Aflac: A Smart Defensive Play

| About: Aflac Incorporated (AFL)

Summary

The company's dividend has been growing for years and should continue to do so.

Insurance is a great business during recessions and bear markets.

Now is the time to be defensive with dividend-paying, conservatively-financed companies like Aflac.

Aflac Incorporated (NYSE:AFL) is a relatively under-the-radar dividend aristocrat that is one of the core holdings of many conservative dividend investors. That's because insurance is one of the most stable business models around and the cash flow from the dividend is paid out no matter what is happening in the stock market.

Warren Buffett made most of his famous fortune by investing in insurance companies, which is a testament to the timeless nature of the business model. One of the key reasons insurance is such a great business in addition to the fact that everyone simply has to have it, is due to the nature of the "float." Basically, the insurance float is all of the money that is paid into the company in premiums that have not been paid out as claims. This is similar to banks holding deposits except with a few major differences that make insurance companies much better investments than banks in many cases.

The first major difference is that the float is not counted as an asset by accounting standards even though it can be invested in the market and earn fat returns for the insurance company, whereas that is not necessarily the case for bank deposits. This makes the balance sheets of large insurance companies much stronger than they look in many cases because the company essentially has huge amounts of compounding assets that are not being counted. This makes an investment in many insurance companies much safer than most other financial institutions.

The second major difference is that claims are not paid out for long periods of time and due to the statistics that insurance underwriters use when writing policies are guaranteed to make large amounts of money over time almost no matter what happens depending on the type of insurance coverage we are talking about. Certain types of coverage like natural disasters can be more risky because it has the potential, even if the odds are still in the insurance company's favor, to wipe out their assets.

But the point is a good insurance company can make an excellent investment because of the conservative nature of the business and balance sheet, and AFL is an exceptional organization because it has been so consistent over time. The most recent earnings report showed seemingly disappointing revenue growth of -2% and pretty good earnings growth of 3.80%, but what we are attracted to in this company is not growth primarily, but cash flow and safety. At a P/E of only 9.9, the company is priced at a substantial discount to the S&P 500, which currently has an average P/E of around 19, even after the recent sell off.

So the company is producing cash flow, trading at a reasonable if not discounted valuation, and paying a decent 2.86% dividend. And even though the most recent quarter doesn't show growth, the 5-year expected PEG is 2.08 showing that analysts do expect the company to continue growing, especially if the Fed continues to raise interest rates, which helps both banks and insurance companies.

Going into a scary 2016 with literally the worst start to the year in stock market history, investors should be looking for safe places to put their money. AFL is the quintessential defensive stock because they will continue to sell insurance no matter what happens to the stock market, they will continue to pay the decent 2.86% dividend as they have for the last several decades, and they are all but guaranteed to outperform the market if we do go into a true bear market cycle because the valuation really doesn't leave the stock with too much room to fall relative to other companies.

The same cannot be said for the vast majority of stocks in the market right now that are still way overvalued by most metrics even after the startling drop they experienced to start the year. Many forecasters predict more declines making companies that provide cash flow more attractive than ever.

Another metric that makes AFL look like a conservative bet is that it is trading at only 1.42 times book value. In other words, the price the stock market is offering for shares of the company is only a tiny premium to its tangible assets, which means we are getting all of the company's value added activities essentially for free, including the investable float. Over the last year, AFL has made $8.36 billion in gross profit with a $24 billion market cap, which is mostly the float that is being reinvested in order to pay, and hopefully raise, the dividend and reward shareholders.

So for investors looking for safety of principle and an adequate return, I really don't see many more defensive investments right now going into a volatile season for a high priced stock market. Especially if you're an investor that is already attracted to dividend paying stocks. You can hold this one for decades and sleep well at night knowing your money is safe and earning at least a nice little bit of cash flow if nothing else.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.