The Rational Walk
Intelligent Investing is not a "Random Walk"

Investors Title Company Approaches Intrinsic Value June 21, 2012

“In the short run, the market is a voting machine but in the long run it is a weighing machine.”

— Benjamin Graham

In this article, we revisit the investment thesis for Investors Title Company which was first profiled on The Rational Walk in November 2010 with an update provided in March 2011.  Investors Title is one of the smaller players in the title insurance industry which provides an essential but little understood product required for nearly all real estate transactions in the United States.

At the time of the initial write-up, we noted that Investors Title appeared to be significantly undervalued but offered no particular assessment regarding when Benjamin Graham’s famous “weighing machine” would close the valuation gap.  In recent weeks, the market has assigned a valuation to the company that appears to be more appropriate, yet no obvious “catalyst” was responsible for the change in valuation.  After a brief detour into the workings of the “weighing machine”, we examine what has transpired at Investors Title over the past year and assess the company’s current valuation.

The Weighing Machine Works … But Not on a Quarterly Schedule

It is easy to dismiss financial markets as hopelessly psychotic given day to day gyrations in prices that often have little to do with changes in the underlying economics of a business.  However, the fact that few investors are able to outperform market indices consistently should lead one to approach market prices with some respect. When an investor decides to take a position in a security, he is implicitly saying that the collective opinion of his fellow market participants, as expressed in the current price, is mistaken. The questions that must be answered include why the market’s assessment is mistaken and what timeframe is being considered by market participants.

Whether the market is “right” or “wrong” very often depends on the timeframe in question.  Most market participants have a short term outlook, despite protestations to the contrary.  Institutional investors may simultaneously agree that a security is deeply undervalued but refuse to purchase shares because there is no obvious “catalyst” that would drive the stock price up during the current quarter.  One only needs to read interviews with “long term” individual investors before and after the recent Facebook initial public offering to observe that while most everyone claims to have a multi-year time horizon, almost everyone wants instant gratification instead.

Value investors who can identify undervalued securities without obvious catalysts and are willing to own shares without knowing precisely when the “weighing machine” will reflect intrinsic value have an important advantage over the vast majority of market participants.

Investors Title’s Texas Expansion 

As we noted in the original write-up in November 2010, Investors Title is one of the smaller players in the title insurance industry and has traditionally focused on markets in the southeastern United States.  In 2009, 44 percent of direct premiums were written in North Carolina where the company was founded in 1973.  North Carolina, South Carolina, Virginia, and Tennessee accounted for 65 percent of direct premiums in 2009 demonstrating that management was not straying too far from its home base.  Notably, the company lacked exposure to markets that suffered the worst of the real estate bust such as Florida, Arizona, Nevada, and California.  As explained in the original write-up, although title insurance is not directly triggered in cases of home prices falling, the discovery of title defects tends to rise in falling real estate markets.

Starting in 2010, Investors Title began an aggressive expansion into the Texas market.  From a standing start with no reported volume in 2009, Texas accounted for 32 percent of direct premiums in 2011 moving North Carolina into second place at 27%.  Total direct premiums increased from $62.2 million in 2009 to $81.6 million in 2011 with Texas accounting for $26.3 million of the 2011 total. Texas has accounted for more than all of the premium growth over the past two years.  Whether this is a positive or negative change remains to be seen but the geographic distribution of business has clearly changed.

Financial Results – 2009 to 2011

The following exhibit displays key data related to Investors Title’s performance over the past three years.  This is not a comprehensive discussion of financial results which can be obtained in the company’s latest 10-K for 2011 and 10-Q for the first quarter of 2012.

