When reliability of an investment is paramount, many investors think of insurance stocks and infrastructure stocks. Companies like Insurance Australia Group Ltd (ASX: IAG) ("IAG") and Medibank Private Ltd (ASX: MPL) are attractive because they have high amounts of repeat business, and their businesses are underpinned by billions in investments that provide good security in the event of a market downturn.
The good stuff for defensive investors
IAG's and Medibank's brands of home/car and health insurance products are attractive because they have a fairly short 'tail' (liability) – usually only one year. While the company might under or overestimate its claim expenses in any year, it's less likely that the company will be blindsided by 'legacy' claim expenses many years down the track.
Any insurance premiums that are not paid back to claimants are kept by the company, and invested in a variety of bonds (usually) as well as fixed interest notes and sometimes equities. Medibank has Net Tangible Assets of 46 cents per share, although $1.6 billion in net assets is a reasonable cushion given the company has no debt. IAG has Net Tangible Assets of $1.30 per share, and net assets of $7 billion stack up favourably alongside its $2 billion in debt.
Medibank has $2 billion in financial investments on its books, while IAG carries $13 billion. By way of comparison, Medibank's market capitalisation (the total value of all its shares) is $7 billion while IAG's is $13 billion.
It's tough to find companies more secure than Medibank and IAG as they sell a staple service (carrying minimal debt), with a collection of financial assets growing steadily larger over time.
Security comes with a price
Although both of the above companies are extremely unlikely to go bankrupt, that does not translate to 'will reliably pay steady dividends every year'. IAG's dividend policy is to pay out between 60% and 80% of reported cash profits, while Medibank pays out 70% to 80% of annual underlying net profit after tax.
If profits fall for whatever reason, dividends will fall too. Companies generally try to maintain average dividends but a quick look at IAG's dividends per share over a 10-year period (see the second chart) reveals the volatility here.
Investors relying on steady dividends for their bread and butter thus need to be wary of owning insurers. In this sense Medibank could be the better buy, as it is not exposed to unpredictable natural disasters the way that IAG is.
Insurers also don't have the growth prospects that other businesses do, and both IAG's and Medibank's chosen markets are highly competitive and price sensitive. This is not to say that they won't grow, but they're unlikely to shoot the lights out.
Either of the above businesses would be suitable for investors for whom the security of their investment is the paramount concern. For investors looking for consistent, growing dividends however, there are better options out there.
