Is Berkshire Hathaway’s Mystery Stock a Buy?

Berkshire Hathaway BRK.A/BRK.B finally revealed what its “mystery stock” is: Chubb CB. We think the narrow-moat insurer is one of the strongest names in its industry. Chubb posted solid results last quarter, and we think the near-term outlook is bright. However, this large-cap stock looks overvalued today.

Like its peers, Chubb is posting strong results thanks to a hard insurance market—higher premiums and stricter underwriting—as well as higher interest rates. Because of its relatively long fixed-income duration, Chubb has been a bit slow to realize higher yields, but the impact seems to be more fully flowing through now. We’ve seen underwriting margins for commercial property and casualty insurers start to level off over the past year or so, suggesting that the impact of the hard market has peaked. With strong underwriting results and a better investment picture, Chubb has tailwinds on both sides of its business, and we think it can continue to generate higher-than-normal profitability in the near term. However, insurance is inherently mean-reverting, and industry capital levels remain healthy. As such, it’s possible these excess returns could get competed away fairly quickly.

Key Morningstar Metrics for Chubb

• Fair Value Estimate: $236
• Star Rating: 2 Stars
• Economic Moat Rating: Narrow
• Uncertainty Rating: Medium

Economic Moat Rating

In general, insurers do not benefit from favorable competitive positions. Industry competition is fierce, and the products are essentially commodities. Most participants do not know their cost of goods sold for a number of years, allowing them to underprice policies without knowing it. Companies are encouraged to chase growth without regard for profitability, a cycle that repeats itself as competitors are forced to match artificially low prices or risk losing business. Although Chubb is a large, diversified insurer, we think its underlying business is moaty. We don’t believe the company’s smaller lines necessarily have moats, but they have been solid performers, and the more advantaged commercial and personal segments account for about 75% of premiums. As such, we believe a narrow economic moat rating is appropriate for the company as a whole.

Read more about Chubb’s moat rating.

Fair Value Estimate for Chubb Stock

Our fair value estimate is equivalent to 1.6 times year-end book value and 2.4 times book value excluding goodwill and accumulated other comprehensive income. We forecast a 5% compound annual growth rate for premiums through our projection period, with slightly higher growth in the near term based on current industry pricing trends. The international operations do boost the company’s long-term growth prospects a bit, but we believe Chubb’s size will make it difficult to dramatically outstrip industry growth over time. We expect the combined ratio to average 91% throughout our projection period, in line with its average over the past five years. We think recent pricing increases will allow Chubb to generate stronger underwriting margins in the near term. However, we expect industry combined ratios to creep up a bit over time, as we expect higher interest rates and investment income will reduce the need to generate strong underwriting profits.

Read more about Chubb’s fair value estimate.

Risk and Uncertainty

The biggest risks for insurers are claims in excess of the amount reserved or material impairments within the investment portfolio. Chubb operates in some lines with long tails, where pricing mistakes are more difficult to rectify. Further, it has meaningful exposure to natural catastrophes and other weather-related losses, which can be quite volatile year to year. About 40% of premiums come from outside the United States, exposing Chubb to currency and event risk. The biggest issue for P&C insurers is climate change, which is likely to increase the frequency and severity of extreme weather events. Profitability could be significantly impaired if insurers do not recognize these risks and adjust their underwriting practices accordingly.

Read more about Chubb’s risk and uncertainty.

Chubb Bulls Say

• Chubb is one of the insurers with a global footprint large enough to service multinational corporations. Its network has created a barrier to entry for potential competitors.
• Chubb has leading positions in the moatiest areas of the P&C insurance industry.
• Chubb’s international operations benefit from significant growth opportunities.

Chubb Bears Say

• Large corporations often have substantial bargaining power, which may hurt Chubb when negotiating on premium pricing.
• Higher political and economic uncertainties often accompany the higher growth rates of developing markets.
• We think the life insurance operations dilute Chubb’s moat, and we don’t see a valid strategic connection with the core P&C operations.

This article was compiled by Susan Dziubinski and Sylvia Hauser.