A) Introduction
American International Group (NYSE:AIG) has to be one of the most unloved stocks in the entire market. While the company was widely criticized for its role in causing the '08 financial collapse, the government bailout of the company infuriated the entire nation. With that being said, AIG is a different company nowadays. The company has long since repaid its debt to the government (with interest), and the company's restructuring efforts have been successful. The company has posted two straight quarters of revenue and EPS growth, and last quarter's EPS numbers beat consensus estimates by over 12%. While some analysts have recently changed tone on the stock (Credit Suisse downgraded it from 'Outperform' to 'Neutral' on January 8th), we believe the stock offers very attractive value at these prices. We'll start this article with a quantitative breakdown of the company's relative value, then analyze its growth profile, followed by an analysis on how the "smart money" is playing the stock, before concluding with some qualitative analysis and conclusions.
B) Valuation Breakdown
We take a quantitative approach to investing, preferring to focus our analysis on a certain set of metrics that have a strong predictive ability. We'll start by analyzing AIG's value profile. This is important to look at as "Value stocks (with low ratios of price-to-book value) have higher average returns than growth stocks (high price-to-book ratios)". AIG's valuation profile is shown below:
On almost every important measure of value, AIG is attractively priced. On a revenue basis, AIG's sales yield (101%) is much higher than the insurance (81%), financial sector (28%), and overall market (4%) averages. It also means that an investor can currently get $1.01 of revenue for every $1 they invest in a company that makes money and is growing EPS. That type of value in a growing, profitable company is very tough to find, especially in an otherwise expensive market. This is undervaluation is true of the company on an earnings basis as well, where AIG's earnings yield (12.4%) is more than triple the insurance average (4.1%), and more than six times the overall market average (1.92%). This story is the same for AIG on a price/book value (0.64) and price/free cash flow basis (12.18), which are heavily discounted relative to the industry group, sector, and overall market averages. It's tough to find a more undervalued stock than AIG. The company's mediocre dividend yield (1.02%) is the lone weak spot though we believe the company should be bought for capital appreciation rather than income generation. Overall, we rate the stock as "Strongly Undervalued" and expect the company to generate 9.09% of outperformance over the market in the next twelve months solely due to its valuation.
C) Growth Breakdown
There are a variety of different growth metrics that have been shown to predict stock returns. Most important among them is price momentum. Winning stocks keep winning, and losing stocks tend to keep losing. While we believe AIG should be bought because of its value, one should never ignore metrics that have been proven to have predictive ability. AIG's growth profile is shown below:
Source
AIG's stock price performed roughly in line with the insurance market over the last twelve months while underperforming the financial sector and overall market. AIG's price performance is especially bad over the last six months, with the stock dropping 6.72% versus -0.75% for the insurance group, -0.15% for the financials sector, and a gain of 0.78% for the overall market on average. While this is definitely worrying sign given that history has shown us that underperforming stocks keep underperforming, the stock has at least managed to stay out of the bottom third of the market in performance over both time periods. On an EPS growth basis, AIG is in the top 10% of the entire market, with its annual EPS growth of 198% eclipsing the strong growth of the insurance group (+57%) and financial sector (+40%) averages. AIG's ROE (8.4%) and ROA (1.7%) are mediocre relative to the market, but barely trail the insurance group averages (10.7% and 2.3%). Overall, we rate AIG as a "Negative Growth" company, but only expect 0.34% of underperformance to be generated from its growth metrics. We should note that the alpha expected to be generated from AIG's value (9.09%) more than makes up for the expected underperformance resulting from its negative growth profile.
D) "Smart Money" Breakdown
In addition to value and momentum, we will also analyze how the "smart money" on the Street is playing AIG. "Smart money" stakeholders are short sellers, company insiders, and institutions. Each of these stakeholders tends to be much more sophisticated than the average investor due to their inherent advantages. Company insiders know their company inside out while institutions and short sellers spend millions of dollars on research. We have found loads of academic research showing that short sellers, company insiders, and institutions all predict stock returns. AIG's "smart money" breakdown is shown below:
There isn't too much to say about the table above, as the company hasn't reported any company insider transactions over the last few months. Though, investors should note that company insiders on insurance companies have been buying their company stock en masse over the last six months (+1.82% in ownership) while company insiders in the overall market have been selling (-13% in ownership). Institutional transactions have been negligible, with institutions reducing their exposure to AIG by less than 0.10% over the last quarter. AIG's extremely low short interest is unquestionably a good sign, as it shows that short sellers (who tend to be sophisticated) don't like much downside in the stock. As you can see by the overall low levels of short interest in the industry group (1.76%), it is clear that these shorts don't see much downside in insurance stocks in general. While limited in data, we see the extremely low level of short interest and company insider buying in the insurance industry as signs that the "smart money" on the Street is bullish on AIG.
E) Qualitative Analysis & Conclusions
As we said at the start of the article, AIG is starting to capitalize on its successful restructuring efforts. As a further sign of its successful recovery, AIG managed to raise $2 billion in debt on January 12th on "darn attractive" terms. This shows that creditors have regained confidence in the solvency of the company after the collapse in 2008, and have thus rewarded it with low costs of capital. Another tailwind in AIG's favor to consider is the long anticipated raise in interest rates, which is expected to finally happen in 2015 (or early 2016). Insurance companies benefit from higher interest rates, as they can generate a higher return on their float. With the US economy showing strong growth (5% GDP growth last quarter) and an unemployment rate hovering around the natural rate of unemployment, the Fed is expected to raise rates in the foreseeable future. While it's true that this eventual interest rate rise could be delayed further into the future, there is no doubt that normalization of interest rates is getting closer and closer.
Even without interest rate normalization, we see AIG as a very attractive opportunity that offers strong relative value, solid EPS and revenue growth, and a successful turnaround. AIG's next earnings release will be extremely important to watch, with analysts expecting the company to generate $1.08 in EPS and $9.899 billion in revenue. AIG reports on February 12th. The company tends to crush analyst EPS estimates, and miss on revenue. Overall, we rate AIG as a "BUY" and expect the stock to outperform the market in 2015 as the market catches up to its value.
