3 reasons QBE should be on your watchlist

The $18 billion insurer is not without its detractors, but its lacklustre share price possible makes up for many of the blemishes.

a woman

Long-term shareholders in QBE Insurance (ASX: QBE) know only too well the difficulties faced by the company, which have manifested themselves in a disappointing share price performance. Over the past five years, QBE’s share price was fallen 38%, despite a 37.6% rise this calendar year, while the S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO) has gained 7% over the same five-year period.

The reasons for the underperformance against the index have been many and varied including difficulties in QBE’s US-Lender Placed Insurance business and its crop protection business. Despite previous issues and an uncertain outlook there are at least three reasons investors might consider keeping a close eye on the global insurer.

Reversion to the mean

Most businesses are cyclical in one way or another, which means that revenues and particularly earnings fluctuate over a business cycle. In QBE’s case, one important measure of its profitability is return on average shareholder funds (ROE). Over the past five years ROE has averaged around 10.5%, while the average ROE over the past 10 years has been closer to 17.5%.

In comparison, for the half year just finished ROE was only 8.5% which is below both the five- and 10-year averages. Given the potential for management to make changes to the business model and for the operating environment to improve, this bodes well for a case of reversion to the mean.

Interest rates to rise

In many countries around the world, official interest rates are either at, or very close to, historic lows. QBE had total investments and cash at 30 June 2013 of US$30 billion, which produced net investment income of just US$359 million, so the return on these funds was obviously very low. With just 1.3% of investments in the form of equities, property and unit trusts, the remainder is primarily exposed to interest rates in the form of corporate and government bonds, short term money and cash.

While identifying exactly when interest rates will return to more ‘normal’ levels is difficult, there is a very high likelihood that at some point in the future interest rates will indeed be higher than they are today and this should lead to dramatically improved investment income for QBE.

Dividends

Shareholders in QBE have had to suffer though a number of reductions to dividends over the past few years. With a steadying of the claims environment, an improving investment outlook and a strengthened capital position there is scope for future dividends to increase in line with any growth in earnings.

Foolish takeaway

QBE Insurance offers shareholders exposure to developed and emerging economies, many with faster growth rates than Australia. While insurance firms are most definitely higher risk investments, given the potential for improvements in its earnings and based on the current share price this stock likely deserves a place on the watchlist of investors prepared to spend the time understanding this complex business.

QBE is hardly a high dividend-yielding stock at present. For investors looking for income discover The Motley Fool’s favourite income idea for 2013-2014 in our brand-new, FREE research report, including a full investment analysis! Simply click here for your FREE copy of “The Motley Fool’s Top Dividend Stock for 2013-2014.”

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Motley Fool contributor Tim McArthur owns shares in QBE Insurance.

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