Stock Quotes in this Article: ALL, CINF, EMCI, IPCC, TRV

MINNEAPOLIS (Stockpickr) -- A rare tornado in Massachusetts last week increased the death and destruction for this year’s storm season. Considering we have yet to reach hurricane season, we could be on the verge of some truly earth-shattering numbers this year. The human and economic impact is already large and getting larger.

What about the impact on stocks? Could Mother Nature's wrath provide an opportunity for traders and investors?

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    With property and casualty insurance stocks, the knee-jerk reaction here is to sell, under the assumption that higher-than-anticipated storm damage will eat into future profits. Let's look beyond that obvious analysis today and take a deeper look at stocks in this category to determine where investors should go from here.

    My guess is that the market is overreacting to events in the news. Far from being efficient, the market tends to get emotionally irrational during extraordinary events like we are seeing with the spring's unusual tornado activity. Those that keep their wits about them can profit from this inefficiency in pricing by sticking to fundamentals.

    Let's take a look at which insurance stocks that could provide investment opportunities this season -- and which to avoid.

     

    Allstate

    Allstate (ALL) is one of the giants in the property and casualty insurance space. The company, which has a market capitalization of $16 billion, has its tentacles deep in the U.S. economy, with insurance products protecting against a variety of risks.

    Since the beginning of May, shares of Allstate have plunged. After peaking at $34.40 per share on May 3, shares have dropped to their current price of around $30.67 per share, a loss of more than 10%.

    The stock market was certainly weak in May, but the S&P 500 was only down 1.4% for the month. I would have expected Allstate to outperform the index because it's a defensive stock with consistent cash flow irrespective of economic activity. The market, however was apparently selling Allstate instead in anticipation of higher claims due to increased tornado activity.

    From a valuation standpoint, the selling wiped out what had been a stellar first-quarter performance. Allstate beat estimates by 25 cents per share in the period ended March 31, which had lifted shares by more than 10%.

    Easy come, easy go, I guess. Going forward, I would not be swayed by the headline carnage of the current tornado season. Use the selling in Allstate as a buying opportunity.

    Big bets on Allstate come from Arnie Schneider's Schneider Capital Management, at 1.6% of the total portfolio, and Richard Snow's Snow Capital, with a 2.3 million-share position.

    Cincinnati Financial

    Another large player in the property and casualty insurance space is Cincinnati Financial (CINF). Headquartered in Ohio, the company sells insurance through independent agents in many of the areas that have been hit hard by tornados. Unlike Allstate, shares of Cincinnati Financial have trended closer to the market performance in May.

    Shares fell 4% during the month, continuing a slide that actually began in late February. Cincinnati Financial hit its 52-week high of $34.33 on Feb. 15. Accelerating that slide was an earning report for the first quarter that missed analyst expectations by 3 cents per share.

    That slight earnings miss may be troubling, but not in the context of cash flow. Cincinnati Financial, one of the
    highest-yielding insurance stocks, pays a dividend that is above 5%, and analysts have the company making 79 cents per share this year and $1.52 per share in the following year. Investors can buy that impressive growth for 19 times the 2012 estimate.

    While there may be risk of higher claims and further selling in the stock, those risks are mitigated by the low valuation relative to growth and an impressive dividend. I would buy Cincinnati Financial at these prices.

    Buying Cincinnati Financial in the first quarter was Jean-Marie Eveillard's Eagle Investment Management, which increased its position in the stock by 1.4% to 10.9 million shares.

    Infinity Property and Casualty

    In the insurance game, strength is in the numbers. On the consumer side, those buying insurance are advised to purchase from the larger companies that are highly rated thanks to strong balance sheets. The last thing you want to do is have insurance that doesn’t pay when needed.

    The same idea holds true on the investment side. Buy the larger insurance stocks since they will hold up the best no matter what the market is doing. As such, one would expect the smaller players such as Infinity Property and Casualty (IPCC), one of TheStreet Ratings'
    top-rated insurance stocks, to be hit harder during a sudden uptick in natural disasters.

    Indeed, that was the case for this $642 million market cap company. During the month of May, Infinity lost more than 10% of its value. The loss may be the result of increased storm activity, but is also related to earnings performance in the first quarter. In early May, Infinity released results that missed analyst estimates by a wide margin.

    The miss was attributable to winter storm activity and does not bode well for the company given the current state of weather. Analysts expect the company to make $3.64 this year and $3.87 next year. With the risk of a further earnings report misses high due to record tornado activity, Infinity is a stock to avoid.

    Travelers

    On the flip side of Infinity is giant insurer Travelers (TRV). This $25 billion market cap company is a behemoth in the insurance industry and likely well prepared to ride out any storm including record tornados and hurricane season. Shares moved only slightly lower in May.

    The stock moved in lock step with the market, losing a modest 1.9% of its value during the month of May and avoiding a knee-jerk reaction to the storm activity. We will have to find opportunity based on valuation and earnings growth.

    Over the last three quarters, Travelers has blown away earnings estimates, beating them by 38 cents per share in the last quarter. For the full year, Travelers is expected to earn $6.30 per share. At current prices the, stock trades for less than 10 times that number.

    With a dividend yield of more than 2%, investors might find the stock attractive. Given its size, Travelers is well-prepared for even the biggest natural disaster. I just don’t think investors can get hurt here, and we can expect the company to continue beating estimates.

    Travelers would seem to be a good stock to own on such basis.

    Travelers, one of TheStreet Ratings' top-rated insurance stocks, shows up in David Einhorn's Greenlight Capital portfolio; Greenlight boosted its position size by 97% in the first quarter, to 4.2 million shares.

    EMC Insurance Group

    I can’t help myself; I'm irresistibly drawn to stocks being pummeled in the market. I love it when there is blood in the streets, leaving the potential for big gains by taking advantage of what often is irrational selling.

    With small-cap EMC Insurance Group (EMCI) we have the blood in the street. Since peaking in March at $24.74 per share, EMC has dropped to $19.60 per share today. That is a 20% decline in value.

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    With no significant changes in operating
    conditions (the company beat estimates by a penny in the first quarter of
    2011), losses in stock market value fall squarely on the shoulders of
    expected increases in claims due to this spring's stormy weather.

      Did the selling go too far?

    I think so. For the current year, analysts expect a profit of 45 cents per share, followed by a big jump to $1.70 a share in the next year. Investors can buy that more-than-100% earnings growth for just 11.5 times 2012 estimates. Big storms or not, that is pretty cheap in my book and worthy of consideration for any portfolio.

    To see these stocks in action, check out the 5 Twister Stocks portfolio on Stockpickr.

    -- Written by Jamie Dlugosch in Minneapolis.

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    At the time of publication, author had no positions in stocks mentioned.

    Jamie Dlugosch is a founder and contributor to MainStreet Investor and MainStreet Accredited Investor. Formerly, he was president and CEO of Al Frank Asset Management. He has contributed editorially to The Rational Investor, The Prudent Speculator, Penny Stock Winners and InvestorPlace Media.