When you see that a stock with returns that blow away the rest of the market, it's understandable that software or biotechnology may be the first thing that comes to mind.
However, what if I told you that an under-the-radar insurance company called Kinsale Capital Group (KNSL -0.15%) has generated a total return of morethan 400% during the past five years?
Kinsale has carved out a unique position in an otherwise competitive insurance landscape, and even after its run-up, this still looks like an incredible time to get in on the stock.
What makes Kinsale so unique?
Broadly speaking, insurance is a fairly commoditized product, and there is no shortage of options for customers seeking auto or homeowners policies.
Kinsale specializes in an area called excess and surplus (E&S) insurance. E&S is often referred to as specialty insurance, and is a relatively underserved pocket of the broader insurance realm.
Specialty insurance providers underwrite businesses that are, for want of a better term, nontraditional. For example, businesses where customers have a higher than normal chance of getting injured -- paintball courses, for example -- may need E&S coverage.
There's limited competition in this niche, but one of Kinsale's more notable peers is American-Swiss insurer Chubb -- a recent addition to Berkshire Hathaway's portfolio.
According to Kinsale's investor presentation, the company only owns about 1.1% of its total addressable market (TAM). However, instead of putting the bulk of its energy into bidding on larger (and highly competitive) underwriting opportunities, Kinsale focuses on small and mid-sized enterprises (SMEs).
Management calls this strategy a "contrarian risk appetite" since SMEs are often overlooked by other insurers in their pursuit of bigger, and perhaps more stable, customers. By focusing on an otherwise underserved pocket of the broader E&S market, Kinsale has been able to command strong pricing power that has fueled its revenue and profit growth.
Image Source: Getty Images
Best-in-breed financial and operating metrics
One of the most important performance indicators for an insurance business is its combined ratio. Basically, this measures how profitable its underwriting policies are. To calculate the combined ratio, add up the company's outflows -- namely, the funds paid out in claims and its administrative operating expenses -- and divide that total by its cash inflows, which largely come from premiums collected.
A combined ratio in excess of 100% means the insurance provider is losing money on its policies.
Image Source: Kinsale.
The company's combined ratio hovers around 77%. By comparison, the average combined ratio among its peers is roughly 92%. This wide gap suggests Kinsale's approach is paying off in spades. And that level of efficiency has helped it consistently generate strong free cash flow (what's left of cash flow after capital expenditures) and profitability. Its impressive earnings profile combined with its total market opportunity make it a compelling long-term investment -- and one that's still available at a reasonable valuation.
KNSL Free Cash Flow (Quarterly) data by YCharts
A hand-over-fist buying opportunity
The chart below traces Kinsale's price-to-earnings (P/E) ratio since its initial public offering.
KNSL PE Ratio data by YCharts.
Its current P/E of 30.4 is a discount relative to its average valuation. But the company's cash flows have continued to soar over the last several years, and it has achieved stronger operating efficiency than its peers. Between those factors and the enormous potential the company has to grow its footprint within its market, I think there's a legitimate case to be made that Kinsale stock is undervalued.
Growth stock investors in particular should buy Kinsale hand over fist right now. The insurer's story is really just beginning, and further share price gains are very much on the horizon -- despite the stock's 400% return over the last five years.
