Updated on January 30th, 2023 by Felix Martinez
Insurance can be a great business. Insurers collect revenue from policy premiums and make money by investing the accumulated premiums not paid out in claims, known as the float.
Even legendary investor Warren Buffet sees the value of insurance stocks –his investment conglomerate Berkshire Hathaway (BRK.A) (BRK.B) owns GEICO, General Re, and more.
High profitability allows many insurance companies to pay dividends to shareholders and raise their dividends over time. For example, Aflac (AFL), has increased its dividend for 40 years in a row.
This means the company qualifies as a Dividend Aristocrat – a group of 66 companies in the S&P 500 Index with 25+ consecutive years of dividend increases.
You can download a free list of all 65 Dividend Aristocrats, along with important metrics like dividend yields and price-to-earnings ratios, by clicking on the link below:
This article will take an inside look at Aflac’s business model and what drives its impressive dividend growth.
Business Overview
Aflac was formed in 1955 by three brothers: John, Paul, and Bill Amos. Together, they came up with the idea to sell insurance products that paid cash if a policyholder got sick or injured. In the mid-twentieth century, workplace injuries were common. And there was no insurance product at the time to cover this risk.
Today, Aflac has a wide range of product offerings. Some of these include accident, short-term disability, critical illness, hospital indemnity, dental, vision, and life insurance.
Source: Investor Presentation
The company specializes in supplemental insurance, which pays out to policyholders if they are sick or injured and cannot work. Aflac operates in the U.S. and Japan, with Japan accounting for approximately 70% of the company’s premium income. Because of this, investors are exposed to currency risk.
Aflac’s earnings will fluctuate based on exchange rates between the Japanese yen and the U.S. dollar. When the yen rises against the dollar, it helps Aflac because each yen earned becomes more valuable when it is reported in U.S. dollars.
Aflac’s strategy is to increase premium growth through new customers and increase sales to existing customers. It is also investing in expanding its distribution channels, including its digital footprint, in the U.S. and Japan.
Aflac continues to perform well overall. On November 8th, 2022, Aflac declared a $0.42 per share quarterly dividend, marking a 5% increase and the company’s 41st straight year of increasing its payment.
On October 31st, 2022, Aflac released Q3 2022 results. The company reported $4.82 billion in revenue for the third quarter, representing an 8.0% decrease compared to Q3 2021.
Net earnings equaled $1.6 billion or $2.53 per share compared to $888 million or $1.32 per share in Q3 2021. On an adjusted basis, earnings-per-share decreased 24.8% to $1.15 per share
For the nine months of 2022, Aflac generated $4.0 billion in net earnings, representing a 22.2% increase compared to the nine months of 2021. Adjusted earnings were down 18.2% year-over-year. However, net earnings per share were up 29.7% from $4.82 per share in 2022 for the nine months to $6.25 per share for the nine months of 2022.
Growth Prospects
From 2011 through 2021, Aflac grew earnings-per-share by an average compound rate of 7.4% per year, although part of that improvement is tax reform-related. Also, remember that the Yen was generally weakening against the dollar for a good amount of the last decade. Results for 2021 were especially impressive amid the pandemic.
Source: Investor Presentation
In Japan, Aflac wants to defend its strong core position, while further expanding and evolving to customer needs. To this point, Aflac Japan is expanding its “third-sector” product offerings. These include non-traditional products such as cancer insurance and medical and income support.
Aflac has enjoyed strong demand in Japan for third-sector products due to the country’s aging population and declining birth rate.
Source: Investor Presentation
Meanwhile, in the U.S., Aflac believes it has a long way to go to penetrate the market. While the brand name is well-known, only a small fraction of the U.S. working population has access to Aflac, and an even smaller fraction actually purchases Aflac – under 5% of the working population.
Aflac has two sources of revenue: income from premiums and income from investments. On the premium side, this is generally sticky, with policy renewals making up the bulk of income. However, Aflac operates in two developed markets where we would not anticipate seeing outsized growth in the business.
