Mercury General (NYSE:MCY) 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, they are guaranteed to make large amounts of money over time almost irrespective of 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 they have 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 the balance sheet, and MCY is an exceptional organization because it has been so consistent over time and had an excellent 2015 as well. The most recent earnings report showed quarterly YoY revenue growth of 4.5%, for a total $2.94 billion in sales for the year. At a forward P/E of only 16, the company is priced at a substantial discount to the S&P 500, which currently has an average P/E of around 20, even after the recent sell-off. So, the company is growing, trading at a reasonable - if not discounted - valuation, and pays a juicy 5.67% dividend.
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. MCY is the quintessential defensive stock, because the company will continue to sell insurance no matter what happens to the stock market, it will continue to pay the fat 5.67% dividend as it has for the last several years, and it is 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 MCY look like a conservative bet is that it is trading at only 1.34 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. Right now, MCY has almost $3.64 billion in cash, with only a $2.45 billion market cap and a solid current ratio of 3.46 - yet another indication of its strong fundamentals.
So, for investors looking for safety of principal 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 who is already attracted to dividend-paying stocks. You can hold this one for years and sleep well at night knowing your money is safe and earning at least a nice 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.