Cincinnati Financial Stock: Dividend King at Fair Value (NASDAQ: CINF)

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Introduction

It’s time to discuss one of the most attractive dividend-paying stocks on the market. the Cincinnati Financial Corporation (NASDAQ: CINF) is not only one of the few American dividend kings with a track record of more than 60 consecutive annual dividend increases, but it’s also a company that still competes with the S&P 500 when it comes to outperformance. In this article, I will do two things. I’m going to look at the company’s ability to pay a growing dividend and whether it’s attractive to income-seeking investors, and I’m going to spend some time comparing the company to the S&P 500, in this case the S&P 500 ETF (TO SPY), as most insurance companies are highly dependent on the value of bond and stock investments. The good news is that the company is performing very well against one of the toughest and most profitable investments in the world, the S&P 500.

Now let’s dive in!

Insurance value

I often say that I’m not a big fan of companies in competitive industries. That’s why I only own one consumer-focused company (at least for now), while two out of three financial companies I own are financial service providers operating in their own niches.

Author portfolio

Author portfolio

That said, companies operating in a competitive industry are not bad companies or bad investments. Some companies excel at what they do. Cincy Financial (I go with that instead of typing “Cincinnati” every time) is one of them.

Incorporated in Ohio (obviously) in 1968 (the Cincinnati Insurance Company was founded in 1950), the company has become one of the largest property and casualty insurance companies in the United States with operations in 46 states.

According to the company, it has three competitive advantages that set it apart:

– Commitment to our independent professional insurance agencies and their continued success

– Financial strength to deliver on our promises and be a cohesive market for our agent business, supporting stability and trust

– Operating structure that supports local decision-making, showcasing our claims excellence and allowing us to balance growth with underwriting discipline

So far, this has led to a high market share in five states. Please keep in mind that the definition of “high” in this industry is not what some may have in mind before I show the numbers.

  • Ohio 4.5%
  • Montana 2.7%
  • Vermont 2.3%
  • Indiana 2.2%
  • Kentucky 2.2%

As one of the top 25 P&C insurers, the company is expanding its business by using agencies to penetrate deeper into the market. An agency-centric business model allows the company to benefit from a more personal approach, more efficient (and difficult to copy) decision-making structures, and a highly centralized organization compared to branch structures, which reduces operating expenses.

On top of that, the company has a strong commitment to distributing a dividend through 61 consecutive annual dividend increases. Only seven American companies can match that. This does not mean that this stock is better than a company that started paying a dividend in 2015. However, it does indicate that the company has done very well in a competitive industry. Raising dividends for 61 consecutive years is a huge accomplishment by any measure – but we’ll get to that later.

The graph below shows that the company has grown its total revenue by 8.9% per year (compounded) over the past 10 years. The two main drivers of sales are premiums and annuities and gain or loss on investments.

Distribution of CINF income

TIKR.com

The company is doing very well when it comes to investing as it only saw a decline in 2018 since the Great Financial Crisis.

At the start of this year, the company had $24.3 billion in investments. 36.4% was invested in fixed taxable maturities. 17.1% was invested in tax-exempt fixed maturities. 44.6% was invested in common stocks.

The company’s equity portfolio is led by Apple (AAPL), which had 7.9% exposure. Overall, the company invests very similarly to the S&P 500, as shown in the chart below.

CINF 2021 10-K

Cincinnati Financial Corp. (2021 10-K)

This is one of the reasons why I think a comparison with the S&P 500 is so important. To put it very simply, investing in insurance companies means taking advantage of their ability to make a profit by selling insurance in a competitive market and investing those profits in profitable investments. Very good companies generate a lot of free cash flow, which stimulates investment. This is where you want to be instead of an index ETF. If not, buying an index fund is almost always a better idea (or a different stock).

So, before comparing CINF to the S&P 500, I need to justify the word “dividends” that I put in the title.

Cincy Financial is a slot machine. Between 2012 and 2021, cash from operations has increased by 12% per year.

CINF operating cash flow

TIKR.com

On January 28, 2022, CINF increased its dividend by 9.5% to $0.69 per quarter. This translates to an annual dividend of $2.76 per share. This is a return of 2.2%. In other words, the company needs around $450 million to satisfy its dividend. As the company has generated more than $1.0 billion in annual operating cash flow since 2015, it’s fair to say that the company has plenty of room to maintain healthy dividend growth.

