There’s a reason why Warren Buffett, the Oracle of Omaha, has built a business around insurance companies. It is because well-run insurers can be extremely profitable. This is why I think Hastings Group (LSE: HSTG) could be a great addition to your portfolio today.
Different approach
In the car insurance industry, Hastings stands out for its differentiated approach. The business makes the most of technology to serve its customers, which means lower costs overall and bigger profits for investors.
Indeed, according to my research, the company’s operating profit margin is one of the best in the business, coming in at 27% for 2017 compared to the UK insurance industry median of just 9.3%.
Management has adopted a policy of returning most of the excess cash the company generates to investors. This means fat dividends. City analysts believe the group will return a total of 13.9p per share to investors for the 2018 financial year, which gives a dividend yield of 6.9%. With earnings expected to jump around 14% year-on-year, analysts are forecasting an even fatter distribution for 2019 of 14.9p per share, giving a dividend yield of 7.4% at the current price.
Usually, such a high dividend yield indicates that the market does not believe the payout is sustainable, so why are the shares trading at such a significant discount?
Undervalued?
It seems to me that investors are worried about the group’s outlook. Back in October, management warned that the market for UK car insurance was becoming increasingly competitive, which was interpreted as a revenue warning. However, management also stated that the company would maintain its “disciplined pricing strategy in the ongoing competitive market,” which tells me that the firm’s fat profit margins are here to stay. This seems to be the right strategy. Chasing growth at any cost is never a good idea in my mind, particularly in the insurance industry.
With this being the case, I think now could be a great time to be greedy when others are fearful and snap up shares in Hastings.
Another income stock I think it’s worth considering today is Galliford Try (LSE: GFRD).
Rough year
It is fair to say that this company had a rough 2018, after the collapse of outsourcer Carillion forced management to raise funds from investors. Now, the uncertainty of Brexit is haunting the stock.
At the current level, and based on City forecasts, the shares are trading at a forward P/E of 5.3 and support a dividend yield of 10.1%. In my opinion, this valuation is too good to pass up.
Even though there is still plenty of uncertainty overhanging the business, and the broader UK construction industry, the shares are trading at a discount of around 33% to the wider homebuilding sector, implying a possible upside of 47% when the uncertainty is lifted. Add in the 10% dividend yield, and investors could be looking at a potential upside of nearly 60% over the next 12 months if Brexit is resolved and investor confidence returns.
So, even though the outlook for the company is unclear, I think there is a wide margin of safety here which more than compensates for the extra risk.
