How I Analyse & Pick Profitable Insurance Stocks 5/5 (2)

How I Analyse Insurance Stocks
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How I Analyse Insurance Stocks Using Companies Financial Statement Like Profit or Loss, Balance Sheet (Financial Positions) And Cashflow – Top Financial Ratios to Find Best Insurance Companies In Nigeria

I had a conversation with a friend, this guy loves penny stock so much that he doesn’t trade stocks that sell above N10 per share. Besides, most of the penny stocks he bought early this year have earned him double-digit return.

I always tell him that I love his confidence when it comes to picking penny stock but you know his major concern? His least performing stocks are insurance companies, while the banking stocks are doing well on a year-to-date return basis YTD), the insurance stocks are underperforming compared to the overall sector index.

The insurance sector is up by 9.5% year-to-date which isn’t impressive when compared to the other indices. As of this writing, the NSE insurance sector, after a 5-day fall, is forming a pin bar at the 20 moving average line, a signal that shows the end of a downtrend.

 

The truth is this, Insurance is the most difficult financial products to sell in Nigeria and if you really want to invest in the sector, you need to find companies that are really making consistent profits, highly efficient and are generating healthy cash flow.

How then can one pick good insurance stocks to buy?

My simple guide to picking great insurance stocks to focus on the best-performing company in the sector, the usual way of analysing the strongest sector isn’t applicable as the sector had always been behind its peers for a long time, a reason not to even give it a shot. Take a look at the 5-year performance, 5-9% is low compared to the banking, industrial, healthcare and even the overall market index, so why would you still take the risk of buying stocks in the insurance sector? The only reason is the opportunity to cash out from penny stocks. When you buy into a big cap stock like Zenith bank, a 50k increase might not necessarily make much money compared to the result of a 50K gain on a penny stock. Why? the low price per share of penny stocks make larger volume purchases easy, hence offers better opportunities to cash out faster. Insurance sector offers more penny stocks than others.

Don’t get too excited about this, the same 50k gain on penny stocks that made millions can also wipe out a larger percentage of your portfolio, so it’s advisable to exercise due diligence when trading stocks in the insurance sector.

Follow me as I share proven and experienced trading strategies to uncover profitable insurance stocks to buy in the NSE market.

Find top performers

Unlike the sectoral performance strategy where you start by scouting for the top sectors, analysing insurance stocks doesn’t require the same strategy, we are already aware of the low contribution of the sector to GDP, less than 1%, a simple reason to skip the sector. So, how then should one find top performers? I look for insurance stocks that had appreciated more than the strongest sector index. In my book, “My Little Secrets that Make Big Money“, I share the best period to look at when comparing top-performing stocks, this will help you avoid stocks that have increased too much and are about to fade out or stocks whose performance are temporary.

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As of this writing, NEM insurance is the top performing insurance stocks. The stock is up by 65.66% year to date.

Check the fundamentals of the selected insurance stocks.

I am a big supporter of fundamental analysis, no matter how fast a stock is moving, if it doesn’t pass my strict financial ratios, I don’t buy. I do this to avoid pump and dump stock; stocks that are only driven by temporary market news.

There are four metrics I use to analyse the performance of an insurance stock.

The first key figure to check which would help you calculate the key ratios for insurance is Net Earned Premium.  When you pay your annual insurance premiums, the proceeds is called Gross Written Premium (GWP). But, what we’re more interested in isn’t the Gross Written Premium but Gross Earned Premium (GEP), which includes the portion of the premiums earned during a financial year. In turn, insurance companies take out insurance themselves. It’s called reinsurance and protects against unusually large risks. Reinsurance costs are deducted from the insurer’s GEP to arrive at Net Premium Income (NPI).

Now that we have sorted out some crucial figures, let’s get cracking on the ratios.

  1. Expense ratio:

The first part of our ratio gives us an insight into how tight the insurance company is running. The expense ratio shows the percentage of the NPI paid out in the course of acquiring, writing and servicing the insurance payments, often simplified as ‘underwriting expense’. The lower the costs, the more customers a company can attract with lower prices without hurting profitability. It’s a simple but effective strategy. To arrive at our expense ratio, we divide our underwriting expense by the NEP, giving us an expense ratio

2. Loss ratio

When bad luck strikes, you may be in line to make a claim. Such claims are an expense to the insurer, and show up as part of ‘net claims expense’. This figure can get knocked around from year to year and is an unavoidable aspect of these businesses. However, it’s with the loss ratio that an insurer’s underwriting discipline will be revealed. So a consistently high loss ratio can indicate that an insurer is selling their insurance too cheaply. It may be obvious that if the price isn’t right, you shouldn’t take the risks, but the history of the industry is littered with ill-disciplined underwriting. The loss ratio is calculated as net claims expense divided by NEP

3: Combined operating ratio

Taking the expense ratio and loss ratio, it’s a simple step to calculate the combined operating ratio (or ‘combined ratio’); simply add the two together. A combined ratio below 100% means an insurance company is operating at an ‘underwriting profit’ – a profit before adding the returns from investing customers’ premiums. On the flipside, a combined ratio of more than 100% represents an ‘underwriting loss’, which means an insurer is reliant on investment income to square the ledger. Again, we need to take into account several years’ of results to determine how the insurer is faring. Generally, a combined ratio below 100% is a good result; a figure below 95% is considered exceptional but might involve forfeiting revenue opportunities (from both investment returns and underwriting profits).

