Though we have seen the markets rise over the last few months, and many investors/traders calling for a market correction somewhere near here, these four companies have been passing on profits through dividends to shareholders while growing their businesses.

These stocks still look cheap by their EV/EBITDA ratio of under 6 and low P/E multiples under 10.

Since the last time I wrote about my portfolio, things have been volatile. Here are my actions since then:

New Buys

With all of the furor over the past quarter, I did not update my actions on my portfolio. Today I do so.

New Buys

Ten months ago I recommended Safety Insurance Group (SAFT). Its share price is down since then, but far from out. While I prefer absolute returns my sense of well being dictates I must look at 2008 through a relative lens. Relatively SAFT was a great performer, beating the pants off the S&P500 by 22%; SAFT is down 20% over the last ten months while the S&P500 has fallen 42%.

In a tough 2008, Safety managed to increase book value by 5.6% to $37.17. With the current share price of $30.84 representing a discount to book value of 21%, P/B is 0.83. As the graph below shows, SAFT has increased book value every quarter.

At the beginning of each calendar year, I sit down and see how my expenses have tracked over the past year. I make a table and a pie chart to show my wife. She is always amazed at how much goes to taxes, though the new amazement is what it takes to put children through college. We spend some time discussing plans for the next year. Since my wife is not money-oriented (not a big spender, and focused on teaching the children) this gives her a quick way to get reoriented in our financial situation.

After that, I look at investment income. 2008 was an unusual year for me in this way: it was the first year in my working life that my net worth fell. Though painful, at age 48, I’m grateful that I have had a good past.

Market Analysis Summary: In a bear market, panic and fear trigger irrational and indiscriminate selling of stocks at prices without the slightest consideration for fundamentals or valuations. On Wall Street, this is typically known as "throwing babies out with the bath water". Year-to-date, the SP-500 benchmark index has declined -36.66%. 

A correction of this magnitude is extraordinary, and while the trend could extend further south before a new bull market emerges, this is a good time to survey the damage.  Some of the bear market’s casualties, i.e. collaterally damaged stocks, will survive the current economic down cycle and be all the stronger and more profitable for it. Investors who can identify the potential survivors and are patient and financially solvent enough to delay immediate gratification for longer-term gains stand to be rewarded. 

With the extreme market volatility that has been taking place lately, investors are looking toward high yield stocks, so they have income coming in while waiting for their stocks to appreciate. In addition, investors prefer companies with no debt for additional safety.

Combine those two features together, and look for the stocks with low P/E ratios and low PEG ratios and you get the following list:

I am overweight financials, but I don’t own any banks, or entities where the primary business is credit risk.  I own a bunch of insurers, because they are cheap.  The first one to report came Monday after the close, Reinsurance Group of America.  They beat handily on both earnings and revenues.  They are the only pure play life reinsurer remaining.  Competition is reduced because Scottish Re is for all practical purposes dead.  They make their money primarily off of mortality, charging more to reinsure lives than they expect to pay in death claims.

This is a nice niche business, and a quality competitor in the space — well-respected by all.  And, you can buy it for less than book value.  Well, at least you could prior to the close on Monday.

A recent article on Seeking Alpha theorized that Safety Insurance Group (SAFT) would benefit from higher gas prices and global warming. I’m unsure whether that thesis will be proved correct, but I am certain the author is clearly a very lateral thinker. I too like to have a thesis when investing, but require hard numbers to validate it. I thought I’d see if there is any safety in Safety’s numbers.

The first important maxim I learnt about investing in insurance companies was, buy at one sell at two. Buy insurance companies at a price to book value (P/B) of one and sell at P/B of two. It sounds too simplistic to be of use, but often the best ideas are incredibly simple.

Before I go any further, I own Safety Insurance (SAFT) in some of the accounts that I manage. It is hard to find companies that we can say directly benefits from higher gas prices and global warming, but Safety Insurance is one of them. Any investor who considers her/himself a value investor should take a close look; it is a great company at a great price. However, this is not some quick trade, but rather a long term position that will likely yield attractive returns.

1) Liberty Mutual buys Safeco? Pays 1.75x book, and 11x estimated earnings? Mutual companies have limited access to the credit markets, and have no equity to pay with, so it is mainly a cash deal. They must have had a lot of cash lying around — might we wonder why they might not have enhanced policyholder dividends instead? This is not an economic use of capital in my opinion. Kudos to those who owned Safeco — it was cheap, though in the negative part of the underwriting cycle.

I know this diversifies Liberty Mutual geographically and from a line of business standpoint, but I don’t expect there are a lot of costs to take out here. Intellectually, it is harder to grow organically, but at this point in the underwriting cycle, it is definitely preferred to acquisitions. There are no equity investors in Liberty Mutual, but I would not lend them money on a trust preferred or a surplus note at present. There are better places to put money at interest — remember, acquirers usually underperform.

Safety Insurance Group, Inc. (NasdaqGS: SAFT) provides private passenger automobile insurance to the commonwealth of Massachusetts. Safety offers property and casualty, homeowners, commercial automobile, fire, umbrella and business owner policies. Safety was founded in 1979 in Boston, Massachusetts.

