonar. That's why its average daily volume is only 620,000 shares per day (data from finance.yahoo.com). Actually, I would never have examined it myself if Warren Buffett had not invested in it. At the current price of about $50, Torchmark trades at a P/E 10, which is really low if you take into account its annual EPS growth of about 9%. As mentioned above, its investments are investment-grade corporate bonds so the risk to reward ratio is really attractive. As I am expecting a general correction in the stock market of about 10%-15%, I would wait for this correction to materialize and then I would add some Torchmark shares in my portfolio.

Source: Torchmark: Aggressive Distribution To Shareholders