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Nicole Benjamin: Hey, everybody. It’s Nicole Benjamin, your host here at Seeking Alpha to bring to you another episode of our series, Portfolio Pulse, where, as the name suggests, we’re going to be keeping a pulse to all the big financial moves happening in the market. Now, joining us for today’s episode is Scott of Seeking Profits. So, thank you so much, Scott, for joining us today.
Scott: Thanks for having me, Nicole. Excited to be here.
NB: Absolutely. Now, Scott, I see you’ve been on Seeking Alpha since 2013. So, tell us a little bit more about that. How’d you get on the platform? How’d you get into investing? What’s your investment style? All those things.
SP: Yeah. No. As you said, I’ve been on Seeking Alpha for like 13 years now. I’ve worked in the investment management industry for most of that time. And I did particularly enjoy writing and discussing my ideas and providing ideas for readers and getting interactions to their comments and starting a conversation. So, when I think about how I invest and how I – the ideas I tend to share, I’m very fundamental in my thinking versus maybe a more technical or quantitative.
I tend to focus on value stocks versus growth generally. So, I like to get into the weeds of the financials, see how a company is doing, think about what the macroeconomic environment may do to that company, project out what they’ll earn and see where I see good values that maybe the market is under-appreciating and see those as good buy opportunities and so forth.
NB: Now, I see in your most recent article that you’re talking about all things Progressive, PGR. So, I’m looking here and Progressive seems to be doing, well, they’re actually doing fairly well financially. So, my first question for you is, I guess, what is the gap between how the business is doing and how the stock is trading when it has recently dropped about 30%?
SP: Yeah. So, Progressive is exactly the kind of company I like to look at because when you look at its underlying financials, it’s about as profitable as it’s ever been. But as you said, the stock has come down 30% or so from its highs. And a lot of that has to do with investors’ expectations for the future. And in particular, if you think about what’s been going on in the auto insurance space, post-COVID auto insurers struggled to make money because they had to pay a lot more in claims when car prices got more expensive.
They then began raising their premiums, as any of us who have a car knows that premiums had gone up quite a bit, which has restored their profitability, but as that has happened, there’s now concern that we’re hitting the peak in profits. So, whenever you see profit growth slow or potentially turn, that sometimes can create a lot of negative sentiment around a stock, which is what’s happened here. And my view is that actually while margins may be about as good as they can get, people are too scared of the future and that the future won’t be as bad as it will be and the stock is now discounting to negative of an environment. And that’s what’s created a good buy opportunity. It’s that negative sentiment that has gotten ahead of what we’re seeing in the actual financials.
NB: Now, you also mentioned in your article this combined ratio of 86.4%. So, what does this number tell us about how much profit they make on every dollar in the insurance space as they’re selling?
SP: Yeah. So, when you ever are looking at a financial, an insurance company, the combined ratio is about the first thing you want to look at. So, if you think about it, when you have, let’s say you get a car premium policy and you pay a $100 in premiums. Combined ratio is how much of that is the insurer actually paying back. So, when you get into an accident and they have to pay a claim, how much of that is being paid?
So, if you have a combined ratio of 86.4%, that means that if they get a $100 in premiums, on average they’re paying out to the customers and all their costs, $86.40. And they have about a 13% or $13 profit margin that is the amount they’re actually making on the premiums.
NB: We’ve all seen car prices go up, go down, all these things, especially post-COVID, as you said. So, how does inflation in the real world, in real time, start to show up in Progressive’s profit margins?
SP: When Progressive writes its premium, it’s policy for you and says, I’ll sell you your car insurance for $600, say. They have an assumption there of when there are accidents, they have an assumption of how many accidents there will be and then what will be the cost of those accidents, the cost when a car is totaled of replacing the car and so forth. That’s going to be based on the estimate of what car prices are right now. If car prices go up 15% in a short period of time, suddenly the cost of replacing parts and fixing up the cars will be worse than they had modeled. And so, they’re actually, even if there’s the same number of accidents, the severity of those accidents may be worse.
