Insurance Australia Group Limited drops 15%: Is this a buying opportunity?

A 6.5% dividend yield is the icing on the cake for long-term investors.

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Insurance Australia Group Limited (ASX: IAG) seems to have fallen out of favour with investors. The share price has fallen from a peak of $6.25 in late November to finish at $5.34 on Friday. This 15% fall has come during a period when IAG announced the purchase of Wesfarmers’ (ASX: WES) insurance underwriting arm and a subsequent capital raising to pay for it, upgraded earnings guidance, and it was included in the ASX 20 index at the expense of Newcrest Mining Limited (ASX: NCM).

So why the drop?

Well, some 13 cents (or 2%) of the drop can be attributed to the company going ex-dividend in late February, while some market commentators have expressed concerns about IAG’s ability to successfully integrate the new insurance business into existing operations.

Aside from that, I haven’t been able to find any company-specific news which could account for the fall. The poor start of the broader Australian sharemarket in 2014 hasn’t helped, and has accounted for some of the 8% drop in the share price since early January.

Interestingly, the share purchase plan was priced at $5.47, a 5% discount to the share price at the time of the announcement, but above the current share price, and the price when the shares were issued. Institutional investors looking for a quick profit from the placement may have sold out when it didn’t materialise.

2014 outlook

IAG has forecast an insurance margin of between 14.5% and 16.5% for the 2013-14 financial year while growth in gross written premium (GWP) is expected to be in the range of 3% to 5%. Net profit is expected to be in-line with 2012-13, which was a 92% increase from 2011-12. 2012-13 and 2013-14 have been characterised by an abnormally low amount of large natural disasters. This has boosted insurance margin and net profit to easily be the best result in the history of the company.

2014-15 will be characterised by analysts assessing how well IAG can integrate the Wesfarmers purchase into current operations, which is currently a significant unknown.

Foolish takeaway

The 15% drop in the share price has bumped up IAG’s forecast 2014-15 dividend yield to 6.5% fully franked, assuming the company pays out 36 cents per share next year. This looks to be a buying opportunity for long-term investors with the company currently trading on a price-to-earnings ratio of around 11, although this is expected to be the earnings peak for the next couple of years at least (pending the Wesfarmers integration).

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Motley Fool contributor Andrew Mudie does not own shares in any companies mentioned

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