  • Revenues.  We can see that title insurance revenues increased significantly in 2011 which was driven by the expansion into Texas as discussed previously.  Total revenues shows a similar pattern. The difference between total revenues and title insurance revenues is accounted for by the combined effect of investment income, realized gains and losses, and other revenues driven from fee, trust, and management services income.
  • Net Income.  Net income rose from $4.8 million in 2009 to $6.4 million in 2010 and $6.9 million in 2011.  Earnings per share advanced at a faster rate due to declining share count driven by repurchases of common stock.  Net income as a percentage of total revenue declined from 8.9 percent in 2010 to 7.6 percent.
  • Agency Retention. One of the most important metrics for a title insurance company is the percentage of premiums retained by agents.  This is particularly important for Investors Title given the increasing percentage of total title insurance revenue attributed to agencies which rose from 65 percent in 2009 to 80 percent in 2011.  We can see that agency retention jumped from 72 percent in 2009 and 2010 to 76 percent in 2011.  According to the company’s filings, this is primarily due to the expansion into Texas which is a market that has higher commission rates.
  • Losses as Percentage of Title Revenue.  Title losses and claims as a percentage of title revenue fell from 14 percent in 2009 to 7 percent in 2010 to 4 percent in 2011.  This is clearly a significant improvement, but the loss ratio rose to 8.3 percent for Q1 2012.  From 2001 to 2011, the average loss ratio was 11.7 percent, so recent results are showing a lower than normal level of losses.  According to the company’s 2011 10-K report, the drop in the loss ratio from 2010 to 2011 was primarily due to favorable development for prior policy years.  Loss estimates are subject to significant error.  At 12/31/2011, 83.6 percent of the $38 million in loss reserves on the balance sheet were incurred but not reported (IBNR), meaning that a large portion of reserves are estimated by management.
  • Book Value per Share.  Total stockholders’ equity increased from $97.3 million at 12/31/2009 to $106.5 million at 12/31/2011 while shares outstanding fell from 2.3 million to 2.1 million due to repurchases.  Tangible book value per share rose from $42.56 at 12/31/2009 to $50.54 at 12/31/2011.  Tangible book value per share advanced further to $51.74 at 3/31/2012.

Stock Price Performance

When one looks at the key data for Investors Title over the past three years, it looks like the company has made steady progress in its operational results and has managed to grow book value per share at a reasonable rate in light of the economic conditions that prevailed during this period.  However, the stock price since the date of our original write-up has been far more volatile as we can see below (click to enlarge):

We are hard pressed to identify reasons for the wild gyrations in price, although someone inclined to do so could probably look for real estate related headlines for the periods where major moves were made and attempt to reconstruct a storyline.  Doing so, however, would be quite pointless as the better explanation seems to be that the stock price of Investors Title only had a vague correlation with business results.  It is true that business results improved along with book value over this timeframe, but the magnitude of the stock price advance was far greater than the increase in book value or intrinsic value.

Intrinsic Value:  Then and Now

In our November 29, 2010 write-up, we noted that Investors Title was trading at a market capitalization of $66.5 million versus tangible book value of $102.5 million as of September 30, 2010.  We also noted that the valuation history of Investors Title suggested that there were relatively few years when the market price of Investors Title common stock did not at least match or exceed the prior year-end book value per share.  Given the fact that Investors Title appeared to be significantly overcapitalized, a large percentage of the intrinsic value is derived from its investment holdings.  The main risk to stated book value is that insurance reserves may be understated, but the company’s long term track record did not indicate a strong likelihood of major reserve problems.  Overall, trading at a price of $29.15 vs. tangible book value of $44.86 per share, buying shares appeared to be equivalent to buying one dollar for only 65 cents.

Since the original write-up, the stock price has advanced from $29.15 to $54.50, or 87 percent, while tangible book value per share has increased from $44.86 to 51.74, or 15.3 percent.  Clearly, the stock price has significantly outperformed the business over the past nineteen months.  With the current stock price at a slight premium to the last reported book value, Investors Title is clearly not the 65 cent dollar it once was.  However, it remains a profitable business with a demonstrated history of growing book value per share over time even through some very difficult economic conditions.  There is no reason to think that Investors Title will be unable to grow book value at mid-to-high single digit rates for many years to come based on its demonstrated earnings power.  However, double digit growth in book value seems somewhat unlikely given the fact that the company has so much of its capital invested in fixed income securities.  Additionally, the risk profile of the business itself has increased due to the expansion into Texas which has suddenly become the company’s largest market.

