Offseason Scouting for Stocks

 | Dec 29, 2011 | 4:00 PM EST  | Comments
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Stock quotes in this article:

cinf

,

emci

As we move closer to the end of the year I want to continue to look for groups that are cheap and may see a catalyst to improve in 2012 and beyond. It is no secret that much of my focus is on real estate and baking-related situations, as those are the areas that are teeth-numbingly cheap and offer an opportunity to build enormous wealth over the next decade.

They are the cheapest by far, but not the only industry groups or situations that we should have an eye on going into 2012. Much as every team (except the Orioles and Mets) is always looking to get better in the offseason, I want to keep an eye out for sectors that can improve and offer additional profit opportunities for astute, patient investors.

One such group is property and casualty insurers. I am not alone in my affection for the group as our own Doug Kass has made bullish comments on the group, as has legendary distressed-assets investor Wilbur Ross. The group is historically cheap on a valuation basis and industry conditions have shown signs of improvement as the year come to a close. The catastrophic losses from the hurricane and tropical storm season are in the rearview mirror for now and many companies should see positive earnings momentum again. Industry supplies have tightened somewhat and that should lead to firmer pricing for many property and casualty companies in 2012.

I have had a toe in the water with P&C insurers for some time now. Every time Cincinnati Financial (CINF) trades down near $25 I have been a small buyer of the stock. Like most insurers they had large, storm-related losses this year. But they have added new business and been able to raise some prices. If storm losses abate somewhat and the economy improves slightly next year this company should have strong results in 2012. Tangible book value is $29.54 so this is a stock where you need to let Mr. Market work for you and wait for the shares to trade at a discount to that value. With a dividend yield in excess of 5% you get paid to wait for a firmer economy and strong insurance market.

There is going to be a lot of consolidation in the P&C industry over the next few years. It just makes sense to buy new assets and premium streams on the floor of the exchange instead of funding expansion when the shares are so cheap. It can be tough to predict which stocks will get taken over but owning a basket of smaller insurance companies that trade well below book value increase your chance of benefitting from the M&A activity that should develop in the sector.

One small insurer that catches my eye when I run the screens is EMC Insurance (EMCI). Although the Iowa-based company has agency representation in 42 states, the bulk of its business is written in the Midwest. About 80% of the premiums for this company come from commercial and personal lines of insurance, with the remaining 20% coming from its reinsurance operations. The company is run with Midwestern values and has been listed as one of the most trusted insurance companies by Forbes. About 24% of the workforce has been with EMCV for more than 20 years and they have the highest percentage of CPCU (Certified Property and Casualty Underwriters) of any other insurance company. It is a well-run, conservative insurance company that can be purchased for 70% of tangible book value at the current quote. As a bonus, the shares yield almost 4%.

The property and casualty business should be a much better business in 2012 than it has been the past few years. Waiting for headlines to drive down the market and accumulating a portfolio of profitable, dividend-paying insurance stocks below tangible book value should be a very profitable strategy for investors in the New Year.

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