This stock is an insurance company that specialises in certain areas of the insurance market, such as property, accidents, shipping and energy. It also makes money selling reinsurance (insuring other companies’ insurance policies).
At first glance, these companies can be rather off-putting to the private investor. Their accounts are full of jargon that could have you reaching for the dictionary every five minutes.
However, as with lots of things, a little goes a long way. In essence, this stock is just like any other insurance company. It makes money if the insurance premiums it takes in are more than it pays out in claims. On top of that it has a large chunk of money set aside in an investment portfolio that produces an income stream.
Underwriting insurance risks is a very skilled job. Knowing which risks to take on and which to avoid is not always easy. Charging customers the right price is vital too. Charge too much and people go elsewhere – charge too little and you run the risk of losing money.
Then there’s always a possibility that a big disaster will come along and blow a large hole in an insurer’s finances.
It would seem that Brit (LSE: BRIT) is quite good at underwriting, compared to some of its peers. Its combined ratio (its claims and expenses as a percentage of the money it takes in from premiums) was just over 85% last year, meaning there was a tidy profit left over. This was boosted by a modest investment return on top.
The key measure of how good an insurance company is is how much profit it makes on the money shareholders have invested. Last year its return on equity was a very creditable 24.5%, but can the good times continue?
Life is actually quite tough for specialist insurers right now. As the industry hasn’t had to make many large payouts for disasters for a while, there are lots of companies with plenty of spare capital reserves.
Some are using them to cut prices on certain lines of insurance, which means that for companies such as Brit, it’s going to be quite hard to grow profits in the years ahead.
Brit is trying to get round this by being smarter with its underwriting and concentrating on areas where prices are firmer, or increasing a little. It is also expanding into new areas, such as aviation, fine art and high-value houses.
Even though profit growth may be hard to come by, it would seem that this cloud may have a silver lining. As Brit has more money on hand than it has profitable insurance opportunities, it is highly likely that shareholders will be in line for some bumper dividend payouts.
Over the next couple of years most of Brit’s profits will probably be paid out, which would give the shares a dividend yield of more than 10%. Its price-to-book value – a key valuation measure – is a relatively undemanding 1.2 times.
If you are looking for a share for your new Isa allowance, then Brit could be worth a look. You might want to consider reinvesting any dividend income too and compound the value of any investment.
Verdict: buy at 244p