Why these ‘overvalued’ dividend stocks could be takeover targets

Roland Head explains why these top performers could still be cheap.

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Shareholders in digital payments group Paysafe received a welcome surprise this morning when the company announced a 590p per share offer for the firm.

The shares had already risen by 46% this year, before news of the bid emerged, but bidders Blackstone and CVC Partners clearly still see value in the stock. I think the lesson here is that private buyers will often take a longer view and be willing to pay more for a company’s future earnings than stock market investors.

Today I’m going to look at two other financial stocks. I believe both of these firms could become bid targets, despite having delivered big price gains over the last year.

Surplus cash

FTSE 250 insurance group Beazley (LSE: BEZ) has risen by 33% so far this year. The group provides a range of specialist insurance services for corporate customers and asset owners. Although companies in this sector have faced soft trading conditions in recent years, several have been taken over at attractive premiums.

It’s easy to see why. Although the gross premiums written by the company only rose by 2% to $1,149.3m during the first half of this year, pre-tax profit rose by 6% to $158.7m. The group was able to release $83.4m of “prior year reserves“. This is money that was set aside to pay out for claims last year but which has not been needed.

Much of this cash will be returned to shareholders in the form of dividends. For example, last year Beazley released $180.7m of prior year reserves and paid dividends totalling about $108m.

Today’s interim results suggest that the company is successfully defending its profit margins. Renewal rates on existing policies fell by 2%, but the group’s earnings per share rose by 17% to 20.2p. The group has also opened a new Dublin-based company to ensure that Brexit doesn’t disrupt its European operations.

Beazley stock currently trades on a forecast P/E of 15.5, with a prospective yield of 3%. This may not seem cheap, but for income investors willing to take a long view, I believe it offers good value. There’s also the possibility of a takeover bid.

A better alternative?

Rival group Hiscox (LSE: HSX) has had a more buoyant start to 2017, recording a 17.3% rise in gross written premiums during the first quarter. The group said its retail operations — selling insurance to consumers and small business — was responsible for most of the gains.

Retail growth is helping to offset declines in the group’s marine and property business, where it is seeing “single-digit rate decreases across the board”. Like Beazley, Hiscox is establishing a new EU-based company to make sure that it doesn’t lose access to European markets after Brexit.

Hiscox’s strong retail growth has encouraged investors to award the stock a higher rating. The shares currently trade on a 2017 forecast P/E of 20, falling o a P/E of 18.5 for 2018. Interestingly, the company didn’t declare a special dividend for 2016, choosing instead to retain spare cash to help fund growth.

Analysts currently expect Hiscox to pay a total dividend of 29.2p per share for 2017, giving a forecast yield of 2.1%. I’d continue to hold this stock, but would probably prefer to buy Beazley today.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be considered so you should consider taking independent financial advice.

Roland Head has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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