Updated on February 3rd, 2021 by Josh Arnold
Every year, we individually review each of the 65 Dividend Aristocrats. The Dividend Aristocrat we’ll be discussing here is Cincinnati Financial (CINF).
Cincinnati Financial has increased its dividend for an amazing 60 years in a row, giving it one of the longest dividend increase streaks anywhere in the stock market. It is a Dividend Aristocrat, a group of stocks in the S&P 500 Index, with 25+ consecutive years of dividend increases.
You can see our full list of all 65 Dividend Aristocrats, along with important metrics like dividend yields and P/E ratios, by clicking on the link below:
Not only that, but Cincinnati Financial is also a member of the Dividend Kings, an even more exclusive group than the Dividend Aristocrats. Dividend Kings have increased their dividends for 50+ consecutive years. There are just 31 Dividend Kings.
Cincinnati Financial’s dividend track record is legendary. And yet, the stock does not appear to be an attractive buy right now. The reason is because its valuation has remained elevated in the past few years, which has simultaneously reduced its dividend yield.
As a result, value and income investors should wait for a meaningful pullback before buying shares. The stock has pulled back meaningfully from its 2020 high, but given the decline in earnings that accompanied it, shares are still overvalued.
Cincinnati Financial is an insurance company, founded in 1950. It offers business, home, and auto insurance, as well as financial products including life insurance, annuities, and property and casualty insurance. Revenue is derived from five sources, with agencies across 44 states.
The company has more than 1,800 agency relationships with 2,550 locations as of the end of Q3 2020. Many of them have meaningful market share as well, as Cincinnati Financial has grown over the years.
Source: Investor Handout, page 8
The company has a profitable business model. Instead of focusing solely on high-margin products, Cincinnati Financial is willing to write lower-margin policies. It earns a high level of profit by issuing high volumes and taking market share. For instance, its home state of Ohio provides 4.4% market share in its product lines. Insurance is a highly-fragmented industry, so market share can be difficult to attain.
As an insurance company, Cincinnati Financial makes money in two ways. It earns income from premiums on policies written, and also by investing its float, the large sum of premium income not paid out in claims. Indeed, $7.6 billion of the company’s cash is invested in common stocks as a way to grow book value over time, with no single stock making up more than 5% of the investment portfolio.
To that end, Cincinnati Financial’s book value is more beholden to stock market performance than some of its peers. However, the rally since the pandemic bottom last year has helped Cincinnati’s book value rebound quickly due to its equity exposure.
This favorable combination of premiums and investment gains has led to steady growth over many years, and there should be room for continued growth up ahead.
Cincinnati Financial has a positive growth outlook moving forward from new policies written, as well as its equity exposure in the US. The company has a successful history of growing profits through new policies written, outperforming the industry benchmark, and taking market share as a result.
Source: Investor Handout, page 8
Price increases helped the company grow premium revenue for the past several years. Interest rates have been a headwind of late given the inversion of the yield curve, and the sharp move down in long-term rates that has been sustained for several quarters. Like other insurers that rely upon investment income, Cincinnati Financial would prefer higher rates, all else equal.
However, as mentioned, the company has a relatively high concentration of common stocks in its investment portfolio, which have performed well while rates have moved down. This presents a risk as well, because an equity downturn will have a sizable impact on Cincinnati Financial’s book value.
The company’s third-quarter results showed a continuation of the rebound off of the tough conditions from early-2020. Revenue increased 31% year-over-year to $2.2 billion. However, for the nine months ended in Q3, revenue was 16% lower than the same period a year ago.
Earnings were up 95% in Q3 to $484 million, or $2.99 per share. The gain was primarily due to $352 million in net investment gains that were partially offset by lower P&C underwriting income. For the nine-month period, earnings were down 88% to $1.03 per share. Book value ended the quarter at $60.57 per share, essentially where it started 2020. We now expect $2.84 in earnings-per-share for 2020.
We see Cincinnati Financial producing just 1% annual growth in the coming years as the company’s insurance business has had a difficult time rebounding from the pandemic, and as equity markets look stretched to the upside.
Competitive Advantages & Recession Performance
There aren’t many identifiable competitive advantages in the insurance industry, other than brand recognition. There are also low barriers to entry in insurance, which leads to fierce competition, as differentiation is very difficult. The good news for Cincinnati Financial is that it thrives on competing on price.
Cincinnati Financial has decades of experience, and has built a close relationship with its customers. That said, insurance companies are not immune from economic downturns. Cincinnati Financial does not have a highly recession-resistant business model. Earnings-per-share during the Great Recession are below:
- 2007 earnings-per-share of $3.54
- 2008 earnings-per-share of $2.10 (41% decline)
- 2009 earnings-per-share of $1.32 (37% decline)
- 2010 earnings-per-share of $1.68 (27% increase)
As you can see, earnings declined significantly from 2008-2010. Insurers like Cincinnati Financial typically sell fewer policies during recessions, along with poor performance of their investment portfolios when markets decline. Given Cincinnati Financial’s relatively high concentration of common stocks, its book value may suffer materially due to broader market declines.
That said, the company did remain profitable during the recession, which allowed it to continue increasing dividends each year. And, the company enjoyed a strong recovery in 2010 and thereafter, once the recession ended.
We also note that the company has seen strong performances from its huge stock portfolio in recent quarters, and it is sitting on nearly $4 billion in book value gains solely from its stock portfolio as of the end of Q3. Given how stock markets have performed in the period since, we expect the year-end stock portfolio update to be a positive one.
Valuation & Expected Returns
Based on 2020 earnings-per-share forecasts, Cincinnati Financial stock trades for a price-to-earnings ratio of approximately 30.7. We see fair value at 20 times earnings, meaning it appears shares are quite overvalued at this point. If the shares revert to our fair value P/E ratio, future returns would be reduced by about 8% per year over the next five years. We see fair value at $57 per share today, which compares very unfavorably to the current share price of $87.
Earnings growth and dividends will help offset the decline. However, the company has fairly modest growth expectations. We forecast just 1% annual earnings growth for Cincinnati Financial. In addition, the stock has a current dividend yield of 2.9%, which is about double that of the broader market.
Cincinnati Financial’s dividend isn’t as secure as it once was as earnings have declined but the payout has risen. The payout ratio for 2020 is expected to be in the area of 85%, which is quite high. To be fair, we expect a strong rebound in earnings back to normalized levels in 2021, but the fact remains that Cincinnati Financial’s dividend has lost a bit of security.
The stock is expected to produce negative total returns of -3.1% per year over the next five years as the dividend yield and earnings growth are more than offset by a declining valuation multiple.
Cincinnati Financial is a time-tested insurer that has run into a rough patch. With earnings declining for 2020 and a rebound looking somewhat uncertain, we are cautious on Cincinnati Financial, and rate it a sell.
While the company has a strong business model and is solidly profitable, it does not seem to be a particularly attractive stock from a valuation standpoint. Overall, investors interested in buying this stock should wait for a lower valuation and higher dividend yield as the stock is highly overvalued today.