Safety is currently priced at $35.52. This represents a 35% decline since its 52-week high of $54.78. This decline is primarily due to the softening - increased underwriting capacity which drives down prices - of the insurance market and the mandated 11.7% reduction in premiums that all Massachusetts auto-insurers are required to make during 2007. As you can see in the graph below, the 11.7% reduction had quite an affect on Safety’s share price; dropping it from the low $50s to the low $40s in the first quarter of 2007.

The Dead — Companies with bad balance sheets, but have been whacked so bad that it is still worth playing

Safety Insurance (SAFT) is one such company, trading at 5.6 P/E , market cap of $557mn, book value of $530mn . It solely caters to the Massachusetts insurance market .It was the second largest private passenger automobile carrier, capturing an approximate 11.2% share of the Massachusetts private passenger automobile insurance market, and the third largest commercial automobile carrier, with an 11.8% share of the Massachusetts commercial automobile insurance market in 2006, according to statistics compiled by Commonwealth Automobile Reinsurers [CAR].

Massachusetts - a highly regulated Insurance market: Private passenger automobile insurance is heavily regulated in Massachusetts. In many respects, this market in Massachusetts is unique, in comparison to other states. This is due to a number of factors, including unusual regulatory conditions, the market dominance of domestic companies, the relative absence of large national companies, and the heavy reliance on independent insurance agents as the market’s principal distribution channel.

My portfolio has concentrations in a number of areas. I have a slight overweight in financials (though only one company affected by the current crises), a large overweight in energy, and an overweight in cyclicals, though cyclicals targeted at foreign demand, not US demand. These areas have underperformed, and so have I. Industries are 60% of the performance of the market in my opinion, so when you run a portfolio that concentrates industries, there will be periods of underperformance.

• Investors are more attuned to subprime, and so the merest hint of trouble sends them running for the exits.
• They are more attuned to CDOs, and so the merest hint of trouble sends them running for the exits.
• They commented that premium volume might decline over the remainder of the year.
• They only met the earnings estimate.
• The cost of their soft capital facility has risen to LIBOR+200, the maximum, leading them to question whether they can’t replace the facility with something better.   (My guess? No.)
• The conference call focused on subprime, CDOs, and the more shadowy bits of their guarantees.

So what does RAM Holdings do?  They reinsure the primary AAA financial guarantors.  They are the only AAA reinsurer that does not compete with the primary insurers.  Typically, they try to take an equal slice of all of the business that MBIA, Ambac, FGIC, FSA, and the three others produce each year.  In that sense, you can think of them as a small version of what the average of the financial guarantee industry would be like if it were a single company.  Unlike a P&C reinsurer, losses kick in only after a threshold is met, and then a lot of losses get paid, with RAM Holdings, the losses are pro-rata from the first dollar.  The primary insurers would have no advantage passing them bad business, because they would be more affected by the bad business.

Safety has about 11% share of the Massachusetts automobile insurance market. It has been profitable every year since inception in 1979, with high returns on equity and strong combined ratios in recent years. The company pays a healthy dividend, now yielding 3%. Senior management also owned 7% of the stock at year end '06.

Despite a history of market leadership and profitability, SAFT shares are trading at 5.1 times trailing earnings, 1.05 times book value, and about 41% below their 52 week high. These numbers make the stock suspiciously cheap.

Safety Insurance suffered due to a small earnings miss, an out of favor sector and uncertainty surrounding Massachusetts auto insurance regulation. In essence, investors are concerned that they will not be able to keep increasing their premium volumes in a highly regulated industry that effectively means that Safety is - to a large extent - dependent on the regulators.

We feel that the correction was far too severe and that this is an undervalued company with good management, a clear strategy and solid fundamentals. We strongly encourage you to have a look at the numbers, not only by themselves but also compared to the industry average, and we are sure you will see a company that will offer mid to high double digit returns for year to come.

I built a simple stock screen to identify companies with multiple characteristics common to the persistent wave of buyouts we have been seeing, and the results are included below.

I was happy when I logged on to the Internet Monday morning and learned that a company I purchased on Friday was a buyout target, and its price was up 7% (not a bad return for one business day).

At the premium that they paid, there were better things to buy. I don’t find a 6% return on capital to be that attractive, and I don’t see a lot of synergies.

It implies that there is not that much for sale among stock P&C companies.

Primary Casualty companies buying Bermuda reinsurers makes a lot of sense (like AGII/PXT). This isn’t as cogent.

It lowers my previously high opinion of Liberty Mutual.

On another note, I found the announcement from KMG America (KMA) to be lightweight. After the stock fell so hard, I had a look at it, and concluded that the purchase GAAP accounting adjustments stripped profits out of the old stable blocks of business to hide losses in the LTC block. Now, that’s just a guess on my part. I could be dead wrong. That said, I would not be surprised to see that KBW finds only limited opportunities for capital enhancement.