Top Picks for 2010: Aflac (AFL)

"In the U.S., its policies are sold through employers on a payroll deduction, as part of companies 'cafeteria plans.'

"They are pretty straight forward. If you get sick and can't work, or are in the hospital, it pays out a set amount directly to the insured.

"It is thus not at risk for rising health care costs (but is if more people get sick). The U.S. unit was under some pressure as payrolls shrank, but with some positive news on the employment front, that should turn around.

"In Japan, once people get AFL insurance they don't drop it (which is very important in the life and health insurance industry) with a persistency rate of 95%.

"The firm has a superb track record, but came under big pressure during the crash last year due to fears about its investment portfolio. I think those fears are being assuaged over time.

"It has already realized $1.7 billion (pre-tax) in investment losses. Some of those are not going to come back, like its holdings in Lehman Brothers and WaMu, but other parts of the holdings that were written down just might come back.

"Aflac did however write down $380 million as other than temporary losses in holdings of some Ford debt, and Ford has been doing much better of late, certainly much better that it looked back at the end of the first quarter when GM and Chrysler were going down for the count.

"The company has generated an ROE of 33.4% over the last 12 months, and its five-year average ROE is 20.84% (it has leveraged up a bit, from having no debt to a still very manageable and conservative 22% debt to capital). As that happens, AFL should return to its historic valuations.

"How much upside potential is that? A lot. Over the last five years (which of course included the big sell off last year) AFL's P/E has averaged 15.4x.

"Based on 2009 earnings estimates, it is going for 9.5x now, and 8.7X 2010 consensus estimates, and those estimates have been rising.

"AFL also has a habit of beating the estimates. It has done so the last three times out, and in 17 of the last 28 quarters, with only five disappointments.

"AFL currently yields 2.4%, which is nice. It has however, increased that dividend in each of the last 27 years, and over the last 15 years it has done so at a compound annual rate of 20.7%.

"AFL happens to be an old favorite of mine, a stock that I first recommended back in 1991, and was a core holding for most of my tenure at C.H. Dean. I know the management team well from those days, and they are amongst the best I know in the industry."

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