Is Insurance Australia Group Ltd a buy for its fully-franked dividend?

Credit: Simon Cunningham

As a young investor, I don’t see much to like about Insurance Australia Group Ltd (ASX: IAG) (“IAG”). Its industry is mature, competitive, and the company will have trouble growing revenues and profits without out-manoeuvring competitors, which is difficult in a business like insurance.

However, for an investor more concerned with a reliable income stream and capital preservation, Insurance Australia Group is more compelling. Its exposure to Motor, Home, Short-tail commercial, and Compulsory Third Party (CTP) insurance (IAG’s four biggest earners) are a reliable source of income and the foundation of the company’s current dividend yield, which is more than 5%.

It may be a stretch to describe insurance premiums as ‘recurring revenue’, given high levels of competitiveness and low customer loyalty, but as one of Australia’s largest players IAG has a fair shot at retaining a chunk of the market, which needs to renew its insurance every year.

This is a chart that shows IAG’s earnings per share and price performance over the past 10 years to July 2015. As readers can see, IAG is not a suitable company for those who might need to sell at any time, as shares tend to track the S&P/ASX 200 (INDEXASX: ^AXJO) (ASX:XJO) – when it is underwater, so are they.

Another risk that readers need to be aware of is the bumpy nature of insurance claims, which can lead to some volatility in profits and dividends on a year-to-year basis. Over the long term, these factors can be balanced out and IAG has grown earnings per share by roughly 20% in the past 10 years.

On the upside, it’s likely that interest rates will be substantially higher in a decade or so, which would lead to a significant increase in IAG’s earnings from its $12 billion ‘float’ or investment portfolio. IAG also has around $2 billion invested in growth assets like stocks, giving it exposure to equity markets and the potential for long-term growth.

With a solid financial position and a defensive business, Insurance Australia Group appears to be a decent purchase for income-seeking investors with the patience to ride out bumpy earnings.

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Motley Fool contributor Sean O'Neill has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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