Searching For Value On The CCC List

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Includes: AFL, AGO, CNO
by: Mike Bruce

Summary

Quickly filter 750 companies to find value.

Lots of potential value in the insurance industry.

Firm balance sheets leading towards strong companies.

“Price is what you pay, value is what you get” – Benjamin Graham

The most cliché investing quote proves truer in today’s U.S. stock market than in recent memory. Today investors are faced with a seemingly never ending bull run which makes it harder and harder to find value in investments. As a 30 year old investor who only began building a portfolio in 2013, the current valuations can prove daunting as one struggles to convince himself that he hasn’t missed out on all the good deals following the Great Recession. In this article, I will primarily look at the ‘Graham Criteria’ portion of my stock screener.

The Graham Criteria weighs each metric equally. The metrics which I will measure the stocks against is as follows:

Current Ratio >= 1.5 Long Term Debt/Working Capital Positive EPS Streak of 5 Years Dividend >0 Current EPS > 5 Years Ago Price/Book <= 1.2 P/Ettm <10

As always, starting from David Fish’s list of CCC companies, available for free here, I filtered down the ‘All CCC’ tab to stocks containing a price/book less than 1.5, P/E ratio less than 15 and a debt/equity ratio less than 1. I was left with a list of 42 companies which I ran numbers on. Following that, I identified eight companies which scored at least a 95/100 based on the metrics bulletized above.

In alphabetical order:

  • AmTrust Financial Services Inc (NASDAQ:AFSI) – 97%
  • Argo Group International Holdings, Ltd. (AGII) – 95%
  • Assured Guaranty Corp (AGO) – 100%
  • CNO Financial Group (CNO) – 97%
  • Unum Group (UNM) – 95%
  • Reinsurance Group of America Inc (RGA) – 96%
  • RenaissanceRe Holdings Ltd. (NYSE:RNR) – 95%
  • Signet Jewelers Limited (SIG) – 95%

Seven of eight companies were from the financial sector and all but one of those from the insurance industry. I will focus on the top two rated stocks: Assured Guaranty Corp and CNO Financial Group. I will compare the metrics of these two companies against average ratios for all insurance companies listed in the CCC list^ as well as one well known insurance company listed as an industry peer on Morningstar.com which also sits on the CCC list.

Due to the fact that Morningstar does not list current assets and current liabilities for financial sector stocks, I substitute total assets and liabilities, effectively changing the metric from current ratio to asset/debt. Note: I choose not to change my screening labels based on the sector as the screener is used as a quick way to identify companies I might be interested in. In conducting my more in depth research, I also look at a few other numbers to help ensure my financial stocks are sound. The additional metrics I use when looking at financial stocks are Interest Coverage Ratio, Financial Leverage, and Combined Ratio. See this excellent article on breaking down an insurance company’s balance sheet.

Interest Coverage Ratio = Operating Income / Interest Expense.

This ratio is one which can be used to stand in for the current ratio in a pinch. By examining how much of the operating income over a certain period is spent on interest payments over that same period, we gain insight into whether a company will struggle to make these payments or if there will be room left over to be allocated elsewhere.

Financial Leverage = Total Assets/Total Stockholders Equity.

As simple as it sounds, the higher leveraged a financial company is, the harder it is to maneuver and create new opportunities to make money.

Combined Ratio = Incurred Losses + Expenses / Earned Premiums.

This is a combination of the loss ratio (claims paid vs. premiums received) and the expense ratio (cost of bringing in new business. These usually show up admin costs, underwriting and other listed operating expenses. Being a ratio it is usually displayed as a percentage. A percentage less than 100% shows a company who is paying out less money than it is taking in, i.e. a profitable business.

There are worse things in life than death. Have you ever spent an evening with an insurance salesman?

Woody Allen

Based on the news of another 0.25% to the Fed’s interest rates insurance companies are licking their chops. One of the sectors benefiting from the raises, “Insurance stocks, especially, tend to flourish as rates rise. In fact, the relationship between interest rates and insurance companies is linear and straightforward, meaning the higher the rate, the greater the growth.” With the economy continuing to look good going forward and the potential for another raise before the year is over the insurance industry should continue its increase. Since the Fed began raising rates in Dec, 2015 the iShares U.S. Insurance ETF (NYSEARCA:IAK) has risen close to 25%, slightly ahead of the SPDR S&P 500 Trust ETF (NYSEARCA:SPY) at around 20%, respectively.

Based out of Bermuda and New York, Assured Guaranty Ltd. is a mid cap focused on maintaining the scheduled principal and interest payments of its debt holders to ensure they do not default. In a recent report, S&P reaffirmed the company’s AA financial strength. Highlights from the report include ‘very strong capital adequacy’ and a ‘proven track record of credit discipline, with a measured approach to international infrastructure and global structured finance transactions.’ The company has increased its dividends for the past six years and currently yields 1.28%.

CNO Financial Group provides health and life insurance, as well as retirement solutions through their family of brands consisting of Bankers Life, Colonial Penn and Washington National. The company is focused primarily on middle income Americans. Standard and Poor’s and Fitch both rate CNO and its subsidiaries with a score of BBB+ across the board. A Challenger on the CCC list, the company recently raised its dividend by 13% along with adding $300M to its buyback plan.

