It's hard to get excited about QBE Insurance Group Ltd's (ASX: QBE) current 3.5% dividend yield.
But this is set to change from 2016 as the company finally gets back into shape after years of binging on unhealthy acquisitions.
Here's your guide to buying QBE Insurance for its dividend in 2016:
Financial performance
QBE is on track to significantly improve earnings in 2016. The cumbersome subsidiaries have been sold off, impairments have been taken and the company has completed a cost efficiency program which should save investors hundreds of millions of dollars.
The result has been a dip in revenue, but a big increase in profit margins and free cash flows. For dividend investors this is good news.
In addition, because over half of QBE's 'insurance profit' actually comes from investing policy holder funds, the recent increase in U.S. interest rates will help to lift investment returns.
The newly-strengthened company has allowed directors to raise the maximum dividend pay-out ratio from 50% to 65% of cash profits, starting with the 2016 interim dividend paid out in October 2016.
QBE Insurance, or IAG?
Given the choice between QBE Insurance and the recently re-branded Insurance Australia Group Ltd (ASX: IAG), QBE in my view is the better pick for dividend investors in 2016.
Both companies operate on similar 'combined' ratios which represent the percentage of earned premiums which get eaten up by operating costs and pay-outs on claims. For the half year to 30 June 2015 QBE had a combined operating ratio of 93.4%, compared to IAG's 94.8%, but it is targeting a full year combined ratio of between 94% − 95%.
| QBE Insurance Group Ltd (ASX: QBE) | Insurance Australia Group Ltd (ASX: IAG) | |
| Combined operating ratio | 93.4%¹ | 94.8%² |
| Yield (trailing 12 months) | 3.5% | 5.4% |
| Price/Book ratio | 1.6 | 3.6 |
¹QBE Half year to 30 June, 2015. ²IAG 12 months to 30 June 2015.
Although IAG's dividend yield is currently higher than QBE, the combination of higher profit and an increased dividend pay-out ratio will likely see a big jump in the cash to be distributed to QBE shareholders.
In addition, at its current share price QBE looks like better value than IAG when comparing the price-to-book ratio, a measure of relative asset value (excluding intangible assets). This may offer some protection if unexpected volatility strikes.
Foolish takeaway
A strong earnings outlook, the prospect of a strong dividend and current relative value makes QBE Insurance a solid dividend pick for 2016 in my view.
