March 10, 2020 | Som Thapa
Recently stock market has been the hot discussing topic due to its highly volatile nature. It moved up from 1200 level to 1632.18 points in a span of 2 months and declined almost 200 points within one week. As of March 5, 2020, Nepse Index closed on 1435.70 points.
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Why I am writing on this topic?
I was in an elevator with 3 other men who were discussing about the stock market. Banking stocks were on the run and Nepse index had gained more than 65 points that day as bank stocks surged. One commented “I own all bank stocks since they are safer”. He seemed quite happy. Others agreed.
In the broker houses to Facebook group chats there is an ongoing battle between investors preferring bank stocks and other investors preferring insurance or microfinance stocks. This is quite common and the general investors are faced with a dilemma about which course of action to follow. Should they purchase bank stocks for lower risks or should they purchase insurance/microfinance stocks for higher possibility of gain.
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There is a general consensus among investors that currently bank stocks are available at the bargain level. That means, the banking stocks are undervalued or safe in the current market context. Several Nepalese investors consider microfinance or insurance stocks to be risky. The rationale behind this misconception is that the bank stocks are available at the relatively lower price than insurance and microfinance stocks. Likewise, insurance/microfinance stocks are more volatile as compared to bank stocks. Since, Citizens Bank is trading at Rs. 200 it is twice safer as compared to Siddhartha Insurance trading at Rs. 560. If I purchase Nirdhan Utthan Laghubitta at Rs. 1000, then my risk will increase by 5 times. Isn’t it? However, that might not be the case.
Judging the stocks based on the absolute price can be a faulty way to analyze the company’s valuation. Because a stock trades below Rs. 100 or below Rs. 200 doesn’t make it undervalued or less risky. The valuation doesn’t depend on the stock price but the benefits the stocks will provide in the future.
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Here I do not intend to suggest you to exclude bank stocks and purchase insurance or microfinance stocks instead. I want to convey that holding all-banks portfolio (thinking bank stocks are safe) might be far riskier than including some microfinance or insurance stocks or some hydro-power or hotel stocks.
Today I will try to discuss about why investing in stocks of insurance companies might be a really good idea.
Why you should invest in the insurance stocks?
Nepal being a developing nation lacks the economic protection through the process of insurance. We are far behind in the development of insurance. Non-life insurance penetration is a mere 6 percent while the life insurance has coverage of almost 20 percent. This is despite the rapid growth seen in the insurance industry in the past 10 year’s period. If we picture our nation growing at a decent pace in the coming years, the insurance business is likely to expand. In the next 20, 30 or 50 years, the insurance will cover most of the living and non living objects that need the economic protection.
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So, if we look into the broader perspective, there is 94 percent market yet to be penetrated by the general insurance companies. Likewise, 80 percent of the life insurance market is to be explored. This is apart from the fact that the population is likely to be doubled in the coming 20, 30 or 50 years. Also, the large infrastructure and material possession that constitute the modern life of man will infinitely increase in the coming years. That too will need the insurance protection. There will be large addition to the current market which indicates the huge potential for the insurance business.
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Most of the insurance stocks are trading at above the bank stocks which has led the investors to believe that the insurance stocks are more riskier than the bank. Given the current earnings, insurance stocks are also trading at a higher multiples i.e. higher P/E ratio. Higher P/E means overpriced. Right? Not exactly. Investors generally provide higher P/E to those stocks that they anticipate has more growth potential in the future. Likewise, P/E ratio is calculated using the past earnings. But investing is all about future. An investor at current doesn’t receive what the company earned and distributed in the past. He/she will receive what the company will earn and distribute in the future. Therefore, the investor needs to select the companies whose industry will grow for the foreseeable future. In Nepalese context, Insurance is one of those sectors.
Several investors have the criticized the purchase of insurance stocks since the growth of insurance (especially non-life insurance) has stalled in the past one year. It surely has for most of the companies. But making a decision based only on that might be a greater mistake when the business will rebound and insurance will again expand at a rapid rate. Looking into the data of only one year inhibits you from seeing the larger picture which is quite predictable. Insurance is a cyclical business. Some years it will rise rapidly while some years the business will see a sluggish growth. However, one thing is sure. The long term growth of the insurance business will be upward.
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Government of Nepal has also prioritized insurance in every budget speech and encouraged the general public to participate in the insurance protection allowing subsidies in the agricultural insurance. However, there is lack of awareness among the pubic regarding the insurance which has led the sluggish growth of the business. That has changed in the past 10 years. The company with a premium collection of 20-30 crores ten years ago are currently accumulating premium of above Rs. 150 crores in a year. This indicates that business has grown by 5-10 times which is a rapid expansion despite the public reluctance to participate in the insurance for protection of the future. Life Insurance business has also witnessed such growth during the same period.
If we consider the possibility that the mass population will be aware and engage in protecting their future through the insurance coverage, then there is tremendous growth potential for the insurance business. Like the general population is fully incorporated in the banking system at current, there will come a time when the public will get involved in the insurance. When that happens, the investors will hugely benefit from their investment in insurance.
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Writing this article, I am just trying to urge the general investors not to completely shy away from insurance stocks. Put at least 20 percent of the portfolio amount in the stocks of insurance companies. This is one of those sectors with promising growth. We might not sense it from here. But looking into the larger picture, insurance will become a necessity in this modern life as the banking has become now. In the coming 10-20 years, you will be quite happy that you invested in this sector.
Major question is not whether the insurance industry will expand or not in the upcoming future. It definitely will if the nation progresses. The hardest question is which company will surpass others, prosper and lead in the next 20, 30 or 50 years? If you ask me, I have only one answer: I don’t know. Big companies might fail. Small companies might lead. No one surely knows.
I can’t tell you which insurance stocks to purchase. That decision I leave into your capable hands. But don’t stay away from insurance stocks thinking they might be risky. Risk is everywhere.
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