American International Group’s (AIG) stock has fallen more than 8% over the past six months. The fall was mainly due to weak operating performance, higher reserve developments, and declining returns on alternative investments.
The company reported an operating profit in the first quarter of 2016 that was lower than analysts’ estimates. This was mainly due to lower investment income. However, its underwriting income increased, which partially offset the falling valuations on its holdings.
Lower interest rates and falling yields on alternative assets led to lower investment income in recent quarters. This trend is expected to continue for the upcoming quarter, given the current interest rate environment.
The Brexit concern
UK lawmakers are meeting on June 23, 2016, over a Brexit (Britain’s possible exit from the European Union) referendum. A Brexit could trigger a sell-off or panic in the Markets. Financial stocks have been declining due to a possible Brexit. AIG could see a further decline if there’s a positive vote on the Brexit referendum, at least in the short run.
Since insurers are balance-sheet-driven, they’re generally valued on the basis of their book values. AIG is trading at a one-year forward price-to-book multiple of 0.7x compared to 1.2x for its peers.
At a current price-to-book multiple of around 0.8x, AIG is trading lower than other insurers, including Allstate (ALL), MetLife (MET), and Chubb (CB). On a one-year forward price-to-earnings basis, AIG is trading at 11.5x compared to the industry’s 11.7x earnings multiple for the same period. The company’s valuations have remained low due to a systematically important financial institution tag, which brings additional regulation costs.
AIG’s shares appear to be fairly valued, given the company’s size, restructuring initiatives, and relatively weak operating performance. There’s an expectation of some improvement in the upcoming quarters, although the recovery is expected to be slower than estimated. Improved capital structure, reduced risk, and deployment of fresh capital in the expansion of the company’s core business are expected to boost its profitability in the long run.
Investors can gain exposure to insurance companies by investing in financial sector ETFs such as the Financial Select Sector SPDR ETF (XLF) and the iShares US Financials ETF (IYF).