Insurance companies make for some of the most reliable stocks on the market. Their business models necessitate this stability.
Insurance companies traditionally make money through premiums, but many are increasingly writing them at breakeven prices. Where’s the profit, then?
Insurance companies get to keep your premiums until they have to pay out claims. This money is called “float.” By investing the float, insurance companies can make a small profit until it needs to return the money to policyholders.
As insurance companies need to constantly service policy claims, they’re typically not investing a huge chunk of the float into risky assets like stocks. Instead, most portfolios are invested in low-risk securities like government and corporate debt.
By investing in an insurance company, you’re essentially betting on a company that can invest “free” money into low-risk assets. It’s now understandable why insurance stocks are so stable.
Want to get in on the action? Here are three top-ranked picks for your portfolio.
Growth plus income
What greater way to begin this list than with Great-West Lifeco Inc (TSX:GWO), which has a fortress-like business?
Since 1995, shares have risen more than 1,000%. It’s also paid a steadily rising dividend along the way. The dividend payout now results in a 5.5% annual yield.
With five subsidiaries targeting regional opportunities in North America, Europe, and Asia, the company has never been more diversified. It has investment-grade ratings from every credit agency and recently bumped the quarterly dividend from $0.389 per share to $0.413. The payout ratio is still under 60%, so there’s plenty of cushion.
A $2 billion share buyback program should allow the company to return capital to shareholders in a tax-efficient manner.
If a bear market hits, expect this stock to easily outperform the market.
Even more diversification
Sun Life Financial Inc (TSX:SLF)(NYSE:SLF) is one of the largest life insurance companies in the world. Given that it was founded in the 1800s, it’s also one of the oldest.
With a 4% dividend and a valuation of just 8 times forward earnings, now looks like the ideal time to pile into this slow-but-steady stock.
On nearly any metric, the company is growing. Over the last four years, earnings have grown by 13% annually while the dividend has grown by 7% per year. Return on equity recently popped to 14.2%.
Management has been incentivized to ensure that this growth remains on track. In the next few years, the company is targeting annual EPS growth of 8% to 10% while maintaining a payout ratio of 40% to 50%.
Due to its diversification, Sun Life is better positioned than most insurers to avoid a share price collapse in the face of recession. Just one-third of profits come from Canada, with the rest split between Asia, the U.S., and the U.K.
Plus, only 3% of the company’s portfolio is invested in equities, making its float one of the most reliable on this list.
Bigger isn’t better
With a market cap of $5.6 billion, Industrial Alliance Insurance (TSX:IAG) is by far the smallest stock on this list. The dividend is also smaller at just 3.4%.
Don’t stop reading, though—there’s real value here.
If you invested $10,000 in 2000, you nest egg would now be worth more than $70,000. That’s a better return than the larger peers on this list. Sometimes smaller really is better, as it allows a company to grow faster for longer without hitting structural limitations due to size.
Since 2004, book value has increased by 9.7% per year. The stock has largely followed suit, but not always in perfect tandem.
Today, shares trade at around book value. Buying at this valuation has consistently produced market-beating returns for investors.
At 1.1 times book, this is your opportunity to buy this long-term winner on the cheap.
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Fool contributor Ryan Vanzo has no position in any stocks mentioned.