Insurance underwriting is a very complex business and is based upon broad statistical averages that allow the insurance company to very accurately calculate the probability of clients filing a claim and the estimated size of those claims so they can set a premium level that will be higher than the claims paid. While they collect the policy premiums and wait for the inevitable claims to be filed, they invest the cash they are holding, known as the float, and earn a return on the funds invested.
Price-to-book value is one of the best metrics available for valuing insurance businesses, and dividend rates of growth coupled with current yield provide a good window through which to assess the attractiveness of a particular company as an investment opportunity. With a market capitalization of only $1.11 billion, Tower Group International, Ltd. (NASDAQ:TWGP) is a small-market capitalization insurer with some impressive numbers for potential investors to consider.
Tower Group boasts a current dividend yield of 3.45%, slightly more than 65% higher than the S&P 500 and has increased the dividend at an annual pace of 37.97% over the last 5 years. While many analysts like to value insurance companies at 1.4 times book (liquidation) value, I prefer to buy below book so I have a margin of safety for my capital. Tower Group International, Ltd. (NASDAQ:TWGP) currently trades at a price-to-book valuation of only 0.85, the equivalent of paying 85 cents to buy $1. To sweeten the deal even more, this business is trading at a multiple of only 7.96 times 2013 projected earnings and has an annualized projected earnings growth rate of 14% over the next five years. This business is carrying a bargain-basement valuation with superb forward projections and qualifies as an excellent choice for capital allocation.
Final thoughts for a diverse dividend-income portfolio
In part one of this two-part analysis, I suggested allocating 50% of capital applied to producing current income equally across three stocks to produce a yield of 4.45%. Allocating the second half of income-producing capital evenly across Wal-Mart Stores, Inc. (NYSE:WMT), Johnson & Johnson (NYSE:JNJ) and Tower Group International, Ltd. (NASDAQ:TWGP) will result in a current yield of 2.98% and produce a yield across all six businesses of 3.715%, 81% higher than the current yield of the S&P 500, while investing in a well-diversified group of businesses with excellent future prospects and a past history of raising dividends much faster than the rate of inflation.
The article Building An Income Fortress With Dividends Part II originally appeared on Fool.com and is written by Ken McGaha.
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