The other lever available is on the investment side, where the vast majority of the portfolio is in bonds. Here there is a possibility for income improvement should rate rise in the future, although lower rates have been persistent. In addition, the share repurchase program has been an important factor as well and we believe it will continue to drive earnings-per-share.
All of these items – premium growth, higher rates, and repurchases – were challenged to some degree by the COVID-19 pandemic. However, the company has proven to be quite resilient. We are forecasting another uptick in 2022 earnings – to $5.26 per share – to go along with a 4% annual growth rate over the next five years.
Competitive Advantages & Recession Performance
Aflac has many competitive advantages. First, it dominates its niche. It operates in supplemental insurance products and is the leading company in that category. Its business model has low capital expenditure requirements and sells a product that enjoys steady demand.
Aflac’s strong brand is a key competitive advantage. Competition is intense in the insurance industry, considering the commodity-like nature of the products. To retain customers and attract new customers, Aflac invests heavily in advertising.
Aflac is also a recession-resistant company. It remained profitable even during the Great Recession:
- 2007 earnings-per-share of $1.64
- 2008 earnings-per-share of $1.31 (-20% decline)
- 2009 earnings-per-share of $1.96 (49.6% increase)
- 2010 earnings-per-share of $2.57 (31.1% increase)
Notably, Aflac had a tough year in 2008, which is understandable given the deep recession at the time. However, its earnings-per-share came roaring back in 2009 and 2010.
Valuation & Expected Returns
Over the last decade, shares of Aflac have traded hands with an average P/E ratio of roughly 10x times earnings.
We believe this is more or less fair value for the security, considering that many insurers trade at a comparable multiple. This lower average valuation multiple allows for the robust share repurchase program to be more effective.
Ongoing owners are much better served if the company is buying out past partners at 10x times earnings as compared to, say, 15x- or 20x-times earnings.
Based on 2022 expected earnings-per-share of $5.32, shares are presently trading hands at 13.7x times earnings. As such, this implies a slight annual valuation headwind (-5.4%), should shares revert to 10 times earnings.
In addition, the 4% growth rate and 2.3% starting dividend yield should aid in shareholder returns. When all three components are put together, this implies the potential for 0.9% annualized returns.
Importantly, regardless of anticipated returns, Aflac’s dividend appears very safe. Aflac’s dividend appears to be secure, with an expected dividend payout ratio of 30% for 2023. The dividend has room for future increases even if EPS growth slows.
Final Thoughts
Aflac is a high-quality company with a profitable business and a strong brand.
The company has increased its dividend for 41 years in a row. Thanks to a low payout ratio and future earnings growth, it should continue to do so.
Aflac does not have the highest yield at 2.3%. But it offers steady dividend increases and a highly sustainable payout.
In addition, shares are presently trading higher than the company’s historical valuation. This results in a low total return expectation. Therefore, the security earns a sell rating.
If you are interested in finding high-quality dividend growth stocks suitable for long-term investment, the following Sure Dividend databases will be useful:
- The Dividend Achievers List: a group of stocks with 10+ years of consecutive dividend increases.
- The Dividend Kings List: considered to be the best-of-the-best among dividend growth stocks, the Dividend Kings are a group of exceptional dividend stocks with 50+ years of consecutive dividend increases.
- The Blue Chip Stocks List: contains stocks on either the Dividend Achievers, Dividend Aristocrats, or Dividend Kings list.
- The Monthly Dividend Stocks List: contains stocks that pay dividends each month, for 12 payments per year.
- The High Dividend Stocks List: high dividend stocks are suited for investors that need income now (as opposed to growth later) by listing stocks with 5%+ dividend yields.
The major domestic stock market indices are another solid resource for finding investment ideas. Sure Dividend compiles the following stock market databases and updates them monthly: