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2 Neil Woodford stocks Warren Buffett might buy in 2017

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After a tough 2016, Neil Woodford may be smiling today. Shares of Lloyds insurer Beazley (LSE: BEZ) — a holding in Mr Woodford’s Equity Income Fund — rose by 9% this morning, after an impressive set of results.

It’s Beazley’s biggest one-day gain since 2008. In my view, today’s results highlight the attractions of these specialist insurance stocks for investors. And Mr Woodford isn’t the only noted investor with a significant commitment to insurers.

Invest like Buffett

Billionaire investor Warren Buffett has always praised the cash-generation qualities of well-run insurance companies.

Earlier this year, Mr Buffett demonstrated his continuing interest in the insurance business by agreeing a $10bn re-insurance deal with US giant AIG. Buffett’s insurance firm Berkshire Hathaway will take on a maximum liability of $20bn, in return for a one-off payment of $10.2bn.

The deal is expected to be profitable for Berkshire. I wouldn’t bet against Mr Buffett pursuing other insurance-related investments in the future. So could Beazley and fellow Neil Woodford pick Lancashire Holdings (LSE: LRE) tempt him to buy?

Strong results in a soft market

Beazley said this morning that the net value of policies written during the year rose by 8% to $1,854m. This helped to generate a 3% increase in pre-tax profit, which rose to $293.2m. Measured in the group’s reporting currency of US dollars, post-tax earnings were broadly flat at 48.6 cents per share.

However, the weakness of the pound against the US dollar meant that Beazley’s earnings received a serious boost when converted into pounds. Measured in pence, earnings were 11% higher at 35.5p per share, significantly above analysts’ forecasts of 32.7p per share.

Beazley’s dividend payout was also above expectations. The group announced a second interim dividend of 7p and a special dividend of 10p this morning. This gives a total of 20.5p per share for 2016, equivalent to a 5% yield at yesterday’s share price.

No compromise

One of the attractions of Beazley and Lancashire is that they’ve refused to slash prices in a market where insurance rates are falling. So-called catastrophe claims — such as the destruction of a major ship or building — have been rare in recent years. This has pushed down insurance rates for this type of cover. But pricing insurance on the assumption nobody will claim is very risky.

Instead of cutting rates, Beazley and Lancashire have scaled back their insurance activity in this sector. This is most notable at Lancashire, where revenue has fallen from $764m in 2014 to an expected level of just $582m in 2016. The group’s earnings have now fallen from $1.29 per share in 2012 to an expected level of $0.67 in 2016.

Lancashire’s shrinkage has resulted in the group returning a lot of surplus cash to shareholders. Dividend yields as high as 10% have been available at time over the last few years.

Larger Beazley has returned capital too, but has also diversified. Chief executive Andrew Horton said today that US growth had helped to offset declines in other areas. Beazley’s earnings have ranged between $0.41 and $0.51 per share since 2012.

Are these stocks a buy?

I don’t expect Warren Buffett to buy Beazley or Lancashire, as they’re mainly UK businesses.

But for private investors looking for attractive long-term returns, I believe both stocks are worth considering.

These income buys could beat insurance

Lancashire is on my watch list. But these specialist insurance stocks are hard to understand and can go badly wrong.

If you're looking for a reliable and growing long-term income, it may be worth considering the attractions of the stocks featured in 5 Shares To Retire On before investing in insurance.

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Roland Head has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended Berkshire Hathaway (B shares). We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.