If there’s one sector Warren Buffett understands more than any other, it’s insurance. He’s been involved in the insurance industry since the late 1960s and, today, his conglomerate Berkshire Hathaway is one of the largest insurance groups in the world.
Over the past five decades, the group has completed a string of deals in the sector snapping up some of the most significant players in the market.
Buffett likes to buy well-run, profitable insurance companies that have a track record of sensible underwriting. Firms like Lancashire Holdings (LSE: LRE).
Well-diversified
Lancashire is really three different businesses: Lancashire, Cathedral and Kinesis. As my Foolish colleague Kirsteen Mackay recently explained, Lancashire and Cathedral provide specialist insurance against catastrophic events such as hurricanes. They also offer unique insurance policies for the property, marine aviation and energy sectors.
On top of this, the Kinesis segment manages reinsurance for the business. It offers a management service for third parties who want to invest in the insurance industry but don’t know where to start.
Lancashire’s profitability track record is outstanding. The group’s 10-year average combined ratio (a measure of insurer profitability) is around 70%, compared to the industry average of nearly 100% (the lower the ratio, the better).
On top of this, management has adopted a policy of paying out as much capital as possible to shareholders. Shares in the insurance group currently support a regular dividend yield of less than 2%, but the company regularly distributes special dividends, which has jacked up the yield to more than 10% in the past.
Analysts are forecasting a total yield of 5.4% for 2019.
Sector leader
Another insurance business that stands out as a sector leader is Sabre Insurance (LSE: SBRE). Sabre stands out because the company has managed to carve out a niche for itself in the highly competitive car insurance sector.
The group’s three direct brands are Go Girl, Insure2Drive and Drive Smart, all tailored specifically to cater to individual needs. While they may be slightly more expensive than other policies, customers seem happy.
Revenue has grown at a compound annual rate of around 10% over the past five years, and City analysts are expecting the company to report a net profit of £50.2m for 2019.
Based on these figures, the stock is currently trading at a forward P/E of 15.3. This is slightly above what I would consider an appropriate valuation for a company that’s for not expected to report any earnings growth for the next two years. However, like Lancashire, Sabre likes to reward its investors with cash payouts.
This year, city analysts are forecasting a full-year dividend of 20.2p, which gives a dividend yield of 6.8% on the current share price. Sabre’s niche brands, as well as the company’s customer loyalty and cash generation, are the key reasons why I believe Buffett would be interested in adding this stock to his portfolio.
