Anatomy of a trade
In his early years as an investor, Chuck Bath, 57, focused on finding undervalued companies, regardless of the industry. But over time the manager of the $1.5 billion Diamond Hill Large Cap Strategy fund (DHLAX) began looking for promising sectors as well as cheap stocks. The strategy has served him well. He has a 10-year annualized return of 10.1%, compared with 8% for the S&P 500. Now he likes insurers, especially the Hartford Financial Services Group (HIG).
1. The P&C business is rebounding
It’s been a tough few years for insurance companies. Low interest rates have put a squeeze on the returns of their investment portfolios. In turn, they’ve had to increase prices. Now, says Bath, demand exceeds supply in the P&C (property and casualty) market. This leaves P&C insurers in a strong position to boost prices again and grow profits. In addition to 2.3 million shares of Hartford, Bath recently bought nearly 618,000 shares of Travelers (TRV) and more than 420,000 shares of Chubb (CB).
2. And Hartford is well-positioned
Hartford is one of the largest providers of property and casualty coverage. And the company has a particular niche within the P&C sector — covering small and medium-size businesses — which adds security to Bath’s bet. In 2011, 28% of the company’s $21.9 billion in revenue was generated from P&C policies for businesses. That kind of scale allows Hartford to operate more efficiently than smaller competitors. Plus, S&P expects a rise in P&C premiums to be driven by growth in small commercial coverage.
3. It's selling noncore assets
Hedge fund titan John Paulson, who owns 7.2% of the company, is Hartford’s largest shareholder. And the hedgie has pushed Hartford to sell noncore assets. “Paulson has lit a fire under management,” says Bath. In July, Hartford sold broker-dealer Woodbury Financial to AIG (AIG) for $115 million; in early September it agreed to sell its retirement-plan business to Massachusetts Mutual Life Insurance for $400 million; and it recently sold its individual life insurance business to Prudential Financial (PRU) for $615 million in cash.
4. Hartford's stock looks cheap now
Hartford’s share price has fallen from nearly $100 in 2007 to just below $20. Bath says the stock is now trading more than 20% below his estimate of the company’s intrinsic value — a number he calculates using normalized earnings, margin growth, long-term revenue growth, and other factors. Hartford has a forward P/E ratio of just 5.6, vs. 14 for the S&P 500. It’s even cheap when compared with its P&C insurance rivals Travelers and Chubb, both of which trade at more than 10 times forward earnings.