Why is Warren Buffett buying shares of this company?

Late last year, Warren Buffett and his holding company, Berkshire Hathaway (BRK.A 0.09%) (BRK.B 0.19%)started throwing billions of dollars into a single stock. In most cases, this would have triggered a disclosure, forcing the company to reveal which shares, specifically, it bought. However, Buffett and his team sought an exemption from the Securities and Exchange Commission (SEC), allowing him to accumulate a large position in secret.

What stocks did Buffett buy? Berkshire now reportedly owns a $7 billion stake (about 6% of outstanding shares) in the world’s largest publicly traded property and casualty insurance operation.

What does Buffett like so much about this insurance stock?

The insurance company in which Buffett and Berkshire were building a stake is none other than Chubb (CB 0.89%). Most investors aren’t too familiar with insurance companies like this, even though insurance companies have been the foundation of Buffett’s long-term investment success. Why? Berkshire’s wholly-owned insurance companies provide Berkshire with consistent levels of investable cash that it can use regardless of market conditions.

“Insurers get premiums upfront and pay claims later,” Buffett once explained to investors. “This collect now, pay later model leaves us with large sums — money we call ‘float’ — that will eventually go to others. In the meantime, we can invest this float for the benefit of Berkshire.”

That excess cash that Berkshire invests without interest — a pool of capital that Buffett calls float — helps insurance companies generate profits even if they write policies with zero expected profits. They can even make a net profit by underwriting policies at a loss, generating enough investment income. But sometimes, an underwriting profit is also made, adding even more to Buffett’s pile of investable cash. “If the premiums exceed the total expenses and any losses, we record an underwriting profit that is added to the investment income generated from the fleet,” explains Buffett. “This combination allows us to enjoy using free money – and better yet, get paid for having it.”

Should you buy Chubb stock for your portfolio?

Chubb fits nicely into Buffett’s portfolio. Berkshire already owns a portfolio of insurance companies, and it’s a space Buffett knows very well. While Buffett won’t have direct control over Chubb’s investable capital, given that Berkshire only owns 6% of the company, there’s no doubt that his interest in the company could unlock a more optimal capital allocation strategy — a win- win for both Berkshire and Chubb. .

Over the past few decades, underwriting profits have shrunk considerably due to increased competition. However, the tide is turning. Last quarter, Chubb posted a combined rate of just 84.2%. That means for every $100 in premiums collected, he only had to pay $84.20 in claims — an underwriting profit of about 15 percent. This is undoubtedly one piece of the puzzle that caught Buffett’s attention. Chubb is a strict underwriter and has historically avoided entering highly competitive, low-margin markets.

But is Chubb right for? your portfolio?

The only thing to know is that Chubb won’t make you a millionaire overnight. This is a slow and steady business, just like Berkshire. And like Berkshire, Chubb has proven its ability to outperform the market over the long term. You just have to be patient. Since 1993, Chubb stock has risen a total of 5,290% in value versus a total return for S&P 500 of only 2,170%. Over the past three years, Chubb has outperformed the market by nearly 33 percentage points. But there are many periods where Chubb fell behind, even as he overcame those deficits over time.

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Right now, Chubb’s valuation is a perfect entry point for long-term investors. Clearly, the current valuation is good enough for Buffett’s money. The stock trades at just 12 times earnings and 1.9 times book value, a figure that’s actually overvalued because of Chubb’s multibillion share buyback program that artificially reduced book value. This company is not a flashy value, but it is a high quality business at a more than fair valuation. No wonder Buffett has been winning stocks.