Why I'd buy Lancashire Holdings Limited for its dividend today

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National Express train at a station

I believe Lancashire Holdings(LSE: LRE) is one of the market's best dividend stocks for several reasons. First of all the company is highly cash generative and requires little in the way of capital spending because insurance is a relatively asset-light business. Second, the company has adopted a flexible dividend policy. Every quarter management approves a token dividend payout of several pence per share. But once a year, the company will pay out a large special dividend, which in my view gives the group more financial flexibility.

In the current insurance market environment, the company needs this flexibility. An influx of capital has sent profits plunging, and some companies are chasing business at any cost. Lancashire is refusing to follow this lead and the company is instead accepting a lower level of profitability. 

Today the company announced that its revenue for the six months to 30 June declined to $381m down from last year's $430m. The value of net insurance premiums written fell to $240m from $279m. However, profitability increased year-on-year by around 14% as the company's combined ratio decreased to 69.8% for the second half, down from 80.6% in the same period last year. A combined ratio of less than 100% shows an insurer's level of profitability accounting for premium income received after paying out insurance claims.

With opportunities for growth limited, but profitability rising, it looks as if Lancashire is perfectly placed to issue a large special dividend later this year. Low reinsurance costs have enabled management to shift risks and this should further free up capital. City analysts have pencilled in a dividend of 54.65p per share for the full year, implying that a special dividend of 42p per share is on the cards after accounting for 13p per share of dividends already paid out to investors. This estimate implies a dividend yield of 7.4% for the full year.

Steady dividend growth 

Lancashire is a top dividend stock because of the company's flexibility and lucrative business. National Express (LSE: NEX) on the other hand, does not look to have the same attractive qualities, but the company remains a strong dividend play.

Today it reported its results for the first half of 2017. Normalised profit before tax grew 11% at constant currency and revenue rose 6.5% at constant currency year-on-year. Free cash flow increased by £15.7m to £81.8m, but despite this, net debt rose by £71m to £873m. Management has approved a 10.1% increase in the company's interim dividend payout on the back of these results. 

Management is focused on maintaining a sustainable dividend for National Express. Over the past six years the payout has increased by 40% and the group is targeting a payout cover ratio of at least two. For the full year, City analysts have pencilled in a modest group dividend yield of 3.7% and the payout has plenty of room for growth in the years ahead. The shares currently trade at a forward P/E of 12.6.

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Rupert Hargreaves owns shares of Lancashire Holdings. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.