Fortunately, the statistics seem to agree with me. The Seeking Alpha Dividend Scorecard for Cincy Financial shows it to be in the A range for dividend safety, growth and consistency. Only performance is a D. However, be aware that these scores are relative. In other words, the CINF is compared to the financial sector. This sector includes many monetary central banks and regional banks that have much higher yields.

CINF Dividend Dashboard

Looking for Alpha

The current dividend yield of 2.2% is about 70 basis points above the yield of the S&P 500. The 10-year average annual dividend growth is 4.8%. These numbers don’t excite me hugely, but they’re also far from bad, especially because the dividend is safe and consistent.

That said, 2022 won’t be so pretty – compared to 2021 – as the stock market and bond market crash. While I don’t expect annuities to suffer, it will likely be enough to reduce total revenue from $9.6 billion to the low $7 billion range – it could be worse depending on the stock market.

On April 28, the company released its 1Q22 results. It saw earned premiums hit $1.69 billion from $1.50 billion in the year-ago quarter. Still, revenue of $1.22 billion missed estimates of $1.83 billion per mile, while investment losses came in at $508 million.

So what does this mean in terms of valuation?

Evaluation

This year, analysts expect CINF to end up with a book value of $77.6 per share.

CINF book value

TIKR.com

This would imply a price-to-book ratio of 1.64.

Chart
Data by YCharts

Given the historical valuation of the company, this is the “fair value” that can be obtained. In other words, the stock will continue to track the S&P 500 as the main driver of profitability will be investment income/losses.

That being said…

CINF or index fund?

Dividend kings don’t have to be slow-moving, high-yielding stocks. CINF is the opposite. Over the past 10 years, the company has returned 402% including dividends. That beats the 278% return of the S&P 500, which isn’t bad either. It’s 14.2% per year.

Chart
Data by YCharts

Since 1994, CINF has returned 11.2% per year, including dividends. That beats the S&P 500 by about 120 basis points. Meanwhile, the standard deviation is almost 10 percentage points higher. The result is that the Sharpe ratio is rather low at 0.38.

According to Investopedia:

The higher a portfolio’s Sharpe ratio, the better its risk-adjusted performance. If the analysis results in a negative Sharpe ratio, it either means that the risk-free rate is higher than the portfolio return, or that the portfolio return should be negative. In either case, a negative Sharpe ratio conveys no useful meaning.

In other words, adjusted for volatility, investors would be better off buying the S&P 500. However, this comes with lower yield, higher market correlation (obviously, because c is the market) and a lower expected performance. And in all honesty, finding a stock that performs well and outperforms based on a Sharpe ratio is a difficult task.

Backtesting CINF, SPY

Portfolio Viewer

The table below shows tracking returns using various time periods.

Backtesting CINF, SPY

Portfolio Viewer

Overall, these numbers show that CINF comes with outperformance and higher standard deviation. Although a higher standard deviation will always be the case, as we are comparing a single stock to a basket of 500 companies. In other words, we demand outperformance because the dividend yield is higher, but not *so* high.

Take away

I still love Cincinnati Financial Corp. The company is one of the few dividend kingpins in the United States, with a balance sheet that continues to be impressive. I believe CINF’s buyers will continue to outperform the market on its ability to run an efficient insurance company, which will translate into strong operating cash flow. Dividend safety, growth and consistency are all A-rated, with only its yield lagging its financial peers.

CINF is a good stock for people looking for “conservative” exposure to the financial sector. Although the current market environment is not very fun, I believe it does provide opportunities to reinvest dividends, add more external cash to an existing position, or initiate a position.

However, be aware that the yield is not extremely juicy. We are at a point where the market sell-off is offering good returns in other segments of finance. Personally, I rather continue to add to the CME Group (CME), which has a higher yield, including special dividends, and a good balance sheet as well.

I’m not bringing up CME to make you jump on CINF, but just to give you something I like better in the same industry (finance).

Long story short, CINF is a great stock and investors can sleep well at night, even if current market sentiment is causing unpleasant volatility.

As always, feel free to (dis)agree with me in the comments section!

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