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The Best Stock To Buy In The 'Industry Of Legends'

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When it comes to investing greats, nearly everyone is familiar with the names Benjamin Graham, the father of modern value investing, and Warren Buffett, considered one of the greatest investors of all time.

But I want to tell you about an investing great who -- outside of value circles -- is relatively unknown. His performance over the years was equally as good as Graham's and Buffett's, and the story of how he accumulated his wealth contains lessons that can benefit any investor. It also happens to set the foundation for the latest pick in my premium newsletter, Top Stock Advisor .

In 1947, at the age of 38, Shelby Davis began investing in earnest with $50,000. Over the course of his investing career, he amassed a $900 million fortune. What's more, he did it by investing in only a handful of stocks that were all in the same industry.

It's the same industry that Ben Graham and Warren Buffett made their fortunes.

That industry is insurance.

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A Misunderstood Industry

It's easy to understand why the average investor stays away from the insurance sector. First of all, insurance isn't a "sexy" investment. It's a stodgy industry with no new game-changing innovations that shake things up. Second, nobody likes having to buy insurance. Moreover, insurance and insurance companies typically have a bad stigma, which is understandable since whenever you have to deal with them it's because something bad has happened. To top it off, the industry can be a little hard to understand.

For better or worse, insurance has become a regular cost of living. Like rent or electricity. You have to have it. So you pay the bill. And to top it off, in order for an insurance company to turn a profit, you have to have "wasted" your own money.

When it comes to talking about insurance, it's understood that nobody likes it. And if you don't like it, chances are it's not at the top of your investment wish-list. But I'm here to tell you that insurance is exactly where you should be invested. If the world's greatest investors have built their fortunes on the backs of insurance companies, then it should be a staple for every portfolio.

The Secret To Insurance

Shelby Davis invested in insurance companies for one of the reasons I stated above: it's a stodgy industry that changes slowly. This helps reduce some of the inherent risks associated with investing in general. If a company doesn't have to deal with new regulations or build a new innovative product to stay ahead of the competition, the company can focus on making money.

Insurance companies can turn a profit through what's called a float. A float is the premiums an insurer collects but has not yet paid out in claims. And this hoard of cash can grow large for insurance firms. For well-run ones, it's also a powerful tool for generating profits. But this is where it can trip up many investors because float actually sits on the balance sheet as a liability, on the premise that the cash could be paid out as claims some day.

But here's the kicker: in reality, float is an asset. The premiums that an insurer collects, or float, are held in a trust for the payment of future benefits, or claims. So for accounting purposes, yes, it's a liability since this money might have to be paid back at some unknown point in the future. But this isn't just cash sitting idle in a bunker somewhere waiting to be deployed. This is money that can be invested, and any income and capital gain are kept by the insurance company.

For example, Buffett's Berkshire Hathaway holds more than $88 billion in float -- money that doesn't belong to them, but that they can invest for Berkshire's benefit. According to Forbes , this is how Buffett himself has managed to accrue such a large fortune. Imagine if someone asked you to hold onto $88 billion dollars and you could keep any interest you earned off of it? Even at a measly 1%, that's $880 million that you get to keep just for holding the $88 billion for a year. At 2% that's $1.7 billion.

And we know great investors like Buffett will make more than 1% per year on their investable funds.

A good chunk of these funds is put into short-term treasuries and commercial paper, which has been returning next to nothing over the last eight years thanks to the low-interest rate environment. But that's beginning to change. The Federal Reserve has slowly raised rates and plans to continue doing so throughout 2017. Each time they bump up the interest rate, that's millions of dollars that flow into the corporate coffers of insurance companies.

When researching what insurance companies to invest in, you want to make sure that it's consistently growing its float. We can do this by seeing whether the company is registering what's called an "underwriting profit." In short, this means that if the total amount of premiums collected exceeds the total amount of claims paid, then the company is generating an underwriting profit.

With this in mind, I set out to find an insurance company that consistently generates an underwriting profit, is growing its float and is fairly priced for my premium newsletter, Top Stock Advisor . Through my research, I found a niche insurance provider that is known for its strict underwriting discipline. What's perhaps even more impressive is that the company grew its book value -- Buffett's favorite way to measure growth -- by 16% last year (this is before share repurchases and dividends). It's grown book value for eight consecutive years, and I'm confident it will continue to grow this number by double-digit rates going forward.

This pick is exclusively for my Top Stock Advisor subscribers, though. But whether you choose to join me and my subscribers or not, I strongly encourage you to consider making insurance a core part of your portfolio. Each month in Top Stock Advisor, I provide my readers with a single recommendation, one that they can buy now and hold indefinitely as part of a market-crushing portfolio. If you'd like access to my portfolio, including a list of my top 10 stocks for 2017, I invite you to click here .

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

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