One of the reasons it is important to document an investment thesis prior to initiating a position is because otherwise one might be tempted to change the rationale for an investment over time without subjecting the change to serious examination.  If an investment was initially purchased based on a large discount to tangible book value, it should be sold when that discount is no longer present unless there is reason to believe that the company can compound book value at rates of return higher than the investor’s hurdle rate over long periods of time.  If Investors Title seemed sure to compound book value at 10 to 15 percent over the next decade, it would probably not make sense to sell merely because the initial discount to book has been eliminated.  However, facing the prospect of relatively modest growth in book value per share going forward, the case for shifting the investment rationale in order to justify holding the shares seems quite weak.

What was the Catalyst?

At the time of the original write-up, there was no catalyst identified that would erase the gap between the stock’s market price and intrinsic value.  In fact, the real estate market was in poor shape and not expected to recover anytime soon.  The real estate market is still in poor shape today and not expected to recover anytime soon.  If we look at the stock chart presented earlier, it is hard to see what catalyst drove the market gyrations.  There seems to be no specific catalyst responsible for moving the shares toward intrinsic value.

Given the choice between an undervalued security with no identifiable catalyst and one that has a very likely catalyst, intelligent investors would pick the latter because it is always preferable to have a sense of how long one will have to wait.  Annualized returns would obviously be far greater if we could buy into undervalued situations shortly before a catalyst magically drives the shares to full value but the investing world doesn’t seem to work that way.  By the time a catalyst is obvious, the undervaluation may have already vanished.  Or there may never be a catalyst and the share price may simply reflect intrinsic value for unidentified reasons.  Value investors who are willing to commit funds to undervalued investments without identifying a specific catalyst have a wider array of possibilities available and an advantage over those who simply must “know” when their investment will turn a profit.

Disclosure:  The author of this article closed out his position in Investors Title between June 6 and June 20, 2012 at prices ranging from $51.80 to $54.50.

Looking For Hidden Real Estate Value at Investors Title Company March 15, 2011

“The way to win is to work, work, work, work and hope to have a few insights.”

— Charlie Munger

Experienced investors know that in order to achieve long term success, it is necessary to read voraciously and to insist on personally reviewing primary sources such as SEC filings when considering investments.  Outsourcing investment analysis, whether to a talking head on television or to a highly paid investment advisor, is almost never a satisfactory substitute for personal research for enterprising investors taking an active role in managing their own funds. Only a careful examination of primary sources can provide the insight required to make decisions and the confidence to stay the course when Mr. Market’s psychological warfare threatens to result in capitulation at the worst possible time.

While examining SEC filings is a necessary condition for long term investment success, it is not sufficient in most cases.  Accounting rules, even when faithfully followed by honest and capable management, often introduce distortions that can result in trouble when an analyst fails to look beneath the numbers.  While there are numerous pitfalls that an analyst must be aware of, in this article we will focus on a specific type of distortion that can occur when the value of real estate on the balance sheet may be understated due to the passage of long periods of time and the effects of inflation.

Bruce Berkowitz and Sears Holdings

In the March 17, 2009 issue of Outstanding Investor Digest, Bruce Berkowitz made the following statement:  “I think almost our entire portfolio is selling at a back-up-the-truck price.”  With the benefit of hindsight, we know that Mr. Berkowitz was being interviewed almost exactly at the bear market lows but he didn’t know this at the time.  However, he had confidence in his convictions and this was due to the depth of research underlying his fund’s positions.

Sears Holdings was one of Fairholme’s largest positions in early 2009 and remains a large position today (click here for dataroma.com data on Fairholme’s history with Sears).   What was Mr. Berkowitz’s investment thesis for Sears based on?  In the Outstanding Investor Digest interview, he made it clear that the investment was based primarily on property values:

Last summer, we spent a tremendous amount of time going to all the tax collectors’ offices around the U.S. trying to get the tax value of Sears and Kmart properties — and we came up with numbers that ranged from between $80 and $90 per share.

So, how much has it changed from last summer?  And where is the stock today?  And how much is the largest appliance servicer worth, or a large automotive center worth, or three or four brands, or Sears Canada and over $11 billion of inventories?  It just doesn’t take a lot these days to get to the current market price ….

So there are many ways to get to heaven.  I think there are many ways that we will  make money in Sears.  Has our estimate of liquidation value declined in this environment?  Yes, it has.  But it’s still dramatically above where Sears is trading today.

[Editor’s Note:  Sears Holdings closed at $39.50 on March 17, 2009 and closed at $82.71 on March 15, 2011.]

