Insurance Australia Group Ltd (ASX: IAG) is a blue-chip stock that has given shareholders a substantial total return over the past five years. As a business, it is probably better known by such brands as NRMA Insurance, CGU, Swann Insurance, State and AMI. It stands as the market leader in general insurance for covering customers' businesses, homes and vehicles.
Over the past six months the stock is up 7.9%, compared to the 5.3% decline of the S&P/ASX 200 Index (ASX: XJO) (Index: ^XJO). Even though the ASX has given up some of its recent gains, I think IAG will continue to hold up well. As the benefits of its recent big acquisitions work their way through, the stock should improve. Here are three reasons why investors should hold onto their IAG shares.
1) Earnings growth and market share leadership
IAG's net profit has recovered thanks to a more benign period of natural disasters recently. In FY 2014, it achieved a 13% increase in cash earnings.
Also, the recent acquisition of AMI and the purchase of the insurance underwriting business of Wesfarmers Limited (ASX: WES) this year further lifts IAG's revenue and strengthens its market leader position.
Its gross written premium had a fair increase and its underlying insurance margin, the insurer's key indicator for the strength of its businesses, gained two percentage points to 14.2%.
2) Comparatively high profit margin
You can compare the performance of insurance companies by their combined ratio. It's the sum of insurance claims paid and the business operating costs divided by the total of premiums received. The lower the combined ratio the better.
In FY 2014, IAG had a combined ratio of 87.4%. So the company is left with 12.6% of the total premiums as profit. Among the other major insurers we have-
Suncorp Group Ltd (ASX: SUN) 85%
QBE Insurance Group Ltd (ASX: QBE) 97.8%
Suncorp wins out here by a few percentage points, but as you can see, QBE's ratio is very close to 100, which means its profit margin is very thin. Companies with bigger profit margins not only make more money, but are able to handle weaker markets better, so IAG is relatively strong in that case.
3) High dividend yield and payment
Like banks, insurance companies can be good sources of dividend income. IAG is yielding a whopping 6.4% fully franked, which beats all of the big four banks' yields. Suncorp comes in second at 6.0% fully franked and QBE is a distant third at 3.3% fully franked.
Special dividends and capital returns tip the scale in Suncorp's favour. It stated it intends to return surplus capital to shareholders as it goes through its current business simplification program. In the last three years it paid out a special dividend while increasing the full dividend each year.
IAG has instead focused on acquisitions and growing market share. This will pay off later as more premiums and potentially higher earnings are achieved. It raised its full year dividend for the fifth year in a row.
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