The Amazing Compounding Power of A Low Combined Ratio
Here are a few interesting facts:
– Chubb’s premium revenue has grown at 0.1% a year over the last decade
– Chubb’s earnings-per-share have grown at 7.9% a year over the last decade
Chubb’s actual business has experienced virtually no growth in a decade. Normally, this would be a cause for concern. Despite this, Chubb’s shareholders have realized solid earnings-per-share growth near 8% a year. How is this possible?
Almost all of Chubb’s growth over the last decade has come as a result of share repurchases. The company has repurchased a phenomenal 6.3% of shares outstanding a year on average over the last decade.
Chubb’s business model is simple:
– Write profitable insurance policies
– Invest float primarily in safe debt securities
– Use earnings to repurchase shares and pay dividends
The company has been able to repurchase over 6% of its outstanding shares a year on average over the last decade because its price-to-earnings ratio has been around 10 for much of the past 10 years. This gives the company an earnings yield of 10% a year. Chubb pays out 25% to 30% of its income as dividends, and ~60% as share repurchases.
The Chance to Own Chubb is over
Chubb Corp (NYSE:CB) used to be one of the top recommendations using The 8 Rules of Dividend Investing. This is no longer the case.
Chubb’s stock price has soared 32% in the last 6 months. This is not what you’d expect from a stable insurance company.
Chubb’s stock price surge is a result of the company being acquired. Remember… There are only 4 property and casualty insurers larger than Chubb.
ACE Limited (ACE) recently announced it will acquire Chubb Group (CB) for $28.3 billion. This sent Chubb’s stock significantly higher. The deal is the largest property and casualty insurance transaction ever.
It also makes Chubb a sell. Chubb stock is now a merger arbitrage play rather than a stable Dividend Aristocrat that will compound investor wealth far into the future. As a result it is not a suitable holding for dividend growth investors.
Good Things Happen To Great Businesses
Chubb is an excellent example of a high quality businesses. When Chubb was recommended to Sure Dividend readers, I had no idea the company would be acquired.
High quality businesses that can withstand the test of time often have favorable surprises. After all, Chubb wasn’t going anywhere. Even with premium revenues virtually flat over a decade, the company was generating solid total returns for shareholders.
I thought investors in Chubb Corp (NYSE:CB) would continue to benefit from the company’s growth over a very long period of time. That didn’t happen. Instead, the pending Ace acquisition gives investors in Chubb an excellent exit point to lock in capital gains and reinvest them into other high quality dividend growth stocks.
There is now only 2 other insurance industry Dividend Aristocrats; Aflac Incorporated (NYSE:AFL) and Cincinnati Financial Corporation ((NASDAQ:CINF). Of the two, I believe Aflac to be the better long-term investment.
Aflac has maintained a combined ratio of around 85% for much of the last decade. The company is highly profitable, and also is addicted to share repurchases. You can read more about the investment merits of Aflac at this link.
Disclosure: None
