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The Travelers Companies, Inc. (TRV) is one of the largest insurance firms in the U.S. It has been a member of the Dow Jones Industrial Average since 2009, after replacing its former parent Citigroup (C).

Travelers Co. has an exciting and lengthy history, reaching all the way back to the second half of the 19th century when the original company was incorporated as St. Paul Fire & Marine in 1853. It has survived many tough times in the insurance business during which it had to restructure and sometimes downsize or refocus to stay in business and keep its profitability.

The current price offers substantial upside potential due to numerous factors described in this article, including the relatively low forward P/E of 11.33, solid dividend yield of 2.3%, and growing earnings per share in the last couple of years. Moreover, the financial sector has been the most underperforming sector in the past ten years. It has been showing signs of aroused investor appetite lately after the current very strong run-up in defensive stocks. Combined, these factors present an attractive buying opportunity for long-term investors with moderate to high risk appetites.

Nonetheless, like every investment, TRV bears certain risks; for example, the slowing of the U.S. economy or another black swan event in the banking or insurance business, which would most probably weigh on financials in general more heavily than on other more defensive U.S. stocks.

Company history

The original St. Paul Fire & Marine company has been through a multitude of mergers, acquisitions and spin-offs. Later known as The Travelers Group, it merged with Citicorp to form Citigroup. Spun off by Citigroup In 2004, the merger of the St. Paul Companies and Travelers Property Casualty Corp created St. Paul Travelers, which later changed its name to The Travelers Companies, after purchasing back the rights to its famous red umbrella logo from its former parent Citigroup.

The Travelers Companies today

Today, The Travelers Companies is the second-largest U.S. insurer of commercial property and also the third-biggest in U.S. personal insurance. The company's corporate structure is organized using subsidiaries. This subsidiary structure provides higher financial stability to the company in case of a black swan mass insurance event. Travelers Co. provides a variety of commercial and personal property and casualty insurance products to all major market segments - businesses, individuals, institutions and international clients - through more than 15,000 independent insurance brokers and agents. The company has offices in every U.S. state and the majority of sales are generated in the U.S. However, TRV also has a presence in about a dozen large foreign countries such as Canada, the UK, Brazil, China, and Singapore.

The positives

1. Attractive dividend yield

The average S&P 500 yield is 2%. The TRV currently has a 2.30% yield. This looks low; however, its payout ratio is much smaller than most of its blue-chip peers. If Travelers Co. increased its payout ratio to 50%, which is an absolutely normal and average payout ratio for other blue-chip dividend stocks, the current dividend yield would be 3.6%.

2. Excellent potential for future dividend growth

Not only does Travelers Co. have a low dividend payout ratio; there is also good potential for earnings growth, which would further increase the dividend amount and yield.

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The long-term nature of the insurance business, which has been serving mankind for many centuries, plus the resilient nature of Travelers Co.'s own 160-year-long history in the insurance business, give us a high probability that this company will still be operational and profitable even 30 years from now.

3. Low P/E and PEG

Travelers Co. currently sports a trailing P/E of 13.33 and a forward P/E of 11.33. This is substantially lower than the current average P/E of the broad S&P index. Compared with its peers in the property and casualty insurance industry, the P/E is in the middle between the industry average of 9 and American International Group's (AIG) outlier P/E of 29.79. The expected PEG of 1.13 is relatively low and favorable compared with the industry average.

4. Solid insurance and real estate industry prospects

As I argued in this U.S. real estate article, commercial segments of real estate are poised to grow in the years ahead. These segments have started to invigorate and show increasing activity and growth, similar to the residential real estate boom that is already one or two years ahead.

Indeed, most of the insurance rates confirm this increased activity and are beginning to climb up. In fact, property, casualty and professional liability insurance rates were up 5% in April, following a similar hike in March, according to InsuranceJournal.com and Market Scout.

5. Fundamental valuations

Current share price is $88
Market cap: $33.04B
Trailing P/E is 13.33
Forward P/E is 11.33
PEG Ratio (5 year expected) is 1.13
Price/Sales is 1.29
Price/Book is 1.29

6. Financials

Revenue: $25.68B
Profit Margin: 9.98%
Total Cash: $3.64B
Total Debt: $5.85B
Operating Cash Flow: $2.95B
Return on Assets: 2.21%
Return on Equity: 10.16%

The risks

1. Fragile U.S. recovery

Should the U.S. recovery slow down, financial stocks will be among the first to feel the pinch and will be dragged down regardless of whether fundamentals of the Travelers Co. would have changed.

2. Black swan event

If the insurance or banking industry in general, or the TRV itself, is hit with some unexpected very negative event such as the 2008 collapse of Lehman Brothers and AIG troubles, TRV stock prices could drop by half, or even more. Therefore, we have to repeat our long-term intent of this investment.

3. Increased competition

Berkshire Hathaway [(BRK.A),(BRK.B)] recently announced that it will be intensifying its activities in the commercial property insurance as well as personal insurance businesses. It has already demonstrated its intentions by attracting four executives from American International Group (AIG). No details of BRK plans are yet available. However, further development of this potential threat is worth watching for any Travelers Co. shareholder.

Conclusion

Sound long-term gradual growth prospects for the insurance and commercial real estate markets, coupled with the current low P/E ratio, offers an excellent entry point to own a share of The Travelers Companies. This 160-year old No 2 - 3 U.S. insurer currently sports a decent 2.3% dividend yield, which has lots of room for steady growth enabled by a low payout ratio as well as solid earnings growth prospects.

Recommendation

Berkshire Hathaway, which has certain exposure to the insurance and financial sector since it operates an insurance company (Geico) and has Wells Fargo bank (WFC) as a top holding, is one of my top stock picks overall, as I explained in this article. Therefore, I already have an insurance exposure through Berkshire.

If, for any reason, you don't want to or can't purchase Berkshire, for example because it pays no dividend, I recommend gradually establishing a position in the Travelers Co. Both Berkshire and Travelers Co. are well positioned for the expected gradual rebound in the financial sector stocks and in the commercial real estate business.

Source: 160-Year-Old Blue Chip With Growing Dividend And Low Payout Ratio