Investors Title: Family-Controlled, Operates In An Oligopoly And Well-Managed

Investors Title (listed on Nasdaq with the tickercode ITIC) was for me an unknown company until about a week ago when I came across this article on Seeking Alpha written by Capital Ideas. The article is an interesting deep-dive into a highly profitable and well-managed small-cap (market cap is only 260 million).

My article is mostly a recap of Capital Idea’s article plus some additional elaborations of the operational metrics of the company. I believe this is a great stock to own – at the right price, of course. The stock has fallen during the Covid-19 pandemic, for good reasons, and I aim for an entry below 120. Unfortunately, as of writing, the stock has risen substantially and is now trading at 140. The stock is illiquid, and I hope for a pullback.

The Company:

The company was founded in North Carolina by J. Allen Fine in 1973, where it still has its HQ. It was not operational until 1976 when it acquired Investors Title Insurance Company, and later in 1983 National Investors Title Insurance Company. These two companies are now the backbone of the business.

The business:

The title insurance business is a niche within the insurance sector and differs quite much from “ordinary” primary insurance, not to mention reinsurance. I quote from Investors Title annual report of 2019:

Title insurance protects against loss or damage resulting from title defects that affect real property. When real property is conveyed from one party to another, occasionally there is an undisclosed defect in the title or a mistake or omission in a prior deed, will or mortgage that may give a third party a legal claim against such property. If a covered claim is made against real property, title insurance provides indemnification against insured defects. There are two basic types of title insurance policies – one for the mortgage lender and one for the real property owner. A lender often requires the property owner to purchase a lender’s title insurance policy to protect its position as a holder of a mortgage loan, but the lender’s title insurance policy does not protect the property owner. The property owner has to purchase a separate owner’s title insurance policy to protect its investment………..

Title claims are typically reported and paid within the first several years of policy issuance. The provision (benefit) for claims reflects actual payments of claims, net of recovery amounts, plus adjustments to the specific and incurred but not reported claims reserves, the latter of which are actuarially determined based on historical claims experience. Actual payments of claims, net of recoveries, were $3.9 million, $2.7 million and $3.8 million in 2019, 2018 and 2017, respectively.

Losses are usually small and not prone to black swans like for example reinsurance, but the distribution costs are high, just like in surety finance. The underwriting is done either via own branches or a network of agents, the latter mostly real estate attorneys, lending institutions or independent agents. For 2019 69.2% of written premiums were done by agents, and the rest through their own branches.

Unlike P&C insurance, the title insurance market is quite cyclical due to the nature of the real estate market. Volume is dependent on the activity of the real estate market, property sales, mortgage financing and mortgage refinancing. And we all know the boom/bust cycles of credits and real estate.

Because of less liabilities than most other lines of insurance, the investment portfolio is small, but for Investors Title much bigger than “necessary”. Volume and overall costs are more important than underwriting discipline. Because of this, title insurance is less likely to suffer from the low rates in the fixed income markets as the “float” is significantly less.

Below I summarize the main points why I believe Investors Title is a good stock to buy under 120 USD:

Reason number one: A stable market that works almost like an oligopoly

The market is heavily regulated. For me, as a European, I’m surprised to see that the implementation of a rate change in most states involves pre-approval by the applicable state insurance regulator. The result of this, I believe, is that the market is dominated by a few players, on the cost of smaller and perhaps more innovative ones. A regulated market is always the friend of the existing business, and usually the better the bigger you are.

In terms of market share,the title insurance market is dominated by just these companies (source , source):

  • Fidelity National Financial (FNF), 7.3 billion market cap, 34% market share.
  • First American Financial Corporation (FAF), 5.3 billion market cap, 25% market share.
  • Old Republic International Corporation (ORI), 4.7 billion market cap, 15% market share.
  • Stewart Information Services Corporation (STC), 700 million market cap, 10% market share.

As you can see, the four biggest underwriters have 84% of the market, while the remaining 16% is smaller independent ones, just like Investors Title, who has about 1% of the market.

An oligopoly is most likely not good for the customer, but usually good for the investors/owners. Furthermore, title insurance is a product that is almost a necessity, as the risk of not having one is devastating: when you buy a piece of real estate you take on a huge financial commitment where problems with the property or the deeds can be ruinous, thus you are willing to pay a small premium relative to the property to cover yourself from this risk. It’s kind of the same system in Norway (where I grew up). Furthermore, if you borrow money to acquire the real estate most likely the lender makes it a requirement to have title insurance. Usually the premium is a percentage of the transaction, and thus dependent on both volume and prices. Needless to say, in a downturn both plummet.

Reason number two: Faster Growth than the market

Investors Title has compounded at 12% since 1990, beating the both the S&P 500 and the title insurance market handsomely.

The chart clearly shows the cyclical nature of their business: each recession experience a drop in the share price. After a drop in the share price the CAGR increases a lot, signalling a good time to acquire some shares.

Investors Title: share performance and rolling five-year CAGR. Source: Yahoo!finance and my own calculations. The share price on the left axis is logarithmic.

