Over the past six months, Selective Insurance Group’s stock price fell to $79.82. Shareholders have lost 5.4% of their capital, which is disappointing considering the S&P 500 has climbed by 15.7%. This was partly due to its softer quarterly results and may have investors wondering how to approach the situation.
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Why Do We Think Selective Insurance Group Will Underperform?
Even though the stock has become cheaper, we don't have much confidence in Selective Insurance Group. Here are three reasons we avoid SIGI and a stock we'd rather own.
1. Long-Term Revenue Growth Disappoints
In general, insurance companies earn revenue from three primary sources. The first is the core insurance business itself, often called underwriting and represented in the income statement as premiums earned. The second source is investment income from investing the “float” (premiums collected upfront not yet paid out as claims) in assets such as fixed-income assets and equities. The third is fees from various sources such as policy administration, annuities, or other value-added services.
Unfortunately, Selective Insurance Group’s 4.5% annualized revenue growth over the last five years was sluggish. This was below our standard for the insurance sector.
Note: Quarters not shown were determined to be outliers, impacted by outsized investment gains/losses that are not indicative of the recurring fundamentals of the business.2. Revenue Projections Show Stormy Skies Ahead
Forecasted revenues by Wall Street analysts signal a company’s potential. Predictions may not always be accurate, but accelerating growth typically boosts valuation multiples and stock prices while slowing growth does the opposite.
Over the next 12 months, sell-side analysts expect Selective Insurance Group’s revenue to drop by 55.9%, a decrease from its 4% annualized declines for the past two years. This projection doesn't excite us and suggests its products and services will face some demand challenges.
3. Recent EPS Growth Below Our Standards
While long-term earnings trends give us the big picture, we also track EPS over a shorter period because it can provide insight into an emerging theme or development for the business.
Selective Insurance Group’s EPS grew at a weak 11.7% compounded annual growth rate over the last two years. On the bright side, this performance was higher than its 4% annualized revenue declines and tells us management adapted its cost structure in response to a challenging demand environment.
Final Judgment
We see the value of companies helping consumers, but in the case of Selective Insurance Group, we’re out. After the recent drawdown, the stock trades at 1.5× forward P/B (or $79.82 per share). While this valuation is fair, the upside isn’t great compared to the potential downside. There are better stocks to buy right now. We’d suggest looking at one of Charlie Munger’s all-time favorite businesses.
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