Cincinnati Financial (CINF) is a legendary dividend growth stock. It has increased its dividend for 56 years in a row.

The Dividend Aristocrats series covers all 50 Dividend Aristocrats – stocks with 25+ years of rising dividends in the S&P 500.  Cincinnati Financial meets this qualification, twice.

The company is part of an even more exclusive group called the ‘Dividend Kings’.  To be a Dividend King, a stock must have raised its dividends for 50+ consecutive years.  You can see all the Dividend Kings here.

Cincinnati Financial has a long history of principled management. The company traces its roots back to 1950, when four independent insurance agents decided to branch out and form their own company. Since then, Cincinnati Financial has prided itself on delivering local, fair, and prompt claims to policy holders.

This has strengthened the company’s relationships with its policyholders, which in turn has richly rewarded shareholders for many years.  Like the Dividend Aristocrats Index, Cincinnati Financial has outperformed the S&P 500 over the last decade (thanks in large part to recent strong performance).

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Cincinnati Financial

Cincinnati Financial currently offers investors a 2.7% dividend yield.  Keep reading this article to learn more about the investment prospects of Cincinnati Financial.

Cincinnati Financial – Business Overview

Cincinnati Financial offers standard market and surplus commercial lines in 39 states, and its personal line policies in 31 states. operates under four insurance lines:

  • Life
  • Personal
  • Commercial
  • Excess & Surplus

The commercial business is Cincinnati Financial’s largest, comprising 58% of its total revenue last year. Personal lines is its next-largest business, at 21% of total revenue.

Cincinnati Financial Source: 2015 CEO Letter to Shareholders, page 2

The company abides by a strict ethical code. Ethics are at the foundation of Cincinnati Financial’s business plan. The company has a motto of “Actions speak louder in person”.

These principles are how it has built such a successful business and high satisfaction rates among its customers. Cincinnati Financial was named one of Fortune’s 50 most trustworthy financial companies in 2015, for the fifth year in a row.

Cincinnati Financial Source: 2016 Annual Meeting of Shareholders, page 8

Cincinnati Financial takes a slightly different approach than others in the insurance business. Instead of keeping a focus on the highest-margin products, Cincinnati Financial does not object to issuing low-margin policies. It makes up for this with volume and capturing additional market share.

Separately, while many insurance companies split their capital allocation programs between share repurchases and dividends, Cincinnati Financial chooses to allocate most of its shareholder returns toward dividends.

Insurance companies make money in two ways, by writing policies and by investing their large pools of capital. This creates multiple income streams and can lead to steady value creation from year to year.

These qualities have attracted some of the world’s legendary investors to the insurance industry. For example, Warren Buffett owns GEICO.

Growth Prospects

Over the past 10 years, earnings-per-share grew by 2.3% compounded annually.  This is not particularly impressive growth.  As mentioned earlier in this article, Cincinnati Financial will write lower margin policies.  This has lead to underwriting losses from 2008 through 2012.

It should be noted that the company’s investment income helped the company remain profitable even when underwriting losses were occurring.

Since 2012, Cincinnati Financial has grown quickly.  Earnings-per-share have increased from $2.40 in 2012 to $3.56 in 2015.  Earnings-per-share are expected to be somewhere around $4.40 per share by 2020.

The most compelling growth catalyst for Cincinnati Financial moving forward is a rise in interest rates…

Cincinnati Financial generates around two thirds of its profits from its investment portfolio (on average). Its investments stood at $14.4 billion at the end of 2015, up 22% over the past five years.

Cincinnati Financial has suffered with eroding net interest income, which is the income earned on its investments. Investment income, net of expenses, rose 4% last year, which was a slower growth rate than the 6% revenue growth from earned premiums.

Higher returns on investments will be critical to Cincinnati Financial’s ability to grow earnings-per-share moving forward. The company is seeing heightened competition and abnormally high catastrophe have suppressed policy pricing and profitability.

That being said, Cincinnati Financial should benefit from the steady economic recovery in the U.S.  If (when) interest rates rise, the company will be able to generate higher investment income, which will lead to higher earnings-per-shares and more dividend growth.

Competitive Advantages & Recession Performance

The insurance industry does not lend itself to competitive advantages. There are not very high hurdles to entry in this market. As such, Cincinnati Financial relies upon its decades of experience and that it has built many successful customer relationships in that time. It relies heavily on its brand image as a competitive advantage.

Intelligent management can be a form of competitive advantage in a highly competitive industry.  Cincinnati Financial allocates its investment portfolio different than most insurers…

Most insurers are very risk averse.  They put almost all their portfolio into lower risk short-term bonds.  Cincinnati Financial is different.  The company invests around 30% of its investment portfolio in blue chip stocks.  This means the company’s investment portfolio is likely to generate superior returns over long periods of time relative to its peers.

Of course, this doesn’t help much in recessions when equity values fall.  The lack of a real competitive advantage did not help Cincinnati Financial during the financial crisis:

  • 2007 earnings-per-share of $3.54
  • 2008 earnings-per-share of $2.10
  • 2009 earnings-per-share of $1.32
  • 2010 earnings-per-share of $1.68

The company’s long-standing relationship with independent insurance agents make up its competitive advantage.  Cincinnati Financial becomes a preferred recommendation for independent agents as they become familiar with the company.

And, the company has significantly recovered in the years following the recession. Last year, Cincinnati Financial reported earnings-per-share of $3.56, up 34% from the previous year.

Valuation & Expected Total Returns

Cincinnati Financial stock has a price-to-earnings ratio of 25. This is right on par with the S&P 500 price-to-earnings ratio. Insurance companies have historically traded for a discount to the market, and Cincinnati Financial is no exception.  The company has historically traded for a median ratio of around 0.9x relative to the S&P 500.

With that in mind, future returns will be comprised of earnings-per-share growth plus dividends, minus any expansion or contraction in the price-to-earnings multiple.

As far as dividends, investors can expect annual dividend growth in line with Cincinnati Financial’s historical average. Over the past 10 years, dividends have increased by 3.1% compounded annually. The stock has a current dividend of 2.7%, which is higher than the 2% average dividend yield in the S&P 500.

If Cincinnati Financial grows at its historical rates, investors will see total returns of around 6% a year, before changes in the valuation multiple.

Final Thoughts

Cincinnati Financial is a legendary dividend stock. It has one of the longest streaks of annual dividend increases in the entire stock market. Plus, Cincinnati has offered special dividends on occasion, like last December when the company declared a $0.46 per share special dividend in addition to its regular dividend.

There’s no doubt the company is very shareholder friendly, but now is not the time to invest in Cincinnati Financial.  The company is trading for a high price-to-earnings ratio for an insurer.  Investors looking for stable dividends, growth, and value in the insurance sector should look at this Dividend Aristocrat insurer, instead.

 

Article by Bob Ciura

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