In the table below I have summarized the most important metrics of Investors Title:

 

Investors Title: Operational metrics. Source: Annual reports and my own calculations.

 

Both EPS and book value growth are very good at 11-12%, way better than most insurers, and return on equity is quite satisfactory (as Benjamin Graham would have said) even though the company is overcapitalized. The title insurance market has grown 2.7% annually from 2015 until 2020, indicating Investors Title is growing faster than the market.

Reason number three: The shareholders – family-controlled

I prefer to invest in family-controlled companies that have skin in the game, like I have explained in a previous article. Family-controlled companies aim for survival – not for streamlining the business and be at risk when a disruption/crisis comes along.

The Fine family owns 30% according to the latest proxy statement, but some of this might be cross-ownership (and in reality a bit less).

What is perhaps less known is that Markel owns 11% of the shares. The CIO of Markel, Tom Gayner, has a track-record of beating the S&P 500 since he was hired by Markel in 1986. I regard Markel’s ownership as very positive.

All in all, this means that the float is low as 35-40% of the company is owned by long-term shareholders.

The only downside is that the family does not give much info about their goals and how they think about their business. Their shareholder letter is “minimalistic”.

Reason number four: Good stewardship and capital allocation

We can argue they should have returned more capital to the shareholders, something they have done in the last three years, but I prefer to own companies that err on the conservative side. I assume we can expect more special dividends or opportune buybacks. I’m no fan of a sticky capital allocation process, for example aiming to pay out 50% of earnings in dividends, and luckily the company only pays a very small regular dividend.

Looking back at their dividend and buyback history, Investors Title is one of the few companies that seem to have an able management that buys back shares when it’s trading below intrinsic value and pays a dividend when it’s above. The chart below summarizes outstanding shares and buybacks since 2000:

Investors Title: Smart capital allocations. Blue bars are reduction of outstanding shares in percent for year x, while red bars are average P/B during that year. Source: Annual reports and my own calculations.

When average P/B is low we see a corresponding drop in outstanding shares, which means that management makes buybacks at low prices and little or next to nothing when the stock is “expensive”, the latter most distinct during the last two years. Currently there is a buyback mandate for up to 500 000 shares, valid until fulfilled or if terminated by BoD. According to the annual report of 2019 they anticipate making further purchases under this plan from time to time in the future. I assume they have bought back shares during the Covid-19 crisis.

The company has paid a special dividend every year the last three years, in total close to 50 million, which has reduced the “overcapitalization” significantly.

Reason number five: Valuation

Investors Title: Historical valuations. Pink line is P/E (left axis) and blue line is P/B (right axis). Source: Annual reports and my own calculations.

The EPS of 2019 shows 16.6 but that number is inflated due to financial gains in the investment portfolio. Adjusted for financial gains the EPS was 13.1, which means the trailing P/E as of today is 9.5 (share price is 125 as of writing). That is slightly lower than the average over the last 20 years. If we look at the P/B, at 101 in December 2019 (and probably a bit lower after 1Q2020?), it is around 1.25, a tad higher than the historical numbers. But in my opinion the current numbers are not comparable to the ones before the GFC in 2008/09 because of the current low interest rates.

Reason number six: Low losses means lower loss reserves

According to this article only about 4-5% of title insureds have been paid out on their policy. Typical claims can be mistakes in public records, fraud, liens, litigation and potential undiscovered heirs. As a result title insurers have less potential liabilities resulting from their underwriting.

The annual report of 2019 states liability reserves of about 31 million, of which 3.8 million was known specific claims and the rest for future potential claims. Because of the uncertainty of future claims, changes in economic conditions and the fact that many claims do not materialize for several years, reserve estimates are subject to variability.

It seems Investors Title is way overcapitalized: loss-reserves at 31.3 million vs. total investments amounting to 192 million. This means the company is overcapitalized six times, which is a drag on the equity returns. 130 million of the investments are low-yielding treasuries, municipal bonds and corporate bonds, while common stocks was valued at 61 million. The notes in the annual report don’t break down the specifics of the common stocks. Obviously, if we strip out the excess capital, the PE ratio is in reality much lower.

Reason number seven: Can “easily” adapt to lean years

As explained in the beginning of the article, 70% of the underwriting is done via agents, and hence costs are mostly variable and the business can scale down without having huge fixed costs. Furthermore, this is done without the leverage you typically find in the housing market. This way you have an option to play the housing market without having the detrimental negative factors that potentially wipe out real estate investors.

Conclusion:

If history is any guide, we can expect high returns after a significant drop in the share price. The business model is not impaired by the Covid-19. I believe any purchases below 120 return annually more than 10% over the next decade, bar a major catastrophe in the real estate market. Title insurance is needed, the population is growing, the Fine-family continues to be at the helm and real estate transactions will most likely continue to grow.

 

Disclosure: I am not a financial advisor. Please do your own due diligence and investment research or consult a financial professional. All articles are my opinion – they are not suggestions to buy or sell any securities.  

(This article was published on the 30th of April 2020.)

  •  
  •  
  •  
  •  
  •  
  •