Updated on January 30, 2023 by Félix Martínez
Insurance can be big business. Insurers earn income from policy premiums and make money by investing accumulated unpaid premiums in claims, known as a float.
Even legendary investor Warren Buffet sees the value in insurance stocks: His investment conglomerate Berkshire Hathaway (BRK.A) (BRK.B) owns GEICO, General Re, and more.
High profitability allows many insurance companies to pay dividends to shareholders and increase their dividends over time. For example, Aflac (AFL), has increased its dividend for 40 consecutive years.
This means the company qualifies as a Dividend Aristocrat, a group of 66 companies in the S&P 500 Index with more than 25 consecutive years of dividend increases.
You can download a free list of the 65 Dividend Aristocrats, along with important metrics like dividend yield and price-earnings ratio, by clicking the link below:
This article will look at Aflac’s business model and what drives its impressive dividend growth.
Aflac was formed in 1955 by three brothers: John, Paul, and Bill Amos. Together, they came up with the idea of selling insurance products that would pay out cash if the insured got sick or was injured. In the mid-20th century, workplace injuries were common. And there was no insurance product at the time to cover this risk.
Today, Aflac has a wide range of product offerings. Some of these include accident, short-term disability, critical illness, hospital indemnity, dental, vision, and life insurance.
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The company specializes in supplemental insurance, which pays policyholders if they are sick or injured and unable to work. Aflac operates in the US and Japan, where Japan accounts for approximately 70% of the company’s premium income. Because of this, investors are exposed to currency risk.
Aflac’s earnings will fluctuate based on exchange rates between the Japanese yen and the US dollar. When the yen rises against the dollar, Aflac helps because every yen earned becomes more valuable when reported in US dollars.
Aflac’s strategy is to increase premium growth through new customers and increase sales to existing customers. It is also investing in expanding its distribution channels, including its digital footprint, in the US and Japan.
Aflac continues to perform well overall. On November 8, 2022, Aflac declared a quarterly rate of $0.42 per share dividendmarking a 5% increase and the company’s 41st consecutive year of increasing its pay.
On October 31, 2022, Aflac released results for the third quarter of 2022. The company reported $4.82 billion in revenue for the third quarter, representing a decrease of 8.0% compared to the third quarter of 2021.
Net earnings were $1.6 billion or $2.53 per share compared to $888 million or $1.32 per share in the third quarter of 2021. On an adjusted basis, earnings per share decreased 24.8% to $1.15 per share
During the nine months of 2022, Aflac generated $4.0 billion in net earnings, an increase of 22.2% compared to the nine months of 2021. Adjusted earnings decreased 18.2% year-over-year. However, net earnings per share increased 29.7%, from $4.82 per share in 2022 for the nine months to $6.25 per share for the nine months of 2022.
From 2011 through 2021, Aflac increased earnings per share at an average compound rate of 7.4% per year, though some of that improvement is related to tax reform. Also, remember that the yen has generally weakened against the dollar for a good part of the last decade. The 2021 results were especially impressive in the midst of the pandemic.
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In Japan, Aflac wants to defend its strong core position, while further expanding and evolving based on customer needs. At this point, Aflac Japan is expanding its “third sector” product offering. These include non-traditional products such as cancer insurance and medical and income support.
Aflac has enjoyed strong demand in Japan for third-sector products due to the country’s aging population and declining birth rate.
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Meanwhile, in the US, Aflac believes it has a long way to go to penetrate the market. While the brand is well known, only a small fraction of the US workforce has access to Aflac, and an even smaller fraction actually buys Aflac: less than 5% of the workforce.
Aflac has two sources of income: premium income and investment income. On the premium side, this is generally tricky, with policy renewals making up the bulk of revenue. However, Aflac operates in two developed markets where we don’t anticipate seeing outsized growth in business.
The other lever available is on the investment side, where the vast majority of the portfolio is in bonds. There is potential here for revenue improvement should rates rise in the future, although lower rates have been persistent. In addition, the share buyback program has also been an important factor and we believe it will continue to drive earnings per share.
All of these elements—premium growth, higher rates, and buybacks—were challenged to some degree by the COVID-19 pandemic. However, the company has proven to be quite resilient. We’re forecasting another increase in 2022 earnings, to $5.26 per share, along with a 4% annual growth rate over the next five years.
Competitive advantages and performance in recession
Aflac has many competitive advantages. First, it dominates its niche. It operates in complementary insurance products and is the leading company in this category. Their business model has low capital expenditure requirements and sells a product that enjoys consistent demand.
Aflac’s strong brand is a key competitive advantage. Competition is intense in the insurance industry, considering the nature of the products as merchandise. To retain customers and attract new customers, Aflac spends heavily on advertising.
Aflac is also a recession-resistant company. It remained profitable even during the Great Recession:
- 2007 earnings per share of $1.64
- 2008 earnings per share of $1.31 (-20% decrease)
- 2009 earnings per share of $1.96 (49.6% increase)
- 2010 earnings per share of $2.57 (31.1% increase)
In particular, Aflac had a rough year in 2008, which is understandable given the deep recession at the time. However, its earnings per share came back strongly in 2009 and 2010.
Valuation and expected return
Over the past decade, Aflac’s stock has traded at an average P/E ratio of approximately 10 times earnings.
We think this is more or less fair value for the stock, considering that many insurers trade at a comparable multiple. This lower average valuation multiple allows the robust share buyback program to be more effective.
Ongoing owners are much better served if the company is buying past partners at 10x times profit compared to, say, 15x or 20x times profit.
Based on expected 2022 earnings per share of $5.32, the shares are currently trading at 13.7 times earnings. As such, this implies a slight yearly valuation headwind (-5.4%), should stocks return to 10x earnings.
In addition, the 4% growth rate and initial dividend yield of 2.3% should contribute to shareholder returns. When all three components are put together, this implies the potential for annualized returns of 0.9%.
Importantly, regardless of anticipated returns, the Aflac dividend looks very safe. The Aflac dividend appears to be safe, with an expected dividend payout ratio of 30% by 2023. The dividend has room for future increases, even if EPS growth slows.
Aflac is a high-quality company with a profitable business and a strong brand.
The company has increased its dividend for 41 years in a row. Thanks to a low payout ratio and future earnings growth, you should keep doing it.
Aflac doesn’t have the highest return at 2.3%. But it offers steady dividend increases and a highly sustainable payout.
In addition, the shares are currently trading above the company’s historical valuation. This results in a low expectation of total return. Therefore, the security earns a sell rating.
If you are interested in finding high-quality dividend growth stocks suitable for long-term investment, the following Sure Dividend databases will be helpful:
The major national stock indices are another solid resource for finding investment ideas. Sure Dividend compiles the following stock market databases and updates them monthly:
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