Shorts Beware; Insure your portfolio !

Markets continued their summer ascend for one more week but it is becoming more frothy in short term. Most of the rally in last one week was due to major short squeeze in few zombie companies like AIG, FRE, FNM. Markets are due for a correction and could anytime take a dip of few hundred points. And that would be a great opportunity to revisit your "wish list of stocks" so keep some cash handy for our shopping list. It is almost given that DOW would close above 10000 by year-end but before that we have to cross months of Sept and Oct.

Now let's visit to insurance sector which had been pretty good overall.

Insurance companies have been on fire lately (and I am not counting AIG in that list which is pure speculative play and I won't touch it or recommend it). In my previous posts, I have mentioned and recommended XL capital, HIG, LNC, GNW, CNO - almost of of them have given multi-fold returns in last 6 months. Once you understand business model of insurance companies, one can understand why they were trading as if world is coming to an end and why they were one of best group for out-sized returns during this rally. Here is my understanding of the insurance company model:

• Sell policies (life, health, home, auto and so on) and collect regular premiums
• Invest the money in high-grade securities (bonds, treasuries, stocks) and collect regular investment income
• When policies mature (or events like death happens), pay policy-holder maturity value. For this companies need to keep part of their investments in most liquid assets

Simple model - but here is what happened in Q4CY08 and Q1CY09

• Markets froze and all supposed high-grade securities which these insurance companies were holding became worth much less and ill-liquid causing these companies to scramble for cash
• BV of many of these companies collapsed. To preserve cash, most of the companies cancelled their dividends and raised cash either via TARP or from markets
• They had to register losses on their investments (in the same way our portfolios went down by 50% or so) even if securities are held for long-term. These losses reduced BV

Here is why these companies have returned multi-fold returns:

• These companies are almost like levered play on S&P due to their investments. Since S&P has gone up by 50%, due to levered play, most of these companies are up by more than 100% (in case of GNW, CNO - they are up by 1000% from their lows)
• The survival fear has gone. These companies WOULD survive
• Book Value is increasing due to market gains

There are still significant opportunities in this sector. My this week's recommendation is one of them:

Company: The Phoenix Companies, Inc.

Symbol: PNX

Buy price: $2.5 to $2.75

Target price in 12 months: $4 to $4.5

Background:

The Phoenix Companies, Inc. helps its customers find straightforward solutions to often highly complex personal financial and business planning needs through life insurance and annuities. Phoenix’s products are available through a wide variety of third-party financial professionals and intermediaries, supported by the company’s wholesalers and financial planning specialists. With a history dating to 1851, Phoenix is publicly traded on the New York Stock Exchange under the symbol PNX

Selection Criteria:

• Long history for the company
• Book Value: Close to $8
• Revenues: Over $1B. Market Cap: < $350 M
• Used to pay dividends of 16 cents - would resume once markets completely recovered
• 52 week hi: $14 52-week low: 20 cents
• Now that this company would most likely survive, it would start trading like normal insurance company which trade closer to their book value.
• Disclosure: Normally I invest in companies which I recommend.

Ganapati Bappa Moraya and have a good weekend !

/Shyam