And they end up paying out more and they have the same amount of premiums that compresses their combined ratio. And that’s what we saw during COVID what happened is used car prices rose like 40%. And so, in a very short period of time, they’re paying out a lot more claims than they had anticipated. They’ve since raised premiums. And the concern has been, one of the reasons why the stock has struggled is with tariffs and other pricing pressures. The fear that car prices could go up and you have a repeat of that. Interestingly, like new car prices haven’t moved, they moved less than 1% over the past year. Used car prices are only at 3%. And that type of inflation, they can match. It’s when you start seeing 8%, 10%, 15% price increases that they start to have problems.
NB: Now, I see here that Progressive has an AA- rating, which, I mean, you noted that Progressive is very liquid. So, I mean, that’s a great thing, but why is it so important for a car insurer to keep their savings account safe and easy to access in this case?
SP: Yeah. So, when you think about any of the insurers, and in some ways it’s like how Berkshire Hathaway and Buffett’s made all their money is, that they take all these premiums and then they can invest those premiums and then they earn money on that until they pay you back with claims and so forth. Generally speaking, the longer they’ll be holding the money, this would be like a life insurer, where you know you won’t be paying a claim for 30 years on average, you can take a bit more risk in your investment portfolio because you won’t be paying out claims tomorrow.
Auto insurance is much shorter in nature, right? Typically policies are 6 to 12 months. They’re facing accidents quite often. And then when you have an event like the hurricane or a significant storm, you could have several hundred million dollars that you have to pay out right away. When you have to pay claims out more quickly, you need to make sure that the money you’d save is liquid and you can easily sell-out your investments like you own treasuries or high quality corporate bonds that you could easily sell to then pay out the claims.
So, generally speaking, in that insurance sector, the quicker you pay claims, the more safety you need in your investment portfolio. And that’s why Progressive has about the safest portfolio of any insurance company I cover.
NB: Progressive is also known for special dividends. So, what should investors be thinking about when they’re receiving these occasional payouts versus something that’s more regular, like on a monthly basis?
SP: When Progressive – when your company is determining what they want to return to investors, they set that regular dividend at the level they can know they can sustain no matter what. Where special dividends or buybacks is much more easier to go up or down. So, as an investor, you should never rely on what the previous year’s special dividends have been is it can change. And so, particularly for a company like Progressive, when you’re an insurance company, depending on the year, your earnings can move quite a bit with, particularly with hurricanes.
So, those catastrophic events where, last year, we had almost, we had no hurricanes hit the U.S. So, they had no hurricane losses, which means they had a greater profit than they probably would in a normal year, which left them with more money at the end of the year. So, they gave a bigger special dividend. When I like to look at any of the insurance companies, what I try to do is assume what do they make in an average catastrophe year, knowing some years are better, some years are worse. And then that probably is a sense of what that average special dividend or buyback can be, but there’ll be years where it’s less, years where it’s more.
So, I think whenever you’re investing in a company, you can focus on relying on that ordinary dividend, but then view that special dividend to say it will toggle up or down and don’t bank on it being the same every year.
NB: Okay. Well, I have one more question before we get out of here for you. Just off the top of your head, you had a Buy rating for Progressive, and you also talked about this negative sentiment with other investors and what’s going on in the market. So, for the future, what would you like to see from Progressive that would potentially tip the scales for you and make that a Strong Buy rating?
SP: What I really look for is, if you see some negative news and the stock doesn’t go down or actually goes up, that’s a way of registering that sentiment has reached an extreme, right? When you stop going down on bad news, it means all the bad news has been priced into the stock and even a little bit of good news, it can start to recover sharply. So, I need that confidence that, I’m trying to make my Buy recommendations out 12, 18 months. And I do think over that period of time, we’ll see sentiment turn, but I don’t know if that sentiment is going to turn today or turn in three months.
So, I need to see a little bit more evidence that we’ve got as negative as we can get on that sentiment front and that’ll probably move me to a Strong Buy.
NB: Alright. Well, perfect. Thank you so much, Scott, for joining us today. And for everybody that’s listening in, go ahead, click the follow button on Seeking Profits page, and also take a look at the articles, see if Progressive might be right for your portfolio. And we’ll see you here next time. Thank you so much.
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