Before I move on from the idea of income investing through value investing, I need to cover one last subject.
It is not enough to have a portfolio of stocks that are cheap, relatively safe and have nice yields. You need to have a component of the portfolio that also offers the potential for dividend growth. Government statistics aside, we all know that the price of the stuff we use every day like food, gas and other staples goes up just about every year. So does the cost of vacation, education and just about every aspect of our lives. Our income must rise along with the costs of living and enjoying life.
Fortunately there is a nice, boring little corner of the stock market where we can find some cheap companies that pay decent yields and can grow their dividends over the next five to 10 years. Insurance is one of the most basic businesses around, and there is nothing terribly exciting about. We all buy it because we have to, but it isn’t on anyone’s list of things that excite them.
Both the life insurance business and the property and casualty insurance business have struggled in the past few years, but there are signs of improvement. Catastrophic losses from events like Hurricane Sandy are removing a lot of the excess capacity that had kept pricing weak. Life insurance companies will benefit from the developing trend of higher interest rates, which will attract customers to their products, and as profits improve as a result of a steepening yield curve.
Prudential Insurance (PRU) is one of the largest U.S.-based insurance companies offering life and health insurance as well as retirement planning and investment management. Life and health sales in the U.S. market are likely to remain weak, but the company is really focusing on the investment management, retirement planning and international insurance businesses that have much higher growth potential.
The stock has recovered somewhat in the past year but still trades right at tangible book value. The stock currently yields about 2%, but PRU has a great record of raising its dividends. Although the company cut the dividend back in 2008, it has since raised the payout every year, higher even than pre-crisis levels. The company should be able to raise the dividend by better than 20% annually for the next several years at least as interest rates rise and business conditions continue to improve, especially in Asian markets.
CNA Financial (CNA) offers property and casualty Insurance as well as a life insurance unit that has been placed into runoff mode. The company is seeing better pricing in its commercial lines business and decent growth from specialty lines like professional liability and auto warranty insurance. CNA cut its dividend for several years during the credit debacle but reinstated it in 2011 and has already raised the payout by 50%. The dividends should grow by 20% or more for the next five years and possibly longer. The stock currently trades at 70% of tangible book value, so it is still cheap.
Insurance might not be an exciting business, but the cheap, consistent dividend growth stocks should be of great interest to income-oriented investors.
As of this writing Tim Melvin did not hold a position in any of the aforementioned securities.