Like most private investors, I drip-feed money from my earnings into my investment account each month. To stay fully invested, I need to make regular purchases, regardless of the market’s latest gyrations.
However, the FTSE 100 is up 82% on its March 2009 low, and the wider market is no longer cheap. It’s getting harder to find shares that meet my criteria for affordability.
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In this article, I’m going to run my investing eye over Direct Line Insurance Group (LSE: DLG), to see if it might fit the bill.
The triple-yield test
Today’s low interest rates mean that shares have become some of the most attractive income-bearing investments available.
To gauge the affordability of a share for my portfolio, I like to look at three key trailing yield figures –the dividend, earnings and free cash flow yields. I call this my triple yield test:
| Direct Line Insurance Group | Value |
|---|---|
| Current share price | 261p |
| Dividend yield | 4.7% |
| Earnings yield | 9.5% |
| Return on tangible equity | 17.3% |
| FTSE 100 average dividend yield | 2.8% |
| FTSE 100 earnings yield | 5.7% |
| Instant access cash savings rate | 1.5% |
| UK 10yr govt bond yield | 2.8% |
A share’s earnings yield is simply the inverse of its P/E ratio. Direct Line’s 9.5% trailing earnings yield equates to a P/E of 10.5 and looks appealing, especially alongside its above-average dividend yield of 4.7%.
Return on tangible equity (RoTE) is a useful measure of profitability for insurance companies, and Direct Line’s adjusted RoTE, which excludes discontinued/run-off businesses, rose from 11.5% at the end of 2012 to 17.3% on an annualised basis during the first half of 2013. That’s an impressive figure, but even Direct Line’s own CEO, Paul Geddes, was moved to admit a degree of luck, saying that “these are a good set of results, even allowing for the benign weather in the period”.
That benign weather hasn’t continued, and a recent report by Bank of America Merrill Lynch analysts suggests that the firm may experience a £145m loss as a result of the recent flooding. Although some of these losses may be booked in 2014 figures, rather than hitting last year’s earnings, some impact is still expected.
Is Direct Line a buy?
Direct Line’s share price has risen by 40% since the firm’s shares commenced trading on the LSE in October 2012.
Although the Direct Line’s dividend yield remains one of the most attractive in its sector, I believe there is a risk that the 2013 results could fall below expectations. Given this, I would wait until after Wednesday’s full-year results announcement to decide whether the insurer’s shares remain a buy, or not.