Our comparison company is the American Family Life Assurance Company or AFLAC (NYSE:AFL). Represented by the most famous duck since Daffy, AFL is based in Columbus, Georgia and is the No. 1 provider of voluntary insurance at the work site in the United States.* The company does business is the United States and Japan and is focused on protecting its clients against asset loss, income loss and supplemental medical expenses. AFL has been paying and increasing their dividend for the past 34 years, putting it in the top ten of seniority on the CCC list. Furthermore, they have led arguably one of the most successful public affairs campaigns through their television commercials. Admit it, you said AFLAC in the duck voice upon reading the name.

* Eastbridge Consulting Group, Inc. U.S. Worksite/Voluntary Sales Report. Carrier Results for 2012. Avon, CT: April 2013

Let’s take a look at how the companies stack up against one another.

Graham Enterprising Criteria

AGO ($41.70)*

CNO ($20.23)*

AFL ($77.94)*

Current Ratio >= 1.5:

1.83

100%

1.17

78%

1.19

79%

Long Term Debt/Working Capital:

20%

100%

91%

100%

26%

100%

Positive EPS Streak of 5 Years:

5

100%

5

100%

5

100%

Dividend >0

0.53

100%

0.32

100%

1.68

100%

Current EPS > 5 Years Ago:

5.99

100%

1.18

100%

0.31

100%

Price/Book <= 1.2:

0.76

100%

0.75

100%

1.51

74%

P/Ettm <10:

4.82

100%

9.45

100%

12.62

74%

SCORE:

100%

97%

90%

Operating Income

458

409

3848

Interest Expense

87

120

265

Interest Coverage Ratio

526.44%

340.83%

1452.08%

Financial Leverage

2.21

7.03

6.57

Debt/Equity Ratio

0.20

0.91

0.26

*Price as of 6/27/17

^Averages based on 45 CCC companies: P/E – 26.25, P/B – 6.04, D/E – 1.27

Graham Scale:

Based on my initial screening numbers, Assured Guaranty comes out with a 100% on the Graham scale while CNO Financial comes in at 97% and AFL in the rear at 90%. The current ratio score, which in this case is more of an asset/debt ratio proves positive in all three cases, however as stated that this number isn’t as useful for financial stocks, since it is positive (over 1) I won’t worry about the drag in score due to it. I will still give the edge to AGO over CNO due to the scale between the numbers. AGO again leads the way in current EPS over 5 years ago. AFL, while positive, may show cause for concern in terms of earnings growth. In the past five years ending 2016, their EPS has been 6.42(‘16), 5.85, 6.5, 6.76. and 6.11(‘12) for a 5yr growth rate of 1.2%. P/B for both AGO and CNO are less than 1, while AFL checks in at 1.5. In a bubble, 1.5x book value is the highest I like to go. However, when looked at in comparison to the CCC average, we see that AFLAC is well below the average of 6.04. Finally in terms of P/E, AGO comes in with a very tempting 4.82. Again, when AFLAC is compared to its industry peers, we see it currently has a P/E that is half the average.

Interest Coverage:

As stated before, this metric serves as a jerry-rigged Current Ratio. All three companies have strong interest coverage. None of the three companies should experience any issues in meeting short term commitments. Both AGO and CNO are significantly lower than AFL, and have seen increases in their Interest Expense over the past three years. This is something I want to keep my eye on.

Combined Ratio:

Note: For transparency in how I calculated a combined ratio for each company here is my chart. Reading through each company’s latest 10-Q, I found it impossible to find common language to calculate a combined ratio based off my research. Therefore, the percentage displayed below may not represent a ‘true’ combined ratio, but provides common error among all four. All figures are pulled from the company’s income statement at Morningstar (hyperlinked).

AGO

CNO

AFL

Premiums

864

664

4638

Benefits and claims incurred

295

669

3052

Acquisition and other expenses

365

305

1359

Combined Ratio

76.39%

146.69%

95.11%

As a reminder, a ratio of less than 100 indicates a profit. Looking at my calculated combined ratios, it would appear that both AGO and AFL are currently profitable through their writing of premiums, while CNO may be plagued recently by an increase in claims paid out.

Financial Leverage:

CNO and AFL’s money is leveraged about three as much as AGO. While not nearly as high as a couple other companies I looked at, this could suggest some restrictions in how the company is able to employ their cash in the immediate future.

Conclusion

From a pure evaluation of the metrics, AGO is the clear winner based on its score of 100%. Very rarely have I found a company which rates perfect score on this scale. In the past three years I have bought three stocks which have had a Graham rating of 100. VLO which I purchased at $47.88 and currently have an overall ROI of 17%, and BLX and NOV which I sold for overall ROIs of 10% and 6%, respectively.

Does this mean I am going to run out and invest in AGO? Since my stock screener is based on a two part scale, I personally need to ensure the stock also meets my dividend criteria. In this case, the 1.28% yield falls well below my preference of 4%. However, with a 5 year dividend growth of 23.6%, this is a stock I will put into my watch list and monitor.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.