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Introduction

Cincinnati Financial Corporation (CINF) is a $6.63 billion company in the property and casualty insurance industry. Market capitalization competitors in this industry include Everest Re, Axis Capital Holdings, and Fairfax Financial Holdings. The property and casualty insurance industry is down 7.79% over the past year compared to the S&P 500, which is up 5.01% during the same period. Over the past month the industry has been down 2.74%, while the S&P 500 has been down 4.62%. Strong undervaluations in this industry helps contribute to strong potential for this industry grow. Specifically, Cincinnati's growth and valuation illustrate the potential for a strong earnings report next quarter.

Business

This section describes what Cincinnati provides. According to Reuters, Cincinnati "markets commercial, personal and life insurance products to businesses and individuals." Owning multiple subsidies, the company focuses on three specific insurance products: property casualty insurance for commercial lines, property casualty for personal lines, and life insurance.

Beginning with commercial lines, Cincinnati runs a package program which includes benefits for workers compensation, commercial auto, and commercial property and casualty. Specifically, the casualty coverage insures against third-part liability, professional services, and employee-related practices (discrimination, wrongful termination, etc). Property coverage insures a broad range of regions including crime, inventory damage, and general bodily and personal injury (slander, libel, etc). In addition, these packages can include a multitude of additional coverages ranging from garagekeeper's liability to fidelity bonds.

The next business segment, personal line casualty and property, focuses on the average consumer. The company can insure houses and automobiles, among other additional products including umbrella services, inland marine, and watercraft liability. And the last business segment, life insurance compiles term insurance, universal life insurance, worksite products, and whole life insurance as the most important components to revenue. Cincinnati also provides annuities for disability insurance.

Growth

Cincinnati is growing at a steady rate. Sales are down over the past year at a negative 5.40%, but many insurance companies are feeling financial health problems, because of the credit troubles. However, looking at a five year average of sales for Cincinnati, investors should feel more confident with 12.18% sales increase. Given Cincinnati's high annual revenue of $4.55 billion, Cincinnati's growth rate is very good compared to the rest of the industry. Moreover, while the past fiscal year also bears bad news for Cincinnati's earnings growth, the same story can be made for many other companies in this industry. However, yet again, Cincinnati's five year average earnings rate is 37.37%--a very respectable number. Therefore, while Cincinnati's share price has been hurt this past year due to smaller growth, because the company has a strong history with sales and earnings appreciation, there is a huge potential in the near future for these numbers to climb.

Given the poor past fiscal year growth figures, many investors may expect poor margins as well. On the contrary, Cincinnati's margins have been excellent. Operating margins at 25.97% and the more important net income margin at 18.68% are both above the company's five year average (20.67% and 15.19% respectively) and the industry's average (19.23% and 13.42% respectively). Moreover, Cincinnati's figures also beat out competitors such as Fairfax, which only posted a 20.67% operating margin and a 14.26% net profit margin. Therefore, despite low growth rates, Cincinnati has still managed to control costs and receive more pennies for every dollar of revenue. Such success will continue and be even better once the company returns to more normal sales and earnings growth patterns.

Better management practices are also apparent in the company's ROE. ROE over the past year for Cincinnati increased to 12.29% from its five year average at 5.93%. This number is comparable to the industry at 14.79% and competitors like Fairfax which is at 12.50%. Cincinnati's ROA at 4.53% has also increased from the company's five year average at 3.53%. The figure is also better than the industry's 3.89% average and Fairfax's 3.49% number. Therefore, once the sales and earnings scenario inevitably turns around, Cincinnati will be in great position to benefit even more regarding earnings and its balance sheet.

Valuation

Along with a strong ROE, Cincinnati looks favorable because of its valuation. Currently, the industry has a P/E ratio of 11.63 and a price to sales ratio of 1.46. Cincinnati's forward projections are higher at 12.53 and 1.74 respectively. A high ROE and a high valuation mean investors have faith in the company, and there is a huge potential for further capital gains. While some investors may want to be less risky and choose oversold valued companies, the potential reward is worth the risk regarding Cincinnati.

Efficiency

Cincinnati is a strong company. The company has a capital spending growth rate at 28.23. The figure is almost twice the industry average. Since the company has an abundance of cash, given its low price to free cash flow ratio of 16.25, the company can buy investments or assets to promote productivity in the future. In addition, it can buy capital with cash to earn more cash in the future, meaning stronger dividends or stock repurchases�both bullish activities for investors.

Sticking with dividends, Cincinnati offers a generous rate at 3.53%. The industry average is only 1.89% and industry competitors like Fairfax, Axis, and Everest all offer rates fewer than 2.00%. Again, a higher dividend rate attracts more investors and illustrates large cash flows. What is also interesting about Cincinnati is that 56.31% of all shares are owned by institutions. Since institutional investors are usually better educated and more cautious with their money, relative to retail investors, there may be some merit to potential earnings and revenue boosts.

Technical Analysis

Cincinnati has not performed fairly well share-price wise. In 2007 the company's share price is down 11.83%, mostly due to bearish economic news the second half of the year and huge price fluctuations. The company was flat in 2006, but had not experienced a negative calendar year since 1999 (the start of a recessionary period) before 2006. Interestingly, since 2000 up to November 2007, Cincinnati's share price is up 30% for an annual steady growth rate of 5%.

More specific to the current month, Cincinnati illustrates strong technical signals. The 50 day SMA and 50 day EMA are separate but with the parabolic SAR above the current share price. Moreover, the company is a little undervalued compared to the RSI index at 41 and the fast stochastic at 46, but it is better to be an advocate of fundamental valuations before technical valuations. In addition, shares of Cincinnati have plummeted given the low beta of the company, so now may be the best time to take advantage of such an unusual fallout.

Conclusion

Cincinnati is a great acquisition for any portfolio. The company's business model and fundamental analysis are both strong. It is very rare to find a company that has both strong valuation and growth, so it is wise to take advantage of these situations as they arise.

-Dennis Biray
November 30th, 2007