Travelers (TRV) Stock: High Return From Fixed Income Portfolio

Introduction

As of the end of 2018, Berkshire Hathaway (BRK.A) (BRK.B) held shares of The Travelers Companies (NYSE:TRV). Berkshire Hathaway divested itself of the investment in the business during the first quarter of 2020. And the stock has gained roughly 47% since the year 2020.

When I looked into Berkshire Hathaway’s stock purchases, I found that the company bought a lot of stocks with great prospective returns, but sold many of them too soon.

As an insurance provider, The Travelers benefits greatly from periods of high interest rates. Higher interest rates have a negative effect on bond prices, but the yield on newly issued bonds is substantially higher. There should be no realized losses for the company if these are held to maturity.

When analyzing the performance of a stock portfolio, I always look how it measures up against the S&P 500. The stock of Travelers has remained consistent with the S&P 500 over the past decade, despite reduced interest rates. And I believe that the increased interest rates will serve as a major motivating factor for the company for many years to come.

Fed Isn’t Cutting Rates Soon

The year 2023 has barely began and the stock market (SP500) is already down a bit, also treasuries slipped. The dollar rose as the possibility of rate reduction in 2023 is muted. Amazon has stated that it will lay off 18,000 workers, and many other tech businesses are likely to follow suit. Is a major economic downturn on the horizon? Well, I don’t know. The yield curve indicates that a new economic recession will occur within the next year.

The Federal Reserve hiked interest rates to mitigate high inflation, causing the yield curve to invert. And with the job market tight and inconsistent with price stability, the Fed won’t be cutting rates anytime soon.

All Federal Reserve officials agreed at a recent policy meeting in December that the US central bank should slow the pace of its aggressive interest rate increases. This would allow them to continue raising interest rates to curb inflation, but in a more gradual fashion that would reduce the potential risks to economic growth. It is expected that interest rates will remain high for some time. The range for the Fed Funds Rate Target is 4.25%-4.50%.

Insurance firms benefit from rising interest rates because they invest some of their float in bonds. In a period of rising interest rates, newly issued bonds will offer higher income. Although the value of currently held bonds has been declining recently, holding them to maturity should pose no problems.

High Return From Fixed Income Portfolio

Despite widespread damage from natural disasters, Travelers still managed to post a healthy quarterly profit. Despite the rough state of the stock market, Travelers’ net investment income has been growing, thanks in large part to the performance of the alternative investment portfolio.

Core return on equity for the period was 7.9%, on the back of $526 million in quarterly core income, or $2.20 per diluted share. The long-term goal of Travelers is to generate a core return on equity in the mid-teens. The strong underlying combined ratio of 92.5% may be attributed to the company’s record net earned premiums of $8.6 billion, up 10% year over year from the previous quarter. Travelers has been able to better control its exposure to catastrophes and organize its claim response thanks to the strategic steps they’ve made in recent years.

High returns from its fixed income portfolio and good returns in its non-fixed income portfolio contributed to net investment income of $505 million after taxes for the quarter. Over the past year, Travelers has increased its adjusted book value per share by 7% after making critical investments and continuing to return excess capital to our shareholders. This growth is the result of Travelers’ strong operating results over the past few quarters and our solid balance sheet. A total of $722 million was distributed to shareholders this quarter, of which $501 million was used to repurchase stock.

Travelers Is A Classic Dividend Compounder

When evaluating a company, I always look at their cash flow statement to determine if their dividend and share repurchase policies are sustainable in the long run.

During the last five years, Travelers has been a strong dividend compounder, with dividend per share increases averaging 5.3% per year. With a current dividend payout rate of $3.72, the dividend yield is 2%.

Both dividends and share repurchases are used to return capital to shareholders, but the latter is more tax-efficient. As a result of the share repurchases, dividends per share will rise.

When looking at the cash flow statement in more detail, we observe that dividends and share repurchases take up around 43% of the total return to shareholders. With a buyback yield of 5.6%, the share price should rise as demand outstrips supply. Long-term investors can count on receiving a satisfactory rate of return.

Valuation In Line With Its Average

Lastly, we discuss the stock’s valuation. The price-to-earnings (PE) ratio is a widely used metric for analyzing stock prices in the present and the past. The PE ratio is currently at 13.7, which is lower than the 5 year average of 14. The stock is valued around its average with the last five years.

Earnings in the coming years should increase as a result of the increased interest rate environment. After an earnings per share decrease in 2022, many analysts anticipate EPS to increase in the years that follow. With a forward P/E ratio of 11 for 2024 and an EPS growth forecast of 13%, this stock appears to be favorably valued.

Conclusion

In spite of widespread disaster losses in the insurance industry, Travelers posted strong quarterly performance. Even though Travelers’ current core return on equity is in the low double digits, the company has set a long-term target of a return on equity in the mid to high teens. Underlying combined ratio was 92.5%. Strategic actions were taken by Travelers to improve its risk management and claims response.

After taxes, the investment portfolio brought in $505 million for the quarter as net investment income increased strongly. The firm’s fixed income portfolio is doing better when interest rates rise, and the Federal Reserve isn’t expected to reduce rates anytime soon. Future interest rate increases act as a powerful impetus for Travelers’ investment income.

As the dividend has grown at a rate of 5.3% each year over the past five years, Travelers is a prime example of a dividend compounder. Shareholders receive roughly 43% of free cash flow in the form of dividends and stock buybacks. As a result of share repurchases, the dividend per share has increased, the current dividend yield is at 2%.

Since many analysts project rising EPS for the year 2023, the stock’s valuation looks promising. A favorable interest rate environment, efficient use of capital, and a fair price for the stock all contribute to Travelers’ attractiveness as an investment.