Mr. Berkowitz did not rely on private appraisals or non public information to determine that Sears had property worth far in excess of the value reported on the balance sheet.  He simply went through the process of locating tax assessment information throughout the country — an arduous task, no doubt, but ultimately a task that anyone could accomplish given enough time and motivation.

Examining Investors Title’s Real Estate Holdings

In late November 2010, we published an investment thesis for Investors Title Company which remains largely unchanged today.  The company recently released its 10-K report for 2010.  Tangible book value per share was $45.58 as of December 31, 2010 while the stock price has barely budged since the initial write-up and stands at $30.87 as of the close of trading on March 15, 2011.

Following publication of the article, one of our readers sent an email suggesting that Investors Title may have real estate that is worth substantially more than the carrying value on the balance sheet.  Inspired by Mr. Berkowitz’s much larger effort to value the real estate of Sears Holdings, we decided to take a closer look at the Investors Title real estate portfolio in Chapel Hill, North Carolina.

Real Estate Portfolio

If we relied only on Investors Title’s 10-K to study the real estate portfolio, there would be little on which to base an analysis.  The following is taken from Item 2:  Properties in the 10-K:

The Company owns two adjacent office buildings and property located on the corner of North Columbia and West Rosemary streets in Chapel Hill, North Carolina, which serve as the Company’s corporate headquarters. The main building contains approximately 23,000 square feet and has on-site parking facilities. The Company’s principal subsidiary, ITIC, leases office space in 30 locations throughout North Carolina, South Carolina, Nebraska and Texas. The Company believes that each of the office facilities occupied by the Company and its subsidiaries are in good condition, adequately insured and adequate for its present operations.

The balance sheet tells us that Investors Title has $3,672,317 attributed to property and equipment, net of accumulated depreciation.  Note 4 to the financial statements provides the breakdown between different types of property:

Keep in mind that the figures adding up to $9,984,298 are carried at historical cost.  In the case of assets such as office buildings, furniture, and automobiles, these assets are depreciated over time to reflect the decreased utility of decaying assets as time passes.  Fully depreciated, the value of property and equipment on the balance sheet is $3,672,317.  Land is not subject to annual depreciation and from an economic perspective office buildings and improvements tend to appreciate with inflation when well maintained.  Under no circumstances are these accounts ever written up to market value when land and property prices appreciate.

Examining Tax Assessment Data

While examining tax assessment data is not a substitute for obtaining true market data for property, we will use assessments as a conservative proxy.  Chapel Hill is located in Orange County, North Carolina and the real estate assessment process attempts to value properties at market value.  In practice, many assessors may value property at somewhat less than market value in order to discourage numerous time consuming and costly challenges to assessments by taxpayers.  As a result, the figures we obtained may be  somewhat understated compared to true market value.

Orange County maintains an online assessment database that makes it easy to look up property tax information, all of which is public record.  We have found that most jurisdictions now have online databases available making physical trips to assessor’s offices mostly a thing of the past. In order to look up Investors Title’s properties, simply go to the website, specify a search by “Business Name” and enter “Investors Title Company” as the selection criteria.  The tax year we used was 2010.

We obtained the following data from this process:

From the 10-K, we know that Investors Title’s headquarters is located at 121 N. Columbia Street which is the second  property in the list shown above.  Most of the other properties are located adjacent to the company’s main office building.  From Google Map’s “street view” feature, we could see that some of the parcels are vacant lots, parking lots, and smaller structures including what appears to be one single family home at 121 W. Rosemary Street.  The map below was obtained through the tax assessor’s GIS tool (click on the image for a larger view):

The cluster of parcels at the southwest corner of Columbia and Rosemary form the area around the Investors Title corporate headquarters with one additional parcel across the street and two larger parcels located a few blocks away in both directions along Rosemary Street.

How should we interpret this data?  The easy part of the analysis involves comparing the historical cost of the land, listed at $1,107,582 on the balance sheet, with the assessed value of land calculated at $5,293,905 based on assessment data.  Since land is not subject to depreciation on the balance sheet, we can conclude that Investors Title’s land is undervalued on the balance sheet by approximately $4.2 million.

