Buffett loves this company. Should you invest alongside him?
Berkshire Hathaway (BRK.A -0.02%) (BRK.B 0.36%), Warren Buffett’s holding company, owns several dozen publicly traded companies. It’s a wise move to start tracking this portfolio. Because Buffett is such a long term investor, there aren’t as many changes to the portfolio as you’d typically expect. But there was a recent purchase worth several billion dollars that deserves attention.
Buffett knows a thing or two about this “boring” industry
The insurance sector isn’t the trendiest place for investors, but it should get more attention than it receives. Berkshire, after all, has a portfolio of insurance companies at the core of its business model. These entities — many of which Buffett has owned for decades — write billions of dollars worth of policies, collecting billions of dollars in premiums in return. Because these premiums only need to be paid in the event of a claim, Berkshire gets the privilege of keeping the money in the meantime. These funds are essentially interest-free capital. Buffett calls it “float,” and he’s invested it very wisely over the years.
Suffice to say that Buffett knows a thing or two about insurance. That’s what makes one of Berkshire’s latest purchases so intriguing. Late last year, it was reported that Buffett was buying billions of dollars in a certain financial stock. This summer, investors learned it was none other than Chubb (CB 1.48%): one of the largest publicly traded property and casualty insurers in the world.
Berkshire is betting big on this insurance stock
What does Buffett love about Chubb? He’s likely attracted to the company’s long term history of conservative underwriting. In recent decades, a deluge of capital has entered the insurance industry, much of it deployed by new companies seeking to replicate Buffett’s successful business model.
This competition rapidly ate into margins, what insurance experts refer to as “combined ratios.” When a combined ratio is 90%, for example, it essentially means that 90% of premiums are being paid out for claims — the hallmark of a profitable insurance business. But combined ratios can often exceed 100%, meaning the company is losing money on its policies.
In times of competition, many insurers lower their underwriting standards. They accept zero to negative underwriting margins in the hopes of earning enough interest from the float to maintain net profitability. But this strategy can easily go wrong, especially during a bear market when the invested float can actually decrease in value.
Throughout many industry cycles, Chubb has proven savvy at navigating the competitive cycle. Chubb’s combined ratio right now, for example, is just 86.8%. The industry, meanwhile, is averaging between 96% and 98%. Over the past two decades, Chubb has never posted a combined ratio of above 100%, even though the industry did so on several different occasions.
Conservative underwriting has allowed Chubb to invest in growth even as other companies pull back. It also allows it to manage its leverage effectively, boosting returns on equity in what otherwise is a low profit industry.
Return on equity, for instance, was above 15% in each of the last three quarters. Just as importantly, Chubb’s valuation is hardly unreasonable. Shares trade at just 12 times earnings. The S&P 500, meanwhile, trades at nearly 30 times earnings. Chubb also manages to pay a 1.3% dividend while repurchasing billions of dollars in stock in recent years.
According to the most recent filings, Berkshire’s Chubb stake is currently worth around $6.9 billion — the ninth largest position in its portfolio. Given Chubb’s conservative approach to a fairly low volatility industry, it’s a great place for Buffett to stash Berkshire’s growing cash hoard. It’s also a great place for everyday investors to park some cash, even just a few hundred bucks. Long term, Chubb should outpace to rate of cash, all while limiting your downside should markets turn sour.
Ryan Vanzo has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Berkshire Hathaway. The Motley Fool has a disclosure policy.
