Investing in stocks that pay high dividends is an effective way for the conservative investor whose concern is mainly with the preservation of capital. When investing for a high dividend yield, the most important consideration for the investor is the sustainability of such dividends. Hence research into the underlying dividend payer is crucial.
A look at the insurance sector often provides steady, high dividend and cash flush stocks with which to work. Large insurance companies by definition pay out high dividends because of their regulated inability to pursue high return and potentially higher risk investments. The insurance industry is a great place to look because insurance companies generate “float” that they keep, in the form of premiums, and may or may not have to pay out claims on that money. As such the company gets money very cheaply to invest. Hence the correct pricing of risk is essential.
The insurance industry is not just limited to insurance companies, however. Brokers also generate income based on premiums without having to take any underwriting risk on the transaction. One such broker paying out a 4.84% dividend is Arthur J. Gallagher & Co. (AJG). The stock is currently trading at around $26.
Arthur J. Gallagher & Co. (AJG), together with its subsidiaries, is engaged in providing insurance brokerage and third-party claims settlement and administration services to entities in the United States and abroad. Its brokers, agents and administrators act as intermediaries between insurers and their customers. The Brokerage Segment primarily consists of Retail and Wholesale Brokerage operations, while the Risk Management Segment provides contract claim settlement and administration services for enterprises that choose to self-insure some or all of their property/casualty coverage and for insurance companies that choose to outsource some or all of their property/casualty claims departments. The Financial Services and Corporate Segment manages Gallagher's interests primarily in alternative energy (clean energy/tax advantaged) investments and venture capital funds. The company’s push into the clean energy space was recently augmented by acquiring Securitas Re of Sao Paulo, Brazil.
Since its founding in 1927, Gallagher has grown from a one-man agency to the world’s fifth largest insurance broker based on revenues (according to Business Insurance magazine’s July 20, 2009 edition) and the world’s largest third-party property/casualty (P/C) claims administrator (according to Business Insurance magazine’s March 16, 2009 edition). Gallagher generates approximately 89% of its revenues domestically, with the remaining 11% derived primarily from operations in Australia, Bermuda, Canada, New Zealand and the United Kingdom.
Gallagher has a 13.4% ownership interest in a Biomass company which owns a Biogas pipeline that removes and sells Biogas from landfills, a 42.0% interest in a privately-held enterprise (Chem-Mod) that has commercialized multi-pollutant reduction technologies that remove mercury, sulfur dioxide and other toxic emissions created by coal-fired power plants and a 5.0% interest in a privately-held start-up enterprise, which owns technologies that reduce carbon dioxide emissions created by burning fossil fuels.
Gallagher has ownership interests in four venture capital funds and an investment management company, none of which is over 20%. The funds primarily invest in turn-around companies and the investment management firm primarily invests in hedge fund managers. The investment management company, which was due to undergo an IPO, effectively ran out of money.
In 2009 the company paid out $1.28 in dividends, which is equivalent to what the firm earned that year. In 2008, the company earned only $0.82 but paid the same $1.28 in dividends. The year before, 2007, the firm earned $1.45 and paid out $1.24. The company has an ability to pay out large dividends despite low earnings owning to the fact that is generates a lot of cash from operations. Last year the company generated $211 million in cash then paid out only $130 million in dividends. While it appears all of accounting earnings are going to dividends, the company is actually generating more cash than it needs – hence the high dividend rate.
I’d be wary of investing in a company that has its fingers in too many pies, purely from a competitive advantage standpoint. The firm may know a lot about insurance brokerage, but what do they know about clean energy and investment management (clearly not much – the investment has been written off).
There are probably more secure and reliable dividend payers out there.
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