The more uncertain part of the analysis involves looking at the value of the building improvements listed at $3,196,546 before depreciation on the balance sheet and $2,256,401 based on the assessed values.  The company does not break down depreciation so we cannot determine how much the office buildings are carried on a net basis.  However, if we assume that accumulated depreciation was applied roughly in proportion to the percentage contribution of office buildings, furniture, and automobiles to total property excluding land, we could infer that roughly $2.3 million of the $6.3 million in accumulated depreciation should be applied to the office buildings meaning that they would be almost entirely depreciated at this stage.  This seems consistent with the age of the buildings listed in the tax records and observed via Google Maps.  Therefore, we may consider the roughly $2.2 million of assessed value of the office buildings to be incremental value not reflected on the balance sheet.

Impact on Adjusted Shareholders’ Equity

Shareholders’ equity on the balance sheet was stated at $103.9 million as of December 31, 2010.  If we add $4.2 million for the undervalued land and $2.2 million for undervalued office buildings and improvements, we would arrive at “adjusted” shareholders’ equity of $110.3 million.  On a per share basis, this would increase tangible book value from $45.58 to $48.37.

In the case of Investors Title, we would stress that most of the land in question could not be liquidated in the manner that Sears Holdings could liquidate excess real estate because the company’s headquarters and adjacent facilities are located on the properties.  However, there are a few parcels that appear to be entirely unrelated to the company’s business activities and could potentially be liquidated.  In any event, the incremental value is not dramatic enough to change the overall investment thesis but could represent a small incremental margin of safety.

Summary

The point of this article is to encourage readers to dig beneath the surface when evaluating potential investments, whether it means looking at potentially higher values in real estate holdings or at some other factor more relevant to another company.  Financial statements provide a wealth of information and the minority of investors who bother to read SEC filings are already miles ahead of those who take casual “flyers” on stocks.  However, for superior performance over long periods of time, investors may be well advised to try to find an additional edge that most other investors may neglect to pursue and that often involves going beyond the SEC filings.

Disclosure:   Long Investors Title Company

Investors Title Company Represents Value in Midst of Housing Turmoil November 29, 2010

The collapse of housing prices in the United States over the past four years has shattered numerous assumptions made by market participants, many of whom previously based their economic models on the idea that a nationwide decline in real estate prices would never occur.  The impact of foreclosures and the “robo-signing” scandal has captured headlines recently but more subtle effects are even more widespread.  While the human misery created by the housing collapse is impossible to ignore, intelligent investors naturally seek opportunities amid the wreckage.

For most home buyers, title insurance represents just one more annoying charge that appears on the closing statement and often throws budgets into disarray if the cost was unexpected.  However, like most forms of insurance, a title policy seems like a bargain when it is actually needed *.

Industry Overview

Title insurance protects home owners and lenders against defects in title that could arise from a number of factors.  Such defects could call into question whether the buyer has clear title to the property.  Title insurers are responsible for performing an examination of the land records to ensure that the seller has proper standing to convey ownership to the buyer.  In the event that the title proves to be defective at a later date, the title insurer is responsible for covering the resulting losses up to the coverage limit of the policy.  For mortgaged properties, the buyer is required to purchase a title insurance policy for the lender.  Purchasing an owner’s policy is not required, but highly recommended.

Title insurance is different from most other forms of insurance because it protects the policyholder against past events. In contrast, most other forms of insurance protect against future events that cannot be precisely predicted in advance.  In theory, rigorous title examinations should make it possible for title insurers to eliminate losses.  However, in practice, the land and property records in most parts of the country are not digitized and are prone to potential errors.  Regardless, title insurers tend to have relatively low loss ratios and high expense ratios due to the labor intensive process of title research.

According to the American Land Title Association’s market share statistics (Excel) for the second quarter of 2010, Fidelity National Financial had the largest market share at 38.4 percent, followed by First American Financial with 26.6 percent.  Stewart Title was in third place with 14.7 percent market share and Old Republic was in fourth place with 10.4 percent.  The top four have over 90 percent of the market so the industry is quite concentrated.  In this article, we will focus on Investors Title Company, one of the “regional” companies with a market share well under 1 percent.

