I have learned to love “boring” businesses and industries.

Firms that sell the stuff we all use every day, or provide services like banking and insurance that help us grow our wealth and protect our assets, tend to pile up the biggest returns compared against the broader market. They’re often some of the most resilient places to park your money during volatile conditions like what we’re experiencing now.

Insurance companies are especially full of potential, and most people don’t realize how good an opportunity it is to own them. It’s played a big role in making Warren Buffett one of the richest men on the planet.

But maybe the best example comes from another well-known investor, Shelby Cullum Davis.

He was the father of the founders of Davis Investment Companies, one of the most respected investment firms and mutual fund companies in the United States. He turned an inheritance of a little less than $50,000 into a fortune of almost 1 billion dollars during his lifetime.

And he only owned insurance stocks. He understood that the math of insurance companies is very much like the math used in running a casino. The company is betting that nothing bad happens to the customer, and the customer is betting that something terrible does happen.

The odds are heavily stacked in favor of the insurance company.

They can experience runs of losses, just as is the case with casinos, and that can cause them to take hits as investors sell off to try and preserve their profits. But in the long run, the firms that correctly evaluate risks will be wildly profitable, and that should make for wealthy shareholders.

That’s why, when I see heavy insider buying in insurance companies that appear to have one of those runs of unexpected losses, it sends me a special signal that there’s a phenomenal opportunity to buy at a discount and reap the benefits.

And one of those situations, with the potential to easily double your returns, just came up on my radar…

There’s No Such Thing as Too Much Insurance

James River Group Holdings Ltd. (NASDAQ: JRVR) owns a number of insurance companies that underwrite what’s known as “excess and surplus” (E&S) lines of insurance. These policies cover things the mainstream insurance companies want nothing to do with. Writing these policies requires specialized knowledge and extra effort in evaluating the risks.

The businesses and industries they serve reads like a grab-bag of highly specialized things you wouldn’t think needed insuring, but do. For example, they insure sports stadiums, batting cage operators, oil and gas drillers, cannabis companies and dispensaries, companies that conduct clinical trials for drug companies, water treatment facilities… the strange, very specific list goes on.

James River also has a Commercial Auto portfolio and Casualty Reinsurance that are in run-off mode after causing a string of losses.

The core E&S business is doing very well, but these two run-off divisions have caused the company to fall short of analyst estimates.

As you might expect, that has caused a lot of investors, especially the big mutual funds that are so sensitive about quarter-to-quarter losses, to dump their shares.

Consequently, the stock has gotten crushed, falling by more than 50% over the last year.

But a deeper dive shows that management is taking the right steps to fix the company, and those steps lead me to believe this stock could potentially turn into a profit rocket.

How James River Is Building Back

First, and most obvious, the new management is running off their two bad lines of business. They have slashed the dividend payout dramatically.

In late 2020 they bought in Frank D’Orazio, a highly experienced property and casualty insurance executive, to replace the retiring founder of the company, J. Adam Abram.

His first move was to reinsure the casualty insurance business, eliminating most of the loss from that segment.

Gallatin Point Capital LLC, a private firm that makes investments in financial services companies, injected $150 million into James River to support the necessary changes. They have also purchased a large number of convertible preferred stocks in JRVR, which will allow them to benefit from the significant long-term potential of the shares.

One top of that, the people running the company have a high degree of confidence that James River shares will go a lot higher this year. Top executives and board members, including both the CEO and CFO, have been making sizeable open market stock purchases this month.

Private equity firms like Gallatin Point and insiders do not buy for short-term single or even double-digit gains. Instead, they are thinking longer term and expect that they will earn several multiples of their investment.

The reasoning is simple: The core excess and surplus lines business is still wildly profitable. As the lines of business that caused the losses fade away, this company will generate substantial cash flows, and it looks like the stock can easily double or more from the current level.

— Tim Melvin

Source: Money Morning