Despite the coronavirus crisis, S&P rallied 16% in 2020, to a new all-time high. Consequently, most Dividend Champions have become fully valued and hence it has become especially hard for income-oriented investors to identify attractive stocks for their portfolios.

Old Republic International (ORI) is a bright exception. This dividend champion has lagged the broad market in the last 12 months and thus it is currently offering a 4.4% dividend yield and is trading at just 10 times its earnings per share. Therefore, income-oriented investors should put this stock on their radar.

Business overview

Old Republic International engages in insurance underwriting, primarily in the U.S. and Canada. General insurance comprises 60% of the revenue of the company while title insurance generates 38% of its total revenue. General insurance is characterized by higher combined ratios (lower margins) while title insurance has strong combined ratios, in the low 90s, and much fewer capital requirements. Old Republic is the third-largest title insurer in the U.S. and a member of Fortune 500.

Investors should be especially careful with insurers, which should be evaluated based on their long-term performance. Some insurers may be tempted to reduce their insurance premiums to gain market share and thus they may post strong results in the short run. However, such insurers will be severely hurt in an adverse year, with too many claims. Therefore, it is critical for investors to examine the long-term performance of insurers.

Old Republic has an exceptional performance record. It has maintained a combined ratio around 96 in general insurance for more than 15 years. It has also paid uninterrupted dividends for 79 consecutive years and has raised its dividend for 39 consecutive years. This exceptional dividend growth record is a testament to the long-term perspective of Old Republic and its disciplined underwriting policy.

In the third quarter, Old Republic grew its net premiums and fees 7% over the prior year’s quarter thanks to 17% growth in title insurance. In addition, its combined ratio improved from 94.4% to 92.0% and thus its operating earnings per share grew 22%, from $0.51 to $0.62. In the first nine months of 2020, the insurer grew its earnings per share 10% over the prior year’s period. Overall, the company has proved remarkably resilient to the severe recession caused by the pandemic.

Growth prospects

Old Republic stock has generated a total market return of 11.0% per year over the last 20 years. However, investors should be aware that the earnings of the company have been quite volatile over the last decade, just like evidenced in nearly all insurers.

Old Republic has grown its earnings per share at a 6.7% average annual rate over the last six years. Thanks to the reliable long-term record of the company and the strong momentum in its title insurance, it is reasonable to expect the insurer to continue growing its earnings in the upcoming years. However, it is important to note that Old Republic achieved record earnings per share of approximately $1.95 in 2020. As this figure is a high comparison base and given the competition in general insurance, it is prudent to assume 4.0% average annual growth of earnings per share over the next five years.

Dividend

Old Republic has raised its dividend for 39 consecutive years and hence it is a dividend champion. The stock is currently offering a 4.4% dividend yield, which is nearly triple the dividend yield of the S&P 500 (1.5%). Even better, Old Republic has offered a special dividend of $1.00 per share in each of the last three years. At the current stock price, the special dividend corresponds to an additional 5.2% dividend yield.

Moreover, the regular dividend is well covered, with a payout ratio of only 43%. Furthermore, Old Republic has a remarkably strong credit rating of A+ in its property/casualty business and A in its title insurance business. It also has no debt maturities until 2024 and its investment portfolio consists of 75% bonds with A+ credit rating and 25% equities, primarily blue chips. Overall, the regular dividend of Old Republic should be considered safe for the foreseeable future.

Valuation – Expected Returns

Old Republic has traded at an average price-to-earnings ratio of 14 over the last decade. In order to be on the safe side, we assume a fair price-to-earnings ratio of 12.5 for this stock. The insurer is currently trading at a price-to-earnings ratio of 9.9. We expect the pandemic to subside at the second half of the year and thus we expect Old Republic to trade around its fair valuation level in five years from now. If this materializes, the stock will enjoy a 4.8% annualized boost in its returns thanks to the expansion of its valuation level.

Given also the 4.4% dividend yield of Old Republic and its expected 4% average annual earnings-per-share growth, the stock is likely to offer a 12.2% average annual return over the next five years. This expected return is certainly attractive, particularly given the fact that the broad market is trading at an all-time high, at a rich valuation level.

Final thoughts

The broader stock market is trading at an all-time high level while interest rates are nearly record-low. As a result, it has become particularly challenging for income-oriented investors to identify dividend champions with an attractive yield and valuation. Old Republic is a notable exception. The stock is offering a safe 4.4% dividend yield and is trading at an attractive valuation level. Given also its exceptional dividend growth record, its healthy payout ratio and its strong balance sheet, Old Republic is likely to continue raising its dividend for many more years.