Markets
ALL

3 Reasons Allstate's Stock Could Rise

Source: Company

The Allstate Corporation has everything investors are looking for: A strong insurance brand in the competitive property and casualty business, with increasing premiums and rising profitability, a cyclical earnings profile, and an encouraging development of its combined ratio.

All three themes justify further upside potential in Allstate's stock, even though the insurance company has already returned close to 20% for investors during the last 12 months.

1. Cyclical insurance business

Property and casualty insurance firms are cyclical businesses, and their stocks are promising investments in a strong economic expansion phase when earnings gradually improve, and when investor confidence is high. On the other hand, insurance businesses are the first investments to get the boot in times of turmoil, as investors gravitate toward defensive industries, such as utilities, to provide downside protection.

In other words, because I expect a strong recovery in the U.S. economy, cyclical businesses like Allstate should benefit from increased premium and earnings momentum during the next two to three years.

2. Improving profitability trend

The property and casualty business is a competitive industry in which many players feel policy pricing pressure.

Source: The Allstate Corporation Investor Presentation Q2 2014.

When evaluating an insurance company, two themes largely stand out: 1) What is the underlying profitability of the policy writing business, and 2) How does the company manage risk? The first question can be addressed by monitoring Allstate's return on equity, which has been steadily increasing during the last six quarters.

In the most recent quarter, Allstate generated an operating income return on equity of 9.8%, which compares against 8% in the year-ago quarter. The gradual improvement in this metric proves that the company is clearly on the right track here for profitability growth as the company continues to see written premium momentum. Allstate's property-liability business saw written premium growth of 5.5% year over year, and there's little that points to slowing growth any time soon.

3. Improving combined ratios

In order to answer the second question, "How does a company manage risk?" investors should look at Allstate's combined ratio. This ratio is quite material for insurance businesses as it reflects upon the underlying profitability of the policy-writing business. The combined ratio indicates how profitable Allstate's underwriting business is as it considers both insurance claims and expenses -- both are items that reduce Allstate's profitability.

Source: The Allstate Corporation Investor Presentation Q2 2014

Generally speaking, the lower an insurance company's combined ratio, the better it selects and prices the risks it puts on its books. Allstate certainly benefits from an improving combined ratio: Its property-liability underlying combined ratio, which adjusts for catastrophe losses, stood at just 84.7 in the most recent quarter, and compares very favorably against a ratio of 89.9 in the same quarter three years ago.

The substantial improvement in Allstate's combined ratio during the last three year indicates prudent risk selection. I expect continued underwriting success going forward.

The Foolish Bottom Line

Allstate is a well-run insurance company that stands out from the crowd with a convincing combined-ratio trend. The insurance company further has attractive upside potential, especially when financial companies rock back into the focus of equity investors who seek out businesses with strong cyclical earnings profiles.

Warren Buffett: This new technology is a "real threat"

At the recent Berkshire Hathaway annual meeting, Warren Buffett admitted this emerging technology is threatening his biggest cash-cow. While Buffett shakes in his billionaire-boots, only a few investors are embracing this new market which experts say will be worth over $2 trillion . Find out how you can cash in on this technology before the crowd catches on, by jumping onto one company that could get you the biggest piece of the action. Click here to access a FREE investor alert on the company we're calling the "brains behind" the technology.

The article 3 Reasons Allstate's Stock Could Rise originally appeared on Fool.com.

Kingkarn Amjaroen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days . We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy .

Copyright © 1995 - 2014 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy .

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

In This Story

ALL

Other Topics

Stocks

Latest Markets Videos

    The Motley Fool

    Founded in 1993 in Alexandria, VA., by brothers David and Tom Gardner, The Motley Fool is a multimedia financial-services company dedicated to building the world's greatest investment community. Reaching millions of people each month through its website, books, newspaper column, radio show, television appearances, and subscription newsletter services, The Motley Fool champions shareholder values and advocates tirelessly for the individual investor. The company's name was taken from Shakespeare, whose wise fools both instructed and amused, and could speak the truth to the king -- without getting their heads lopped off.

    Learn More