Last week, I introduced you to the concept of investing with a coin-flip mindset.
The idea behind it is simple.
Find investment opportunities that – like a coin flip – have only two possible outcomes:
Outcome one: You break even
Outcome two: You make money.
It is a selective investing approach that protects your downside risk. It also forces you to be selective and patient.
It is no coincidence that Warren Buffett’s No. 1 rule for investing is “Don’t lose money!”
Buffett is the greatest stock market investor of all time, and his approach is essentially based on this coin-flip model.
I ended last week’s article promising to point you toward an entire sector that offers one of these low-risk, high-reward coin flips today.
I’m excited to present it to you today…
These Stocks Have Only One Direction to Go
Insurance is a boring business.
While living in Bermuda (the reinsurance capital of the world) for a decade, I learned about the industry from the inside out.
And truth be told, boring is a good thing. A well-run insurance company can steadily compound shareholder equity for decades.
Insurance is also a business with staying power. The industry dates back hundreds of years and involves a product that we will need for hundreds more.
Today, the stock market has served us an opportunity to get into this industry on the cheap. I mean really, really cheap.
Never before have insurance companies traded so inexpensive relative to the value of their net assets.
Net Assets = Total Assets – Total Liabilities
Net assets are more often referred to as book value. Book value is a common metric that investors use to value businesses.
Buying depressed stocks with low price-to-book ratios is a classic value investing approach that was pioneered by Benjamin Graham almost 100 years ago. (Benjamin Graham, of course, was Warren Buffett’s mentor.)
I researched how three of the largest publicly traded insurance companies are trading today relative to their net assets. They are all trading for under 0.5 times book value.
That means these stocks are selling at less than $0.50 on each dollar of net assets that they own.
Historically, these companies have traded at or above book value.
More importantly, with these stocks trading at $0.50 on the dollar and at historic lows, it seems to me that their long-term downside risk is almost nonexistent.
This has all the makings of a coin-flip investment opportunity that offers plenty of upside and little risk of permanent loss of capital.
Now Is the Time to Buy
The reason the market is so sour on insurance companies today is no mystery…
Interest rates have plunged to near zero.
That is bad for the insurers because they primarily make their money by investing the premiums they collect from their customers.
With rates so low, the amount they can earn on their investment portfolio is negatively impacted.
Wall Street is well aware of this correlation. Thus, insurance stocks are more than priced for it.
Here’s the silver lining…
The only way interest rates can go from here is up. And they can go up a lot.
This is the bottom of the cycle for insurance company earnings because interest rates eventually have to go up and because the pricing on their policies is about to go up.
As investment earnings fall, insurance companies always respond by increasing the rates they charge their customers.
Insurance company earnings are driven by the combination of investment earnings and their insurance policy revenues.
Today, everything is bottoming out for these companies: investment earnings, premium pricing and their stock prices.
The downside risk in this sector is minimal, and the potential upside returns are very rewarding. All that is required is some patience to watch this low-risk, high-reward opportunity play out.
Now flip that coin!
Good investing,
— Jody
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Source: Wealthy Retirement