... which includes Amlin (LSE: AML), Aviva (LSE: AV) and Legal & General (LSE: LGEN).
I'm always searching for strategies and shares that can help ordinary investors like you make money from the stock market.
So today I am launching a demonstration 'mini-portfolio' that I hope shows how a particular investment approach -- and the five companies I've chosen -- can prove profitable over time.
The idea for this mini-portfolio came from a special Motley Fool report called "Top Sectors For 2012", which reminded me how focusing on particular industries could deepen my knowledge of such sectors and lead to better investment decisions. More on that free report a little later.
The two types of insurance
For this mini-portfolio I'm going to concentrate on the insurance sector, which has been thumped during the last few years and is currently home to many lowly rated shares.
Insurance comes in two forms. There's "life", which is insuring people, and "general", which covers everything else including cars and houses. Life insurers have been better performers in the last few years as their business tends to be less volatile than general insurance, and they also enjoy fairly reliable fees for managing pension funds and other investments.
There's an old saying that insurance companies are investment trusts with an expensive hobby -- namely losing money by selling insurance. The problem is that insurance is a very competitive business, so underwriting losses are very common and companies often only make a profit by investing their premiums.
Consequently, many investors value insurance companies as if they were investment trusts by looking at their net asset value (NAV) and the level of discount.
Tough times for insurers
The recent recession hit the general insurance industry with a double whammy. That's because the number of claims always rises when times are hard, which increases their underwriting losses, while poorly performing markets cut the profits that they expect to make by investing the premiums received.
2011 was an especially tough year thanks to the disproportionately large number of natural disasters in rich countries, such as the Japanese and New Zealand earthquakes and the floods in Australia.
All of this is reflected in the valuation of many insurers, with market caps trading below balance-sheet values and dividends providing above-average income yields. Assuming that at some point the recession ends and the stock market picks up, I feel the sector's fortunes should turn and today's ratings could look very attractive in hindsight.
The companies
With all that in mind, here are the five shares I think can do well over time:
Amlin (LSE: AML) is the largest insurance underwriter at Lloyds of London. It's the only one of the five companies that isn't a member of the FTSE 100 (UKX) index and its shares usually trade at a premium to their NAV because it has a history of making underwriting profits, though it was hard hit in 2011 by claims for natural disasters.
Aviva (LSE: AV) is a "composite" insurer as it sells both life and general insurance. Aviva is a popular share with many Fools because its shares trade at a substantial discount to their NAV of 445p or 595p (see later) and they yield 8.7%, though there are strong indications that shareholders should expect the dividend to be cut in the near future.
Legal & General (LSE: LGEN) is technically a composite insurer, although its business is very strongly biased towards life insurance. It is one of the biggest fund managers in Europe, so it has a more stable income than most other insurance companies, which means that its shares yield only 4.9%. That's low for an insurer!
RSA Insurance Group (LSE: RSA) is a general insurer that was formed in 1996 when Royal Insurance merged with Sun Alliance. It's the company behind the "More Th>n" adverts, which used to show Lucky the Dog getting into all sorts of adventures. RSA's shares have one of the highest yields in the FTSE 100 at 8.2% and they trade at a small premium to their NAV.
Standard Life (LSE: SL) is a life assurance company that demutualised in 2006 by issuing shares to all of its with-profits policyholders. As a result, it is one of the most widely owned companies with over 1.5 million shareholders in 50 countries, the vast majority of whom are private investors.
A £5,000 demonstration portfolio
I am going to monitor these five shares through a mini-portfolio, but let me stress that this is a paper portfolio and is for demonstration purposes only.
I will track my chosen shares with a £1,000 'investment' in each. Here is the starting position, with purchase prices taken from the close of business yesterday, dealing costs charged at £10 and stamp duty at 0.5%.
| Company | Number of shares | Purchase price (p) | Total cost (£) | Net asset value | Discount to NAV | Dividend yield |
|---|
| Amlin | 260 | 379.1p | £1,000 | 287.1p^ | (32.0%) | 6.1% |
| Aviva | 330 | 299p | £1,001 | 445p or 595p* | 32.8% or 49.7% | 8.7% |
| Legal & General | 760 | 129.6p | £999 | 147p* | 11.8% | 4.9% |
| RSA Insurance Group | 890 | 111.1p | £1,003 | 108p | (2.9%) | 8.2% |
| Standard Life | 405 | 242.6p | £997 | 317p* | 23.5% | 5.7% |
| | | TOTAL | £5,000 | | | 6.6% |
* This NAV is the European Embedded Value, an industry standard measure which includes the future profits generated on the company's existing policies in today's money. ^ This NAV includes Amlin's includes its intangible assets, if they are excluded it is 243p.
Though I am confident about the future performance of my selections, I would never advocate anyone to rely on just five shares. Indeed, I would back these shares only as part of a wider portfolio.
Now back to that special free report I mentioned earlier.
"Top Sectors For 2012" sees three Motley Fool Share Advisor analysts each studying a favourable industry -- and pinpointing a particular share to consider for this year and beyond.
Various opportunities are covered in the report. One might provide "solid returns and... nice dividends", another could offer "global diversification and long-term growth potential", while a third looks a "high-quality business" from a battered sector.
You can read "Top Sectors For 2012" today by requesting the report for free. But hurry, the report is available for a limited time only.
Next month
I'll be back next month to let you know how this mini-portfolio is going. Stay tuned, too, for the occasional buy and sell trade. As I say, I hope this approach and the five shares chosen can prove profitable over time.
At last -- a special free report that introduces novices to shares! "What Every New Investor Needs To Know" and The Motley Fool are helping Britain invest. Better.
Further Motley Fool investment opportunities:
> Tony owns shares in Standard Life but he doesn't own shares in any of the other companies that are mentioned in this article.
