StreetAuthority investing guru Amy Calistri has covered the profitable opportunities from this ingenious investing strategy many times. In her October 2012 issue of Stock of the Month, she wrote:
“Reinsurance companies profit by collecting more premiums than they pay out in claims. But they can make much more money if they invest those premiums wisely.”
Alleghany Corporation (NYSE:Y)’s recent acquisition of Transatlantic Holdings has produced exceptional returns. The company doubled pretax earnings for the first quarter of this year compared with the same period last year. Core specialty insurance holding RSUI Group reported underwriting income of $57 million, up 30% from the year before.
At the close of 2012, Alleghany reported common stockholders’ equity per share of $379.13, a 10.8% increase over the previous year.
These results come in spite of significant losses due to Hurricane Sandy, which cost the company a reported $268 million in claims.
For the five-year period that ended Dec. 31, 2012, the company reported that common stockholders’ equity per share increased at a compound annual rate of 6.1%, compared with a compound annual rate of return of 1.6% for the S&P 500 over the same time.
The company is trading at a forward price-to-earnings ratio of 12 and a price-to-book ratio of 1.0. Analysts predict annual revenue to grow at a rate of 6% over the next seven years. Return on equity is forecast at 10% in the short term but should rise to 12% once the Transatlantic acquisition is fully integrated.
The firm uses growth in book value as the metric for compensation in the form of restricted stock. This system helps keep management’s interests aligned with shareholders’.
Management has also indicated that it plans to begin making private equity investments, which, if done correctly, could lead to additional growth opportunities.
Risks to Consider: To finance the Transatlantic deal, Alleghany issued roughly $2.7 billion worth of stock. While the deal appears to have been a success, issuing new shares to pay for acquisitions (as opposed to using existing capital) can be a risky proposition if the deal doesn’t work as planned. In this respect, the company differs significantly from the strategy employed by Berkshire, which doesn’t issue new shares to fund an acquisition.
In addition, insurance companies are subject to unpredictable losses stemming from events such as natural disasters or terrorist attacks.
Action to Take –> Alleghany Corporation (NYSE:Y) appears to be fairly valued at today’s prices. While it may never achieve the lofty heights that Berkshire Hathaway has attained, it remains a solid, stable company that has outperformed the broader market year after year.
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