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When hunting for undervalued stocks, few things excite value investors more than seeing a quality business trading at a bargain-bin valuation multiple. Insurance group Hiscox (LSE:HSX) could be such an opportunity after the 2020 collapse in the share price has the FTSE 250 stock still potentially well undervalued.
Valuation
Shares are currently trading a staggering 71.3% below the firm’s calculated fair value estimate, at least according to a discounted cash flow (DCF) calculation. This gaping discount suggests the stock could represent one of the most compelling value plays among FTSE-listed companies right now.
Obviously, this isn’t a guarantee. However, with many companies now fully recovered from the pandemic, when a company sits significantly below historical levels, I’m interested.
Future outlook
To be sure, the company has faced some near-term challenges that have likely contributed to the depressed share price. Pre-tax profits in 2023 fell 28% year on year as the insurer navigated elevated claims from natural catastrophes and lower investment returns.
However, the long-term outlook appears favourable, supported by growth projections for the global insurance industry. Analysts forecast that revenues will expand by nearly 11% annually over the next few years as it attracts customers across retail and reinsurance. Not dazzling numbers by any means, but with confidence that growth can be sustained, which is what I like to hear.
The firm is also guiding for improved underwriting performance and pricing conditions, key drivers behind the ability to bounce back from the recent earnings weakness. Management remains bullish, with CEO Aki Hussain describing the outlook as “one of the best periods for compound pricing increases in over 15 years“.
Dividend
In addition to the valuation discount and growth prospects, the business offers investors a decent income stream through its reinstated dividend policy. The company currently yields 2.7% and aims to grow the payout over time, having skipped dividends during the pandemic.
While the dividend track record has historically been a bit uneven, the relatively low 18% payout ratio suggests ample coverage and room for growth if the earnings recovery materialises as planned.
Risks
No investment is without risks. With the share price still down from 2020, there are clearly red flags giving many bargain hunters pause for thought. For me, the amount of insider selling over the past three months is a major concern. Obviously this isn’t always related to performance, but with the shares being apparently at a discount, I’m not encouraged when members of the management team are in sell mode.
There are also broader industry pressures like competition, rising costs, and the ever-present threat of outsized catastrophe losses, especially as climate change progresses.
The verdict
Hiscox stands out as a potentially deep value play for those seeking a contrarian opportunity in the FTSE 250. The valuation seems to price in an overly pessimistic scenario, providing a good amount of potential if management can deliver. Despite the risks, I suspect that those willing to be patient may see some rewards in time. I’ll be buying shares at the next opportunity.
