While reviewing the presentation of a new reinsurance company, I run across some interesting data on historic price to book multiples for insurance companies ().
In the context also of low banking multiples, it seems like the financials is one interesting place to look for ideas. There are several P&C insurance companies with good track records below 1x book value. But before getting too excited, let me remind you the warnings about investing in banking and in financials in general:
- Black Box: you will never be 100% sure of its balance sheet quality
- Leverage: no perfect margin of safety
- Thin margins: usually no competitive advantage and bad performance pays
- Macro matters: you just can not ignore it. Deflation, inflation and interest rates have an impact
- Leadership matters: more than in any other sector, good management is crucial to control risk and allocate capital. This is not Coca Cola (NYSE:KO) that can survive a series of bad CEOs
Part of the reason for the low insurance valuations is the soft pricing environment discussed at length in several articles by the StreetCapitalist and RationalWalk. Insurance is a cyclical business, where commercial pressures drive uneconomic pricing, that destroys capital, leading no the next hard market. As Peter Lynch mentions in his books, one way to invest in the sector is to anticipate these waves. Not an easy thing to do if you are not a card carrying member.
Let me also remind you the critical questions when using book value multiples in financials:
- How conservative is that book value?
- Is it improving?
- How are capital ratios and the need for value destroying new capital or a reorganization?
An excellent blog to read for an inside view of the sector is the now classic David Merkel’s Aleph blog. He posted recently an excellent analysis of reserve practices of several insurance companies that is tightly related to question #1. Very recommended.