These 2 Insurance Stocks Are a Good Bet

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I referenced Shelby Davis and insurance stocks earlier this week and have spent some time thinking about the legendary investor’s approach to stocks. Davis built a fortune of about $900 million by investing in insurance stocks over a 47-year period. During that time, he averaged a little over 23% a year focusing his efforts on what he considered to be well-run insurance companies purchased at low price-to-earnings ratios and low price-to-book multiples.

Most of us think of insurance stocks as being somewhat boring, but when you consider that both Shelby Davis, and to a large extent Warren Buffett, have used them to grow enormous fortunes, they get a little more exciting.

At the heart of it, everyone buying insurance stocks are pretty much just betting on math. It operates on the same actuarial principles as a casino — and we all know those are pretty profitable when managed correctly. They are betting nothing bad will happen to you, and you are betting that something will. Of course, the insurance company is the house, so they have the bet priced on terms favorable to themselves. It also helps that while no one is required to gamble, many forms of insurance are required by law, so you are forced to make a bet.

I started putting together a list of insurance stocks I want to own for the very long term. I think these companies are well positioned to be long-term winners that deliver exceptional returns. I am hoping they all have poor short-term results when they announce this quarter, so I can buy them at lower prices.

It has been a long road to profitability for Conifer Holdings (CNFR) , since its founding in 2009 and IPO in 2015, but it looks like the firm will turn the corner and report a profitable 2017. It has been growing its book of business at a decent pace, and I like the lines of insurance it writes.

Conifer offers insurance for restaurants, bars, and taverns — including liquor liability, an area where it has high levels of expertise. It also offers homeowners’ insurance in high-wind areas like Florida and Texas, so it will probably have some short-term losses from my good friend Matthew, who just passed through Florida, but in general it has been pretty conservative in underwriting and reserving for this line of business. The firm also writes coverage for industries like small grocery and convenience stores, contractors — comprising plumbers, painters, carpenters and electricians — as well as security service providers — such as companies that provide security guard services, security alarm products and services, and private investigative services. These are all markets underserved by larger companies, and Conifer has developed the expertise needed to serve these specialty markets. As they put their growing pains behind them and can focus on profitable growth, this has the potential to be a wildly successful company over the long term. The stock is currently trading at 82% of book value, and further declines would make the stock too cheap not to own.

Hallmark Financial Services (HALL) is another specialty insurer that I think can see strong long-term growth. The company writes insurance for industries including restaurants, storage facilities, airports, and medical professionals. It also offers specialized space and satellite programs for that fast-growing industry.

The company had some significant storm-related losses in Texas and the Midwest during the second quarter — and still had a combined ratio of 95.9% in the quarter, so it appears to be doing a solid job of underwriting the specialized risks it is accepting. Hallmark has fallen short of Wall Street’s expectations, with three consecutive negative earnings surprises, and that has put pressure on the stock price. The shares now trade at just 95% of book value and 12x earnings, so another selloff because of an earnings miss would represent a buying opportunity.

Note that I am waiting for a pullback to even-greater bargain levels with these stocks. I am in complete agreement that Shelby Davis’ statement that, “A down market lets you buy more shares in great companies at favorable prices. If you know what you’re doing, you’ll make most of your money from these periods. You just won’t realize it until much later.” This is not a down market by any stretch of the imagination, so I am quite stingy about the valuations I am willing to pay, right now. I am hoping these two fall further, because I think they both could be very profitable for disciplined, patient long-term investors.