Thursday, June 9, 2011


It is time for the Oracle of Omaha, Warren Buffett, to put his money where his words are and to announce a buyback of Berkshire Hathaway (BRK.A/BRK.B) shares.

It would be an exclamation point to his bullishness.

Insurance stocks represent one of the most attractive areas in which to invest.

Across almost every sector of the market, the insurance stocks represent one of the most attractive areas in which to invest.

The group has rarely been as inexpensive statistically.

Note: ROI = Book value obtained from Yahoo! Finance/2012 EPS estimate

* Strong profit: On average, insurers should demonstrate EPS growth over 20% in 2011 and 10% in 2012.

* Valuations are cheap: Selling at 6.8x 2012 consensus earnings forecasts and at only 0.74x book value, both of these metrics are well below the historical averages - P/E ratios and discounts to book value are both over one standard deviation below long-term averages. (The industry has traditionally traded at 1.2x book value.)

* Share buybacks: Given the improved capital bases, most companies are buying back stock. And at current valuations, those buybacks are very accretive to EPS. For example, this week Prudential (PRU) announced a large $1.5 billion buyback.)

* Sector underweight: According to Goldman Sachs' analysis of mutual fund weightings, the life insurers are underweighted (by nearly 40%) relative to the S&P 500.

* Insurance industry credit spreads are narrowing.

* Short interest has expanded.

* Rising interest rates: Life insurance stocks typically do poorly when interest rates are declining. I expect a rise in the yield on the 10-year U.S. note.

The largest component of the financial sector in terms of S&P weighting is the banks. While I currently expect a bounce from very depressed levels, it is hard to see a sustainable rise in bank stocks given the absence of loan growth, ongoing regulatory pressures and more stringent capital requirements. By contrast, the insurance sector may take up the slack for investors seeking financial exposure.

Multiple black swans (earthquakes, flooding, tsunamis, etc.) have begun to have a salutary impact on the reinsurance industry's pricing.

Run, don't walk, to read 'The Economy: When Will Happy Days Be Here Again?' on Knowledge@Wharton.