Prudent Picks in Insurance

08/15/2014 7:00 am EST

Focus: STOCKS

John Buckingham

Editor, The Prudent Speculator

We have little reason to believe that the direction of equity prices in general—and our broadly diversified portfolio of undervalued stocks in particular—will not be higher over the next three-to-five years, suggests John Buckingham, editor of The Prudent Speculator, who highlights two featured ideas in the insurance sector.

Aetna (AET)

Aetna is one of the largest managed care organizations, covering approximately 22 million members.

The firm recently announced Q2 results with profits boosted by its Medicare and Medicaid provider Coventry Health Care, which it acquired in mid-2013.

Excluding costs related to that purchase, earnings were $1.69 per share, higher than the $1.60 per share that analysts had anticipated. Furthermore, the insurer raised its full-year 2014 earnings forecast to a range of $6.45 to $6.60 per share from $6.35 to $6.55.

While there still are sure to be a few operating potholes in the managed healthcare space, we think Aetna offers attractive long-term upside as it enjoys accretive benefits from its Coventry Health Care acquisition and takes advantage of its scale and financial flexibility.

We also like the company’s diverse product lines, relative pricing discipline, cost control initiative, and solid cash flow generation. AET shares are currently trading at 12 times forward earnings projections.

Axis Capital Holdings (AXS)

AXS is a global specialty insurer and reinsurer. The firm offers a diversified portfolio of specialty commercial property, casualty insurance, and reinsurance, emphasizing high severity and low frequency business.

We like that leadership is focused on controlling costs and bringing specialist underwriting to new target markets, as well as creating more business balance and decreasing volatility.

Second-quarter earnings of $1.63 per share easily topped consensus estimates of $1.19. The firm generates attractive free cash flow and has been actively repurchasing shares, with an additional $450 million remaining in its current program.

We see the potential for continued increases in the quarterly dividends, with shares currently yielding 2.5%. AXS also trades at less than eight times earnings, and less than 90% of book value per share.

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