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Summary

  • AIG posted very strong Q2 results last night.
  • AIG's underlying strength in all of its businesses prove management has completely turned the company around.
  • AIG is simply cheap based on book value, earnings and projected total returns going forward.

American International Group (NYSE:AIG) reported earnings last night and the results have pleased investors at first look. The company beat on the top and bottom lines and also initiated a new $2 billion share repurchase program, leading shares to trade up about 3% in the pre-market as I write this. AIG's history is as interesting as you will find in the capital markets but with the financial crisis firmly behind it, what can we expect from AIG going forward? In this article I'll attempt to assign a fair value to AIG and see if it has some room to run higher or if the money has been made.

To do this I'll use a DCF-type model you can read about here. In essence the model takes inputs such as earnings estimates, which I've sourced from Yahoo!, dividends, to which I've assigned a 12% annual growth rate, and a discount rate, which I've set at the 10 Year Treasury rate plus a risk premium of 6.5%. It's important to understand any of these estimates are open to interpretation so your model wouldn't necessarily look like mine; but I feel these estimates are reasonable for AIG.

2013

2014

2015

2016

2017

2018

2019

Earnings Forecast

Prior Year earnings per share

$4.56

$4.45

$5.00

$5.59

$6.25

$6.99

x(1+Forecasted earnings growth)

-2.40%

12.40%

11.80%

11.80%

11.80%

11.80%

=Forecasted earnings per share

$4.45

$5.00

$5.59

$6.25

$6.99

$7.82

Equity Book Value Forecasts

Equity book value at beginning of year

$67.65

$71.60

$76.04

$81.01

$86.56

$92.76

Earnings per share

$4.45

$5.00

$5.59

$6.25

$6.99

$7.82

-Dividends per share

$0.50

$0.56

$0.63

$0.70

$0.79

$0.88

=Equity book value at EOY

$67.65

$71.60

$76.04

$81.01

$86.56

$92.76

$99.70

Abnormal earnings

Equity book value at begin of year

$67.65

$71.60

$76.04

$81.01

$86.56

$92.76

x Equity cost of capital

9.00%

9.00%

9.00%

9.00%

9.00%

9.00%

9.00%

=Normal earnings

$6.09

$6.44

$6.84

$7.29

$7.79

$8.35

Forecasted EPS

$4.45

$5.00

$5.59

$6.25

$6.99

$7.82

-Normal earnings

$6.09

$6.44

$6.84

$7.29

$7.79

$8.35

=Abnormal earnings

-$1.64

-$1.44

-$1.25

-$1.04

-$0.80

-$0.53

Valuation

Future abnormal earnings

-$1.64

-$1.44

-$1.25

-$1.04

-$0.80

-$0.53

x discount factor(0.09)

0.917

0.842

0.772

0.708

0.650

0.596

=Abnormal earnings disc to present

-$1.50

-$1.21

-$0.97

-$0.74

-$0.52

-$0.32

Abnormal earnings in year +6

-$0.53

Assumed long-term growth rate

3.00%

Value of terminal year

-$8.89

Estimated share price

Sum of discounted AE over horizon

-$4.94

+PV of terminal year AE

-$5.30

=PV of all AE

-$10.24

+Current equity book value

$67.65

=Estimated current share price

$57.41

As we can see the model produces a fair value of $57 for AIG given the inputs I described above. That is reasonably higher than the $53 AIG is trading for in the pre-market following earnings; does it mean we should run out and buy AIG? It depends, but to answer that question for yourself, we need to understand what the model is saying.

Basically, the model is calculating the present value of the company's expected earnings. Thus, the $57 is a fair value and not a price target. The distinction is important because the model suggests AIG is a good buy today at any price lower than $57.41 and since we are firmly below that, we can assume there is some value in AIG shares.

The chart of AIG looks great as shares have rallied very consistently over the past three years, more than doubling in the process.

(click to enlarge)

We can see that after shares briefly violated the 200 DMA they simply resumed the uptrend each time. Shares are a couple of dollars over the 200 DMA right now so watch that level for support going forward. Hopefully, with the earnings-fueled rally, shares will punch back through the 50 DMA and that will become support. Either way the strong uptrend appears well intact for AIG.

AIG is firing on all cylinders. For a company that basically went out of business during the financial crisis and was saved only by the taxpayers' checkbook, AIG is as strong as you could reasonably expect. Every meaningful operating metric was higher in the second quarter; operating income and book value were both up around 10% versus the comparable period last year. AIG's segments are also contributing improved results with the Mortgage Guaranty unit more than doubling profits, L&R showing increases in deposits and premiums and AUM while improving operating income 27%, and P&C experienced lower catastrophe losses and boosted operating income 25%. The list goes on but the point is that AIG is not a one-trick pony; the company is extremely well run and while management failed miserably during the crisis, that problem has been unequivocally fixed in my view. AIG's management team is top notch and shares have proven that out over the past three years. The company is getting strong contributions from all of its businesses and that helps not only boost results but provide diversification for its income streams.

AIG looks like a reasonable value at $53. The strong uptrend in the chart is intact, earnings are very strong, the underlying businesses AIG competes in are strong and the company is returning capital to shareholders. The downside risk I see to shares and my fair value are that earnings estimates of 12% growth per year may be difficult to attain. A large business, particularly an insurance business, may find it challenging to post those numbers every single year. If that is the case the fair value of AIG will move down over time. Right now it looks like AIG is having no problem posting double-digit earnings growth so that is a future risk and not a present one. However, there is some upside potential as well. The company is paying a small dividend now and that could be ratcheted up in the future, boosting total returns for shareholders. In addition, the company is buying back large amounts of stock which will reduce the float and boost EPS more quickly than earnings are growing. This will undoubtedly help AIG hit 12% earnings growth per year and may provide some upside to my fair value.

At any rate, AIG is cheap right now based on its forward earnings multiple of less than 11 and the fact that operating results have been so strong. Couple that with the very strong share repurchase program and the company's $67 book value and you've got a pretty compelling case for value. AIG isn't the same company from the crisis era and with the turnaround complete, I still think there is value in AIG shares going forward.

Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in AIG over the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.