An inexpensively-priced stock isn’t always a bargain. A thorough fundamental analysis is essential to spot the chance that overlooked problems will make it a perilous value trap.

As an example, take the venerable property & casualty (P&C) insurer and long-time Dow component The Travelers Companies Inc. (NYSE: TRV). A price-to-earnings (P/E) ratio of just under 10 was low enough to make it the cheapest stock in the Dow Jones Industrial Average until very recently. (Faltering oil and gas giant Chevron Corp. (NYSE: CVX) now holds that distinction, with a P/E of a little over 9.)

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But you can’t interpret TRV’s low valuation as a buying opportunity without confirmation. After all, revenue growth has been below-average for several years and profit margins have stagnated in the face of a persistently soft market for P&C policies.

The key question now: is TRV withering under tough industry conditions, or is it still a fundamentally robust enterprise that’s substantially underpriced?

Market sentiment suggests the former. TRV’s stock is up solidly in the past few years, but not nearly as much as those of major rivals such as Markel Corporation (NYSE: MKL), The Hanover Insurance Group Inc. (NYSE: THG) and HCC Insurance Holdings Inc. (NYSE: HCC). As a result, TRV’s earnings multiple is substantially lower than competitors’ and 25% below the P&C industry average of about 13.

Travelers Has A Competitive Edge
But I think the market is judging TRV too harshly. The firm has competitive edges that should lead to outperformance, including dominance of more specialized commercial P&C markets, where competition is lighter and pricing power is better.

“As one of the three largest U.S. commercial lines insurers, Travelers has been able to develop expertise in less commodified areas of the P&C market like oil and gas, agribusiness, and inland marine,” wrote Morningstar analyst Brett Horn. He adds: “In a survey, Travelers was one of the three top commercial carriers for 53% of independent agents. Being one of the first insurers considered creates opportunities to underwrite preferred risks.”

Looking ahead, these advantages should stimulate faster revenue growth and help push profit margins higher, particularly since many parts of the P&C market are finally firming up. Among the commercial areas that have already seen modest but substantial premium increases are: workers’ compensation; commercial auto and property; directors and officers liability; and employment practices liability.

Primacy in these and numerous other commercial markets has propelled TRV to industry-leading margins and returns on equity. For instance, the current net margin of just over 13% is nearly four percentage points better than the industry average. At almost 15%, return on equity is about 5% greater than the peer group, indicating superior ability to profitably allocate capital. I expect TRV’s lead in these areas to widen further as market conditions improve.

Another key sign of TRV’s financial strength: the combined ratio, which is a widely followed insurance industry measure of underwriting profitability. Combined ratios under 100% mean that an insurer collects more in premiums than it pays out in claims; the lower the ratio, the greater the underwriting profit. (A combined ratio of over 100% means that there’s an underwriting loss).

TRV posted combined ratios of 89% and 91% in the first two quarters of 2015, respectively. And as my colleague Chris Walczak recently noted, the firm’s combined ratio was below 100% in eight of the past ten years and under 95% in seven of those years. That’s impressive considering P&C insurers often struggle to just to break even.

Travelers Is On The Hunt For A Profitable Acquisition
The pressure is on for TRV to make a major acquisition following the recently announced merger of rivals Chubb Corp. (NYSE: CB) and Ace Limited (NYSE: ACE). The combined entity created by this deal will be a formidable foe. At the time of the announcement, Chubb and Ace had combined annual revenue of more than $33 billion, versus TRV’s $27 billion.

TRV had actually considered buying Chubb for itself, but wisely reconsidered. The return potential “just didn’t measure up,” CEO Jay Fishman recently told Insurance Journal, explaining that there was only a “modest opportunity to improve the performance of an already high-performing company.”

But look for TRV to strike another deal soon, since management is actively seeking acquisitions and analysts consider the company to be well-positioned financially and strategically for a big takeover. The top prospect is Hartford Financial Services Group Inc. (NYSE: HIG), a diversified financial firm with nearly $18 billion of revenue and several complementary product lines.

Indeed, HIG’s key offerings include substantial group benefits and mutual fund businesses, as well as extensive P&C insurance operations. Also, Hartford’s partnership with the AARP would provide a reliable source of affluent customers in need of a variety of financial services.

Risks To Consider: Huge claims for natural disasters have been less common than usual, thanks mainly to a substantial decline in hurricane activity in recent years. Such activity is apt to pick up again eventually, though, potentially exposing TRV to large losses.

Action To Take –> I believe that TRV is the deep value that its P/E suggests. With the Federal Reserve poised to hike interest rates, the stock is especially attractive now since rising rates portend progressively more interest income from TRV’s large, bond-dominated investment portfolio. That income will further boost profits, which analysts already see climbing solidly in the coming years.

Travelers was recently identified as a “Wealth Magnifier” in StreetAuthority’s premium newsletter, Total Yield. Chief Investment Strategist Nathan Slaughter uses his Total Yield strategy to find companies with “Hidden Dividends” that beat the market. Not only has the strategy returned an average of 15% per year since 1982, but it’s outperformed the S&P during the “dot-com” bubble and the 2008 financial collapse too. To learn more about his “Total Yield” investing strategy, click here.