A Way to Protect Your Portfolio Is Adding an Insurance Company

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Feb 20, 2014

On December 31, Donald Smith (Trades, Portfolio) added XL Group plc (XL, Financial) at an average price between $29.65 and $ 32.16 and currently holds 6,022,052 shares of the stock with a value of $175 million in his portfolio. It was the second time he added the stock during 2013, which makes me feel that Smith is making a bet in favor of the insurance industry. So let's take a look at this company and try to explain to investors the reasons this is an apparently appealing investment opportunity.

Expanding Operations

XL Group is an insurance and reinsurance holding company and is engaged in providing property, casualty and products to industrial, commercial and other firms, insurance companies and other enterprises.

In 2010, the company´s subsidiary (XL Insurance Company Limited), received the license from the Malaysian authorities to engage in several lines in the insurance market. The following year, the subsidiary made an agreement with Keith D. Peterson & Company. The aim was to provide insurance coverage to the forest products industry. In 2012, the deal with Hays Affinity Solutions offer professional liability insurance to dentists.

More recently, XL Group has received approval to arrive at the Brazilian insurance market. Through XL Seguros Brasil S.A. it will provide a wide range of insurance products.

Analyst Recommendation

Its fourth-quarter 2013 earnings per share surpassed the Zacks Consensus Estimate. The firm is currently Zacks Rank # 3 - Hold, and it also has a longer-term recommendation of “Neutral”

Relative Valuation

In terms of valuation, the stock sells at a trailing P/E of 10.3x, trading at a discount compared to an average of 13.2x for the industry. To use another metric, its price-to-book ratio of 0.8x indicates also a discount versus the industry average of 1.17x and the price-to-sales ratio of 1.2x is above the industry average of 1.13x. The first two metrics indicate that the stock is relatively undervalued relative to its peers.

Earnings per share (EPS) increased in the most recent quarter compared to the same quarter a year ago. It has demonstrated a positive trend over the past four years. In the next graph we include the stock price because EPS often lead the stock price movement.

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Finally, I always like to see one of the most important financial ratios applying to stockholders, the best measure of performance for a firm's management: the return on equity. The ratio has increased when compared to its ROE from the same quarter one year prior. Let´s compare it with competitors in the next table:

Ticker Company Name ROE (%)
XL XL Group 6,2
ACE ACE LTD 9,8
AIG American International Group 3,5
AZSEY Allianz SE 9,2

As we can see, American International Group (AIG) has a lower ROE than XL Group. But for those seeking for a great ROE, the option should be Allianz SE (AZSEY, Financial) or ACE LTD. (ACE).

Final Comment

Taking into consideration the P/E ratio, Wall Street values good every dollar of the company's earnings (the lower the ratio, the more attractive the investment). Moreover, the firm’s EPS and ROE growth, revert past performance while the market expects an improvement for this year. In addition, the company demonstrates its commitment to return cash to investors through a share repurchase program.

I would recommend investors to consider adding the stock for their long-term portfolios. Hedge fund gurus have also been active in the company in Q4 2013. Paul Tudor Jones (Trades, Portfolio) and Joel Greenblatt (Trades, Portfolio) have also invested in it, as well as the funds RS Investment Management (Trades, Portfolio) and Diamond Hill Capital (Trades, Portfolio).

Disclosure: Victor Selva holds no position in any stocks mentioned.