Everybody that has ever paid a car insurance premium has probably asked the question in the headline. The fascinating answer to this question was provided by the few auto-insurance financials I could locate.
The question becomes even more important with Google Inc. (NASDAQ: GOOG) poised to enter the U.S. auto insurance business. Google is currently testing a tool that will sell policies directly to U.S. auto owners, Tech Crunch reported. Like Warren Buffett, the Google (NASDAQ: GOOGL) team sees auto insurance as a potential cash cow.
It can be difficult to determine revenue figures because most American insurance companies are mutual organizations. That means they do not issue stock, so they are not under the same requirements as publicly-traded companies. Fortunately, there are a couple of prominent publicly-traded auto insurance companies operating in the U.S.
One of the most visible is Progressive (NYSE: PGR), which, like Berkshire Hathaway’s (NYSE: BRK.A) GEICO, is known for flooding the television airways with goofy advertisements. Progressive is a rather interesting company because its share price is rather low ($30.55 on September 28, 2015), yet it seems to have a lot of float.
The Vehicle Insurance Float Theory
Buffett’s classic theory is that insurance companies can generate a lot of float from the premiums. The idea is that large numbers of people send in premiums every month, so as long as the amount of payments taken in exceeds the claims paid out, the insurer has a big pile of extra cash it can tap.
Vehicle insurance is very attractive to classic value investors like Buffett because it is required by law in every U.S. state except New Hampshire. That provides a large captive market for the company’s products.
The financial numbers at Progressive seem to verify the vehicle insurance float theory. Here are the numbers that Progressive reported on June 30, 2015:
- A year to year TTM revenue of $20.12 billion
- A net income of $1.32 billion on the same date
- A gross profit margin of 6.88%
- A free cash flow of $627.50 million
- Cash and short-term investments of $1.933 billion
- $2.114 billion in cash from operations
So yes, folks, Progressive is making money and, more importantly, sharing that money with investors. Here is what Progressive did for shareholders:
- A diluted earnings per share number of 2.245
- A dividend yield of 2.25%
- A payout ratio of 30.46%
- A return on equity of 18.82%
Progressive’s enterprise value also exceeded its market capitalization by $890 million on September 28, so it appears undervalued. For the record, Progressive reported a market capitalization of $17.89 billion and an enterprise value of $18.78 billion.
What’s more intriguing is that Progressive reported a high rate of growth. Its revenue was growing at a rate of 11.43% on June 30, 2015. Progressive’s revenue grew from $18.59 billion to $20.12 billion between June 2014 and June 2015. The charts show us that Progressive’s revenue has been growing steadily for the past five years, by around $2 billion a year.
That indicates Progressive’s business strategy of intensive direct marketing is working. The company has discovered a steady source of revenue that is constantly growing in a crowded and competitive market.
Progressive vs. Allstate
The interesting question we need to ask is, can this growth be maintained? One problem appears to be that Progressive is growing by stealing market share from companies such as Allstate (NYSE: ALL), not by generating new customers.
Allstate’s revenue was growing at a rate of 1.38% a year on June 20, 2015, according to YCharts. Despite that, Allstate did report an impressive amount of revenue growth. Its revenues have been growing at a rate of around $1 billion a year for the past five years.
For the record, Allstate reported a TTM revenue of $33.92 billion in June 2013 that grew to $34.8 billion in June 2014 and $35.63 billion in June 2015. Allstate is obviously growing, but does it make money?
The answer that YCharts data provided to that question is yes. Some of the most recent financial numbers for Allstate include the following:
- A net income of $2.637 billion
- A profit margin of 3.85%
- A free cash flow of $663 million
- $3.626 billion in cash and short-term investments
- $3.338 billion in cash from operations
Like Progressive, Allstate also paid back to investors. Allstate shareholders recently enjoyed these numbers:
- An earnings per share number of 5.918
- A dividend yield of 2.04%
- A payout ratio of 22.83%
- A return on equity of 12.89%
Another characteristic that Allstate shares with Progressive is that it is undervalued by Mr. Market. Allstate had a market cap of $23.15 billion and an enterprise value of $26.93 billion on September 28, 2015. It also had an attractive share price of $57.83 on the same day.
Are Auto Insurance Companies a Good Investment?
The numbers show us that insurance companies can generate a lot of float from the premiums. They make a lot of money, and they pay a nice dividend. If you’re looking for something boring that makes money but offers growing revenue, auto insurance is definitely a sector to look at.
The only clouds on the horizon in this sector are new technologies such as self-driving cars and the entry of Google. It is currently too early to tell if Google will take revenue from insurers or enhance the revenue stream they get from premiums
My prediction is that Google will help direct-market auto insurance organizations such as Progressive and GEICO by increasing their market. Yet it could hurt more traditional organizations such as Allstate that rely heavily upon insurance agents. One problem facing the insurance industry is a generation of Americans used to buying insurance directly online rather than from an agent.
Allstate, though, is poised to benefit from this trend because it owns the popular online insurance marketer Esurance. Like GEICO, Progressive and Allstate, Esurance markets heavily online and through television.
The bottom line is that auto insurance is still a great value investment because vehicle insurers generate a lot of cash and float. They are also relatively safe from disruption because of the nature of the business. The insurance companies own the policies, so they make money no matter how they are marketed.
What’s more interesting is that the disruption caused by new marketing tools such as Google could actually benefit direct market insurance companies like Progressive by driving more business to them. If you are looking to add some shares that generate cash and add value to your portfolio, auto insurance is definitely a sector to check out.