Insurance is one of Warren Buffett’s favourite sectors. Today, he owns or has positions in a vast number of insurance businesses including GEICO, General Re, National Indemnity Company, and Berkshire Hathaway Speciality Insurance.
Here, I’m going to explain why Buffett is so enamoured of the sector. I’ll also look at how it’s throwing up some bargains for investors to consider at the moment.
Why Buffett loves insurance
Buffett’s connection with the insurance industry began over 50 years ago when he spent $8.6m to acquire property and casualty insurance business National Indemnity. And since then, he has added a lot more insurance firms to his portfolio.
Earlier this year, it came to light that he had been buying shares in global insurance giant Chubb. In the first quarter of 2024, he acquired 26m shares in the company at a cost of around $6.7bn.
The main reason he likes such businesses is that they tend to generate a lot of cash. In his words: “Somebody hands you money and you hand them a little piece of paper.”
He also likes the fact that cash flows tend to be pretty stable since insurance companies collect premiums on a regular basis. This can be beneficial during economic downturns when other industries are experiencing turbulence.
Of course, Buffett realises that these companies face risks. The main risk is that claims can be substantial at times. So, the challenge for companies in this industry lies in accurately assessing future risks and pricing policies accordingly. That’s not always straightforward.
Cheap UK insurance stocks
Now, the good news for UK investors is that many London Stock Exchange-listed insurance companies are trading cheaply at the moment.
Legal & General, for example, currently trades at just nine times next year’s earnings forecast. Similarly, Aviva trades at 10 times next year’s earnings estimate.
One stock that’s really cheap, however, is Prudential (LSE: PRU). It currently trades on a forward-looking price-to-earnings (P/E) ratio of just 7.7.
Now, this stock has been an absolute dog recently (I’d know because I hold it). That’s because the company is focused on Asia and Africa these days and its performance has been impacted negatively by the downturn in the Chinese economy.
Taking a long-term view here, however, I see scope for a rebound. Developing countries across Asia and Africa remain largely untapped from an insurance perspective, so there’s plenty of growth potential in the long run.
It’s worth noting that last month, Prudential increased its interim dividend by 9%. To my mind, that large increase indicates that management remains confident about the future.
The company also announced a $2bn buyback. This suggests that management believes the stock is cheap.
The structural drivers of growth in Asia and Africa for our industry remain intact, with ongoing strong demand in respect of protection, long-term savings and retirement propositions as broader based economic growth returns to our markets. We continue to be confident in achieving our 2027 financial and strategic objectives.
Prudential H1 results
Of course, the weak economic environment in China remains a risk in the short term. When economic conditions in the world’s second largest economy will improve is anyone’s guess.
With the shares currently down more than 60% from their highs and trading on a super low P/E ratio, however, I like the long-term risk/reward set-up here.
