Every star player strikes out now and then and Warren Buffett is no different. Uncle Warren has some real duds in his Berkshire Hathaway (NYSE: BRK.B) portfolio.
One of these is Torchmark Corporation (NYSE: TMK); a McKinney, Texas-based provider of supplemental health and life insurance policies. Torchmark made up just .28% of Berkshire’s holdings last year, but it still stinks.
A big reason why Torchmark stinks is that it’s overpriced. This is a company that reported revenues of $3.679 billion and a net income of $540.8 million on June 30, 2016 yet it was trading at $62.04 a share on August 16, 2016. Okay to be fair one of the companies ycharts listed as its direct competitor American Equity Investments (NYSE: AEL) reported a net income of $100.95 million on the same day.
An Insurance Company with No Float
Despite that Torchmark simply is not generating enough cash to justify its share price. It reported a free cash flow of $264.33 million and cash and short-term investments of $98.26 million on June 30, 2016.
It looks as if Torchmark is an insurance company that is not generating any float. The reason to buy insurance stocks is that the premiums generate float or extra cash flow that sustains perks like high dividends.
Torchmark offered investors a dividend yield of .89% on August 9, 2016. That is not much for company that generated $1.271 billion in cash from operations during second quarter 2016. Nor is it much a company that supposedly had an enterprise value of $8.74 billion and assets of $21.57 billion on August 9, 2016, according to ycharts.
Why Isn’t Torchmark Generating any Cash?
Many people will be wondering why Torchmark is not generating that much cash. The answer seems to be found on its website where it lists this mission statement:
“Torchmark is a financial services holding company specializing in life and supplemental health insurance for middle-income Americans, marketed through multiple distribution channels including direct response and exclusive and independent insurance agencies. Our success is earned one family at a time.”
That sounds all great and noble, but if it is true such words indicate a seriously flawed business model. Readers of this blog might remember another statement from the Pew Research Center Quoted here on May 22, 2016. It is below:
“The shrinking of the middle class at the national level, to the point where it may no longer be the economic majority in the U.S.”
Logic dictates that the fewer middle-class people the fewer customers for Torchmark and its products. Pew reported that the percentage of Americans living in middle class households fell by 4% between 2000 and 2014.
To make matters worse the so-called middle class is making less money; in 2014 49% of the aggregate income in the United States went to upper income households and 43% went to middle income households, Pew estimated. Back in 1970; when Torchmark’s business plan seems to have been written, 62% of the wealth in America went to middle income households.
Why Torchmark’s Business is Shrinking
Get the picture folks there are fewer middle class families around and they have less money. That hurts companies like Torchmark because they sell products can live without; namely life and supplemental health insurance.
Think of it this way you are a middle class soccer mom faced with two bills; one for life insurance and one for the mortgage, and a shrinking income. Which bill do you stop paying first the one that puts a roof over your kids’ heads; or something you might never need – life or supplemental health insurance?
Part of Torchmark’s dilemma is that it sells products that offer a theoretical benefit; many people will never see. Such products only sell when people have a lot of additional income. Those with less cash spend their money on products that offer a tangible benefit they can experience now.
Unless Torchmark can come with new ways of marketing its product such as GEICO’s clever car insurance commercials it faces an uncertain future. Even with such marketing Torchmark’s products can be a tough sale because car-insurance; GEICO’s product, is required by law. Torchmark’s products are purely optional.
Therefore Torchmark might be a good stock to short because its share value will probably fall over the next year perhaps dramatically. Stay away from this one because it isn’t generating enough cash to sustain its share value.
Torchmark should serve as a lesson for investors; always do the math, because all investors including Uncle Warren pick a dud now and then. Only the financial numbers and your gut can tell you if a stock is a good investment.