Why Insurance Stocks Will Continue To Outperform

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Includes: AFL, AIZ, ALL, AMSF, ANAT, ARGO, EIG, ERIE, FFG, HCC-OLD, HIG, MET, MHLD, NAVG, PGR, RGA, SFG, SIGI, UFCS, UVE
by: Quantified Alpha

Summary

Back in December, we wrote that the insurance industry group would outperform in 2015 because of its attractive valuations.

Since then, the group has returned 9.20%, while the S&P 500 returned 3.78% - an outperformance of 5.42%.

The stocks that we highlighted as our top 5 overall insurance stocks have since returned 10.83%, while our top 5 value returned 11.13%, each outperforming the S&P 500 by +7%.

The thesis holds, as the stocks are still relatively undervalued, have strong momentum, and interest rates hikes are still on the horizon.

Introduction

In our first article, "Why Insurance Stocks Will Outperform", published on December 18 (written on December 17), we predicted that insurance stocks would outperform the market over the next 12 months due to their attractive valuations and the prospect for interest rate hikes. While the interest rate hikes have yet to actualize, the insurance group, represented by the S&P 1500 Insurance Index (X8FB), has outperformed the S&P 500 by a wide margin. The index has gained 9.20% in the 8 months since publication, while the S&P 500 returned 3.78%, representing an outperformance of the benchmark of 5.42%.

We highlighted MetLife, Inc. (NYSE:MET) and FBL Financial (NYSE:FFG) as our top two picks in the group, while also highlighting Assurant, Inc. (NYSE:AIZ), Navigators Group (NASDAQ:NAVG), and AFLAC Inc. (NYSE:AFL) to round out the top 5. While MET and FFG have been slight disappointments (returning an average 6.45% versus a group average of 9.20%), the top 5 as a whole have returned 10.83%, outperforming the group by 1.63% and the market by 7.05%. These gains were led by our 3rd-ranked stock, AIZ, which has returned an impressive 20.26% since publication. All of these outperformance numbers are understated, as they don't include the returns from dividends that most of these companies issue.

We will now revisit our original thesis to see if it still holds, and consider future prospects for the industry.

Industry Overview

Before identifying individual insurance stocks that should outperform, we'll first analyze how the overall industry group is performing against other industry groups in the financial sector. The table below shows how the insurance group is doing on a value basis relative to the other sub-groups in the financials sector:

(Source: Quantified Alpha)

The outperformance of the insurance group has caused its overall valuation to decrease slightly, and the group has lost the number 1 ranking that it held during our initial publication to the consumer finance group (that was previously ranked second.) When comparing the two groups, though, it's clear that they are similarly undervalued when compared to all of the other groups in the market.

(Source: Quantified Alpha)

At an average earnings yield of 7.54%, the insurance group has the second highest yield in the market, behind the 9.17% average of the consumer finance group. The group also has the 3rd lowest price-to-book ratio in the market, at 1.13x, behind only marine industrials and energy equipment & services. Both groups are similarly undervalued and should outperform over the next 12 months, based on their attractive valuations, but what makes the insurance group a superior option is that it combines that value with strong momentum and growth.

(Source: Quantified Alpha)

Insurance has the best overall growth profile of the 7 groups in the financials sector and the 17th-best growth profile of the 65 groups in the market. The strength of the growth profile is the 17.10% average 12-month price performance that the group has achieved, the highest in the sector. The group's 6-month price performance of 6.92% is the 3rd best in the sector, and its ROE and ROE also rank near the middle of the pack. While its trailing twelve-month (TTM) EPS growth isn't impressive at 2.99%, the consistency and momentum in its growth profile make it the most attractive group in the financials sector.

