Thanks to their asset light, high-return-on-equity business model, insurance companies can be some of the most cash generative businesses around.
And realising this fact early on in his career, helped billionaire Warren Buffett build the business empire he presides over today.
In particular, during the late 60s Buffett paid around $9m for two small, well-run insurance companies, National Indemnity and its sister company, National Fire & Marine.
Today, after five decades of growth and business reinvestment, these two companies are worth $111bn, a value which exceeds that of any other insurer in the world.
Of course, I’ve cherry-picked this example, but it illustrates how lucrative insurance investments can be.
That’s why insurers Admiral (LSE: ADM), Esure (LSE: ESUR), Amlin (LSE: AML), Direct Line (LSE:DLG) and Lancashire Holdings (LSE: LRE) are my five top income stocks.
Best of breed
Lancashire is the perfect example of a well-run insurer that looks after its investors. Strict insurance underwriting controls have allowed the company to return around 100% of income to shareholders during the past five years.
Including both dividends and capital growth Lancashire’s shares have returned approximately 500% since coming to market during 2006.
Lancashire’s shares aren’t expensive, either. The company currently trades at a forward P/E of 10.7. City analysts believe that Lancashire’s dividend yield will top 9.5% this year as the company continues to return the majority of its income to investors.
Dividend champion
Over the years, Admiral has built a reputation for being one of the FTSE 100’s dividend champions.
Although the company’s dividend yield lags that of Lancashire, it’s still highly impressive. Over the past five years, Admiral has returned a total of £1.1bn to investors via both regular and special dividend payouts. This works out as around 90% of Admiral’s net income generated over the period.
City analysts have pencilled in a dividend yield of 6.1% for Admiral this year and 6.5% during 2016. The company currently trades at a forward P/E of 15.7.
Catching up
Direct Line and Esure have only been public companies for a couple of years, but they’re moving rapidly to build the same dividend appeal as Admiral and Lancashire.
Direct Line is planning a special dividend of 27.5p per share to investors this year following the disposal of its international division. Including the company’s regular payout, Direct Line’s cash return to investors will be in the region of 44.3p per share this year, a yield of 12.9%.
Analysts expect Direct Line’s dividend yield to fall back to 4.6% next year.
Esure is set to support a dividend yield of 6.0% this year and 6.3% during 2016.
According to City projections, Esure’s dividend payout will be covered 1.3 and 1.2 times by earnings per share during 2015 and 2016 respectively. The company currently trades at a forward P/E of 13.4.
Takeover play
Lloyds of London insurer, Amlin is a great play on the wave of mergers currently sweeping the insurance industry.
Including a special dividend of 34p per share issued during April, Amlin’s shares have returned 12.3% year to date, outperforming the FTSE 100 by 9%. Excluding special dividends, City analysts expect Amlin’s shares to yield 5.9% this year and 6.2% during 2016. The company currently trades at a forward P/E of 11.8.