Investors Title Overview

Investors Title Company was incorporated in North Carolina in 1973 and remains highly concentrated in the Southeastern United States.  North Carolina accounted for 44 percent of premiums in 2009 while North Carolina, South Carolina, Virginia, and Tennessee accounted for 65 percent of premiums.  The exhibit below shows Investors Title Company’s direct premiums written by state:

The company’s concentration in areas that were not at the center of the housing bubble is a significant advantage.  While title insurers are not directly exposed to losses in the event of a foreclosure, title claims tend to rise in areas where the housing market is in distress because various parties have greater incentives to discover title problems under such circumstances.  Additionally, transaction volumes often decline most precipitously in areas where many homeowners are “underwater” on their properties and reluctant to sell.

Title insurers are dependent on property transfers or refinancing when it comes to generating premiums.  If homeowners are reluctant to sell because their property has declined in price, they may also be unable to refinance at today’s attractive rates.  One additional problem facing title insurers occurs when they contract with unscrupulous third party agencies.  Defalcation, fraud, and other misconduct by agencies can cost a title insurer significant sums because agents handle large amounts of money in escrow accounts during a real estate transaction.  In periods of rising markets and robust transaction activity, corrupt agents can hide fraud in a ponzi-like manner as new escrow funds are arriving regularly.  In bad markets, the dominoes can collapse quickly exposing title insurers to losses.

Financial Record:  1999  to Q3 2010

At a recent price of $29.15, Investors Title has a market capitalization of $66.5 million while book value as of September 30, 2010 stood at $102.5 million.  The company had no intangible assets on the balance sheet as of September 30.  While title insurance revenues have declined significantly over the past few years, the company has been profitable in every year except for 2008 and has continued to pay a modest dividend throughout the housing crisis.  From 2000 to 2009, book value per share advanced at a rate of nearly 11 percent thanks to retained earnings and periodic share repurchases.

The exhibit below presents annual income statement data from 1999 to 2009 as well as data for the nine months ending September 30, 2010.  In addition, we present selected ratios to help spot trends in losses and other costs.  Click on the exhibit for a larger view of the data.

From the data, we can see that title losses have declined significantly from the levels of 2007 to 2009 and have actually been below the long term average ratio for the first nine months of 2010.  The company has been trimming employee costs in response to lower revenues, although some effort is still required to bring the ratio of employee costs to revenues down to historical averages.  The agency retention ratio has remained roughly in line with historical averages over the past few years. All things considered, Investors Title has turned in a solid performance during the crisis, much of which must be attributed the fact that the company lacks major exposure to the bubble markets of California, Florida, Arizona, and Nevada.

Valuation History

As we pointed out previously, the company has a solid record of growth in book value per share over the past decade due to retained earnings and share repurchases.  During the boom years of 2003 to 2006, the company delivered earnings per share ranging from $4.09 in 2004 to $5.14 in 2006 and typically traded at a premium to book value and at P/E ratios from 6 to 10.  A summary of the past ten years appears in the exhibit below (click on the image for a larger view):

After posting a loss of $0.50 per share in 2008 due to a very high loss ratio and realized investment losses, the company posted earnings of $2.10 per share in 2009 and $1.75 for the first nine months of 2010.  It should be noted that these profits were posted at a time when market activity is still very depressed.  While the past decade has been anything but “normal” in the housing market, average earnings per share from 1999 to 2009 were $2.85 per share.  We will not begin to guess whether $2.85 represents “normalized earnings”, but it is an interesting data point that spans both boom and bust market conditions.

In our opinion, the more interesting valuation yardstick for Investors Title is the price to book ratio which currently stands at 0.65.  Without looking at the historical data, a discount of this magnitude for a fundamentally sound business seems unjustified.  Apparently, the market usually agrees with this assessment.  If we look at the year-end book value for the past ten years and compare this figure with the stock’s high and low price for each year, we can see that the stock’s high for the year has exceeded book value in every year except 2001, 2009, and so far in 2010.  The exhibit below illustrates the relationship between the stock’s high and low price for each year compared to period-end book value:

While we should not read too much into past trends in price vs. book value, it is interesting to observe that we are looking at a company that has not historically traded at a major discount to book value even during periods of significant market stress.