Group Leaders

As we just outlined above, the overall industry group looks strong on a value and growth basis. We will now delve into specific stocks that look poised to lead the industry group over the following 12 months. As we did before, we focus our analysis on the growth and value metrics that have been repeatedly shown to predict stock returns. The table below shows the top five insurance stocks, based on value:

(Source: Quantified Alpha)

The 5 insurance stocks profiled on December 18 with the highest-value alphas have returned an average of 11.13% (excluding dividends) since publication. Due to their outperformance, none of those 5 stocks are still in the top 5 most undervalued, so today, we profile 5 new undervalued insurance stocks. The most undervalued now is Erie Indemnity Co. (NASDAQ:ERIE), led by the strongest earnings yield (17.18%) and lowest price-to-book ratio (0.50) of the top 5 value insurance stocks. Maiden Holdings (NASDAQ:MHLD) is the second most undervalued, led by its strong sales, dividend and free cash flow yields. American National Insurance Company (NASDAQ:ANAT), Reinsurance Group of America (NYSE:RGA) and Allstate Corp. (NYSE:ALL) round out the top 5 most undervalued in the group. All 5 of these stocks rank in the top 3% of undervalued stocks in the market.

Next, we'll analyze the top five insurance stocks, based on growth metrics:

(Source: Quantified Alpha)

While StanCorp Financial Group (NYSE:SFG) has had the strongest price performance over both horizons, returning ~70% in the last 6 months alone, HCC Insurance Holdings (NYSE:HCC-OLD) has the more attractive overall growth profile because of its superior returns on assets and equity. Both companies have been huge outperformers over the past 6 months, while Universal Insurance Holdings (NYSEMKT:UVE) has been the best performer over the past year, gaining 115%. Amerisafe Inc. (NASDAQ:AMSF) and Selective Insurance Group (NASDAQ:SIGI) round out the top 5 insurance growth stocks, both with solid 12-month price performances and strong EPS growth. Since our last publication, the top 5 insurance growth stocks returned an average of 8.73%, outperforming the S&P by ~5%, but underperforming the overall group by ~0.5%.

Next, we'll analyze the top five insurance stocks, based on their overall quantitative profile:

(Source: Quantified Alpha)

The 5 insurance stocks profiled on December 18 with the highest total alphas have returned an average of 10.83% (excluding dividends) since publication, outperforming the insurance group by 1.63% and the S&P 500 by 7.05%. None of those 5 stocks are still in the top 5 overall, and so we have 5 new stocks to profile today.

The insurance stock with the highest total alpha rank is Selective Insurance Group, which combines attractive value with strong growth and momentum, great earnings quality, and solid "smart-money" sentiment. SIGI is one of our top overall stocks in the market, and we've set a 12-month price target of $41.63 on the company, representing 29.27% upside, versus the Wall Street average price target of $33.00, representing 2.48% upside.

United Fire Group (NASDAQ:UFCS) is our second highest total alpha ranked insurance company that also has strength in all 4 factors of our equity pricing model. We've set a 12-month price target for the company at 27.63%, representing upside of 27.63%, versus the Wall Street average price target of $37.00, representing 1.18% upside.

Rounding out the top 5 total alpha stocks are Argo Group International Holdings (AGII), Employers Holdings, Inc. (NYSE:EIG), and Erie Indemnity. All of these stocks rank positively on all 4 factors of our equity pricing model, and we see an average outperformance of 18.5% based on their attractive quantitative profiles. None of these 5 stocks are highly liquid, none have average trading volumes over 200k, and so we'd also like to profile our top 3 highly liquid insurance stocks. These stocks are Hartford Financial Services Group (NYSE:HIG), Allstate, and Progressive Corp. (NYSE:PGR). All 3 of these stocks trade an average of 1 million or more shares per day, and all 3 are set to outperform by 20% or more over the next 12 months.

Conclusion

With the success of the insurance group since our last article, we feel even more confident that the insurance group will continue its momentum and trend upwards over the next 12 months. With the likely hike in interest rates looming, insurance companies should continue to prosper with higher revenues and even better valuations. We feel that this is only the beginning of a cycle of prosperity for an undervalued sector of the economy.

We've highlighted our 5 top value, growth, and overall insurance stocks so that investors who agree with our analysis have a starting list of companies to consider in the sector. We're pleased with the outperformance of the group and the even further outperformance of the stocks that we profiled 8 months ago. We look forward to constructive feedback in the comments. Please feel free to dig deeper into our analysis by clicking on any of the source links in the article.

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.