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Gauging AIG’s stock performance and valuation

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Price performance

AIG’s (AIG) shares fell short of the performance of the Dow Jones Insurance Index as well as the broader market. Over the last year, the Dow Jones Insurance Index posted ~15% returns, compared to AIG’s shares returning around 10%. The Dow Jones US Property & Casualty Index, which posted ~17% returns, also outperformed AIG.

AIG’s underperformance could be attributed to headwinds faced by the insurance industry such as lower investment yields and evolving regulations. Other contributing factors include a drop in earnings primarily because of debt retirement charges and prior year reserve strengthening, as we mentioned earlier.

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Valuation

Being balance sheet–driven businesses, insurers are generally valued on the basis of their book values. For more information on how to value insurance companies, please read our investor’s guide to the insurance business.

In the above chart, we show how AIG’s price moved between the price-to-book value bands. Over the last three years, AIG traded between a multiple of 0.5x and 1.0x. At a current price-to-book multiple of around 0.7x, AIG is trading cheaper than other insurers, like Allstate (ALL), ACE (ACE), and Chubb (CB).

AIG’s shares are undervalued

AIG’s shares appear to be currently undervalued despite the improvements in its operating and financial metrics, which we outlined in this article. Debt retirement charges impacted the drop in AIG’s bottom line, which improved its risk profile by reducing the amount of debt in AIG’s balance sheet.

Operating earnings from insurance operations remained flat. However, AIG’s profitability improved in 4Q14 in the property and casualty lines, which contribute over two-thirds of AIG’s revenues compared to 4Q13.

Investors can invest in insurance companies by investing in financial sector ETFs like the Financial Select Sector SPDR ETF (XLF) and the iShares US Financials ETF (IYF).

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