Risks

When we discuss risk, we are not referring to the typical measures of volatility used by many market participants.  Instead, we need to examine whether the investment thesis may have weaknesses that would expose the investor to a permanent loss of capital if the business is purchased at the current market quotation.  In the case of Investors Title, we can purchase shares at a significant discount to book value, but what are the risks that book value could be eroded in the future?

The risk that is likely weighing most heavily on the market is the prospect of years of continued depression in housing.  A sustained depression would result in low transaction volumes as “underwater” borrowers are reluctant to move and new construction continues to bounce along the bottom with very low levels of housing starts.  While this risk is not negligible, Investors Title has a geographic concentration that does not include the bubble markets of California, Florida, Nevada, and Arizona and is therefore protected from the worst regions.  Additionally, the company seems to have proven the ability to post profits in periods of exceptional stress, with the exception of 2008.

Another risk is that loss reserves may prove inadequate to protect against future claims.  This is a universal risk facing investors in any insurance company and, as outside observers, we can only rely on management’s track record in the past and the fact that most title claims occur within five years after the policy is issued.  With the exception of 2008, title losses have generally ranged from 10 to 15 percent.  It appears that management has adequately reserved for the 2008 loss year but, of course, nasty surprises cannot be discounted entirely.

Investors Title has a $131 million investment portfolio with nearly $90.9 million in fixed maturity securities subject to interest rate risk.  As of September 30, 2010, 43 percent of the value of the fixed maturity portfolio was due in under five years with an additional 41 percent due in five to ten years.  81 percent of the fixed maturity portfolio is invested in municipal or agency securities, of which the vast majority are classified as Level 2 securities.  The remainder of the portfolio is invested in corporate securities, most of which are also Level 2 securities.  (Level 2 securities are valued using third party pricing services rather than quoted active market prices which are classified as Level 1.) The company also has $12.9 million in common and preferred stock investments.  While the prospect of declines in market price of investments due to interest rate increases or default cannot be discounted, Investors Title has a relatively short duration bond portfolio and management does not have a history of incurring major losses on investments.

Summary

There are many reasons that could account for Investors Title’s current valuation, but it is likely that “guilt by association” with the real estate industry may be the major culprit.  In addition, the company has a very small market capitalization and is not one of the major players in the industry.  This is not to say that the company is entirely unknown.  Markel Corporation, led by President and Chief Investment Officer Thomas Gayner, owns ten percent of Investors Title common stock.

While we cannot know the specific reasons for the current wide discount to book value, it seems very likely that the market will eventually assign a more appropriate valuation to a company that has demonstrated a long term record of profitability, book value growth, and resilience during a period of unprecedented stress in the housing market.  Investors purchasing stock at the current quotation are likely to enjoy appreciation of close to fifty percent when the price eventually rises to book value without accepting much risk of a permanent loss of capital.

Trading Note:

Investors Title is one of the least liquid stocks we have come across in some time.  While some shares usually trade each day, volume is often extremely limited and bid/ask spreads are very wide.  Average volume is only 1,200 shares per day and often only a few hundred shares trade.  As an example, on a recent day, typical bids were in the $29.50 range while asks were around $32.

In situations like this, it pays to be patient and refuse to bid up to the asking price.  On several occasions, lower bids were eventually taken in the last half hour of trading.  Needless to say, it is critical to place limit orders.  In addition, placing small orders of 100 to 300 shares on a “all or nothing” basis can avoid very small fills (we had one order filled for a mere 12 shares which incurred a regular commission.)

For larger investors, it may be nearly impossible to build a position in a reasonable period of time.  Larger investors may want to look at Stewart Information Services which also trades under book value, albeit at a narrower discount, and with a less impressive track record over the course of the housing crisis.

Resources:

Investors Title 2009 10-K
Investors Title Q3 2010 10-Q

* A personal note:  The author can personally vouch for the value of title searches and surveys after narrowly avoiding the purchase of undeveloped acreage several years ago that had a major defect:  The home site’s future location resided on a neighboring parcel of land and there were no alternate building sites.  Therefore, for a few hundred dollars of survey and title search costs, several hundred thousand dollars of losses were avoided.

Disclosure:  The author of this article owns shares of Investors Title and Stewart Information Services.