Updated on January 13th, 2022 by Felix Martinez
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 61 years in a row, giving it one of the longest dividend increase streaks anywhere in the stock market.
It is on the Dividend Aristocrats list, 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 36 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 that 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 a little from its 2021 high. Even though earnings are expected to be higher for the full year of 2021, the stock still looks to be 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 45 states.
The company has more than 1,900 agency relationships with 2,687 locations as of the end of Q3 2021. Many of them have a meaningful market share as well, as Cincinnati Financial has grown over the years.
Source: Investor Handout, page 7
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 a 4.5% 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, $4.3 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.
Still, the 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 7
Price increases helped the company grow premium revenue for the past several years.
Interest rates have been a headwind in the past several years, but a rising rate environment in 2022 could be a positive catalyst. 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. This presents a risk as well because an equity downturn (perhaps from rising interest rates) would 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 decreased 19.8% year-over-year to $1.79 billion. However, for the nine months ended in Q3, revenue was up 30% than the same period a year ago.
Earnings were down 69% in Q3 to $153 million, or $0.94 per share. The decrease was primarily due to $352 million in net investment gains that were partially offset by lower P&C underwriting income in 3Q2020.
For the nine-month period, earnings were $9.07 per share. Book value ended the nine months at $73.49 per share, which is 21% higher than the first nine months of 2020. We now expect $5.58 in earnings-per-share for 2021.
Source: Third-Quarter 2021 Press Release
We see Cincinnati Financial producing just 8% annual growth in earnings for the coming years as the company’s insurance business since the 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 generally 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 price competition.
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 $5.79 billion in book value gains solely from its stock portfolio as of the end of Q3.
Valuation & Expected Returns
Based on 2021 earnings-per-share forecasts, Cincinnati Financial stock trades for a price-to-earnings ratio of approximately 21.9. We see fair value at 20 times earnings, meaning it appears shares are slightly overvalued at this point.
If the shares revert to our fair value P/E ratio, future returns would be reduced by about 1.7% per year over the next five years. We see fair value at $112 per share today, which compares very unfavorably to the current share price of $122.
Earnings growth and dividends will help offset the decline. However, the company has fairly modest growth expectations.
We forecast just 8% annual earnings growth for Cincinnati Financial. In addition, the stock has a current dividend yield of 2.1%, which is above that of the S&P 500.
Cincinnati Financial’s dividend is secure. The payout ratio for 2021 is expected to be in the area of 45%, which is satisfactory.
Thus, we expect a continued strong rebound in earnings back to normalized levels in 2022, which will help Cincinnati Financial’s dividend safety.
The stock is expected to produce positive total returns of 8.0% per year over the next five years as the dividend yield and earnings growth make up for the declining valuation multiple.
Cincinnati Financial is a high-quality dividend stock that has delivered compelling results for shareholders in the past. The company is not a high-growth name, though, and we believe that earnings will rise at a meager mid-single-digit pace.
Cincinnati Financial is trading at a high valuation compared to what seems justified based on its growth outlook and historical valuation.
As a result, the shares earn a hold recommendation at the current valuation level.