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Earlier this year, shares in Lloyd’s of London insurer Lancashire Holdings (LSE: LRE) slumped after the company announced its first underwriting loss since its IPO, thanks to the string of hurricanes that whipped the east coast of the United States throughout the second half of 2017.

While this was disappointing, the fallout from these catastrophes has allowed insurers to increase rates charged to customers for the first time in several years. As Lancashire’s first quarter results show, the company is taking full advantage of the favourable environment to make up for last year’s issues.

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Profits rising

Today the insurance group reported that pre-tax profits for the first quarter of 2018 nearly doubled to $42.4m on gross insurance premiums of $216m. 

Higher rates charged to customers as well as a benign loss environment help boost profits. The company’s combined ratio — a measure of underwriting profitability — improved to 65.2% from 85.6% (a ratio of less than 100% indicates a profit).

Based on these figures, I’m expecting the company to announce a bumper dividend payout towards the end of the year. Lancashire has a history of paying out almost all of its profit to shareholders via special dividends. Unfortunately, last year due to catastrophe losses, the group decided not to issue a special payout as it needed the cash to meet claims. 

But with profits rising, it’s more than likely that the group will reinstate its distribution policy towards the end of the year. City analysts have pencilled in a special distribution of approximately 30p per share, giving a dividend yield for the full year of 5.6%. However, if profits continue at the current rate for the rest of the year, according to my figures, Lancashire is on track to earn a net income of $170m for 2018, similar to the level recorded for 2015 and 2016. 

In both of these years, the company paid out a special dividend of 60p. With this being the case, I believe the City’s 30p estimate is far too conservative. A special payout of 60p per share would leave the stock yielding 9.6%.

Growth champion 

I plan to own Lancashire as an income stock forever and to complement it, I’m looking at growth stock XLMedia (LSE: XLM).

XLM looks to me to be a long-term growth story. Even though the City is expecting earnings per share to fall this year, a rebound is planned for 2019 and in the years following. With an operating profit margin of close to 30%, the group is also a cash cow. There’s no debt on the balance sheet, and cash currently makes up 10% of the market capitalisation.

Based on these numbers, I believe the company has plenty of cash available to reinvest in growth initiatives and return to investors at the same time. Cash distributions combined with earnings growth should result in highly attractive returns for investors. 

Despite these returns on offer, the shares currently look undervalued, trading at a forward P/E of 14.1 (or 12.3 excluding the cash on the balance sheet). They also support a market average dividend yield of 3.5%.

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Rupert Hargreaves owns shares in Lancashire Holdings. 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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