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4: Insurance margin

Next on our ratio list is the insurance margin; a combination of the combined ratio and earnings from the investment of ‘float’ There’s typically a gap between the time someone pays their premiums and when a claim is paid. During this period, an insurer has cash in its hands that it can plonk in the bank account to collect interest or invest in other assets in search of higher returns. By adding the return from investing the float to the underwriting result, we derive a figure called ‘insurance profit’. To calculate the insurance margin, we simply divide our insurance profit by NEP.

source

Using the above ratios, let’s see how NEM insurance is doing:

First Quarter 2017: Gross premium written grew to N5.1bn (N4bn in 2016), a 27% growth, but was chopped down by a near double-digit growth in unearned income of N2.5bn (N1.4bn). This led to a flat growth in gross premium earned, N2.6bn. Reinsurance expenses spiked by 1017% to N911.7bn (N81m), hence dragged net premium income to N1.7bn from N2.5bn (2016). Net underwriting income would have also decreased but was adequately supported by fees and commission income of N235m (N13.8m).

  • Underwriting profit declined by 50% to N1.5bn (from N3.2bn in 2016).
  • Profit before tax also declined by 73% to N715m (from N2.7b in 2016)
  • Profit after tax declined by 73% to N604m (from N2.2bn in 2016).
  • Cash flow from operation also grew to N1.7bn (N1.3bn in 2016)
  • Return on equity also declined.
  • Expense ratio also increased by 51% (underwriting expenses of N885m/net premium income of N1.7bn) against 24% in the comparable quarter. This is attributable to the reduction in net premium income to N1.7b from N2.5bn.
  • The loss ratio was 25.6% (claim expenses of N439,907/net premium income of N1,717,146) to 52% in the previous quarter.
  • The combined ratio for NEM is 76.5% for Q1, 2017 vs 76% for Q1, 2016.
  • To compute the insurance margin of NEM insurance, add the underwriting profit of N1.5b to investment income of N67.8m, then divide by net premium income of N1.7b. The margin for Q1 is 91% vs 130% in Q2 2016. The margin, though not bad, but reflect the significant decline in underwriting profit following larger re-insurance expenses.

Second Quarter 2017:

  • Gross premium written grew by 39% to N8.1bn (N5.8bn in 2016), Unearned income also grew from N987m to N1.6bn.
  • Net premium income N4.3bn against N3.7bn reported in the previous comparable quarter, 16% growth
  • Underwriting profit grew slightly by 8%, from N2.3bn to 2.5bn.
  • Profit before tax and profit after tax also grew from N1.3bn and N1.1bn to N1.4bn and N1.2bn respectively
  • Return on equity stands at 14.8% in the half-year period against 18% in 2016.
  • The second quarter result is not bad.
  • Expense ratio improved from 38.8% to 43% (N1.8bn/N4.3)
  • The loss ratio increased from 5.5% in Q2 2017 to 8.3% (Q2, 2016)
  • The combined ratio in Q2, 2017 was 48.5% against 47.1% (Q2, 2016)
  • Insurance margin declined from 6.8% in Q2 to 6.4%. The fall isn’t unconnected to the jump in underwriting and claim expense.
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Third Quarter 2017

  • Gross premium expanded significantly to N11b (N9bn in 2016) – 22%
  • Net premium income grew to N6.3bn (N6.1bn in 2016) – 3%
  • Underwriting profit increased to N3.3bn from N2.8bn – 17%
  • Profit before tax grew to N2bn (N1.4bn in 2016) – 42%
  • Profit after tax also increased to N1.6bn from N1.2 – 33%
  • Return on Equity stands at 18% against
  • Operational efficiency, measured by expense ratio increased from 35% to 43.3%.
  • The loss ratio declined to 12.3% from 24.8%.
  • Combined ratio improved from 59.8% to 55.6%.
  • The insurance margin rose to 60% against 51.2%.
  • The recent increase in the price is not far from earnings expectation.

Few minutes to the conclusion of this analysis, NSE had just posted the 2017 audited report of NEM insurance which will also be subjected to these three core financial ratios.

  • The company reported a Net premium income of N9.8bn against N8.5bn.
  • Underwriting profit expanded by 31% to N4.5 (N3.4bn in 2016).
  • The expense ratio increased from 34.6% to 42.4%, this is a result of double-digit growth in underwriting expenses.
  • The loss ratio improved from 31.3% to a record low of 18.1%
  • The combined ratio improved marginally from 65.9% to 60.5%.
  • Insurance margin stood at 53.2% against 46%, thanks to the lower loss ratio.
  • Profit after tax increased by 50% to N2.7bn (N1.8bn in 2016)
  • Return on equity rose to 28% (24% in 2016) while total debt to equity declined from 95% to 80%.
  • EPS also increased to 53k (34k in 2016)
  • Dividend payout also grew by 33%.
  • Cash from operation also grew by 26%, from N1.1bn to N1.4bn.

The stock still maintains a strong fundamental which is a supporting factor that will drive the share price.

Know when to buy

In my book, I have also discussed the simple technical tools to time your entry. NEM insurance, as of this writing, is trading at N2.7 and already overbought; the upside potential is limited as the stock is already overbought. I am currently watching the insurance stock closely, any fall on profit-taking should be an opportunity to jump in (as long as the next low is higher than the previous low). But, if you are a long-term trader, you can jump in now.

I hope you enjoyed this guide? feel free to ask questions or share your favourite insurance stocks.

New! Discover How I Pick Fast-Rising Nigerian Stocks In These Practical Videos

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