AIG: Worth More Than Its Share Price

Summary

• American International Group has had a run up of late, but its share price remains well below its book value.
• The company has flagged its intention to sell down some of its assets, presumably at book value, or above, and repurchase shares at current depressed prices.
• On top of this, analysts' forward EPS estimates are well above recent years' historical levels, providing another avenue for upward pressure on share price in coming years.
• Furthermore, a 2.6% dividend yield adds to the attractiveness of this stock.
• Looking for more investing ideas like this one? Get them exclusively at Dividend Growth Income+ Club. Learn More »

Photo by Spencer Platt/Getty Images News via Getty Images

Investment Thesis

Management have been pruning costs, and based on analysts' consensus EPS estimates, EPS growth for American International Group (NYSE:AIG) is likely to improve over the next three years compared to the last three years. Share price growth is a function of EPS growth and investor sentiment reflected in the P/E multiple. While many stocks currently enjoy expanding multiples, AIG forward P/E ratio is well below historical levels. This provides room for potential multiple expansion, and a solid current dividend yield of 2.61% could possibly lead to double-digit returns for an investor holding through to end of 2023. Another factor at work is the ratio of share price to book value. Table A below is based on detail provided in AIG's FY-2020 !0-K filed with SEC.

Table A

On both a GAAP basis and the more conservative adjusted book basis, AIG share price is well below underlying book value. AIG management have indicated their intention to progressively dispose parts of the business and use the proceeds to buy back shares. From the Q4-2020 earnings call transcript provided by SA Premium:

Additionally, in connection with our October announcement, we received inquiries from parties interested in strategically aligning with us and potentially purchasing the 19.9% stake in Life and Retirement. We are pleased with the level of interest and quality potential partners for Life and Retirement business and believe a sale of a minority stake could be an attractive option for AIG, its shareholders, and other stakeholders. We are carefully weighing the relative merits of this path compared to a minority IPO taking into account the impact on value creation for AIG, execution certainty, regulatory and rating agency implications, and delivery of Life and Retirements' growth strategy over the long term. As you know, any decisions we make will be subject to regulatory approvals. Overall, I am very pleased with the progress we are making on the separation and we'll provide a further update in the near term....As we move forward on the path to separate Life and Retirement and generate capital, we will continue to focus on de-levering and investing - investing in growth in our businesses. We also intend to be active and prudent managers of capital and return it to shareholders when appropriate. Our current expectation is that an initial disposition of 19.9% of Life and Retirement, whether through a minority IPO or sale to - to a third party will generate net proceeds such that some portion can be used toward further share repurchases.

Clearly, there are arbitrage gains available if assets are sold at book value, or above, and used to repurchase shares. With the buoyancy in the market at present, I believe AIG and its shareholders will do well out of the proposed initiatives. I also expect there is the likelihood of an earnings beat in the first quarter and further updates on asset sales. A combination of the various matters discussed above is likely to further lift the share price in the near term. Improved operating metrics also are likely to underpin earnings and share price growth in the mid to longer term.

Looking for share market mispricing of stocks

What I'm primarily looking for here are instances of share market mispricing of stocks due to distortions to many of the usual statistics used for screening stocks for buy/hold/sell decisions. The usual metrics do not work when the "E" in P/E is distorted by the impact of COVID-19. And if the P/E ratio is suspect, so too, then, is the PEG ratio similarly affected. I believe the answer is to start with data at the end of 2019, early 2020, pre-COVID-19 and compare to projections out to the end of 2022 or later, when hopefully the impacts of COVID-19 will have largely dissipated. Summarized in Tables 1, 2, and 3 below are the results of compiling and analyzing the data on this basis.

Table 1 - Detailed Financial History And Projections

Table 1 documents historical data from 2016 to 2019, including share prices, P/E ratios, EPS and DPS, and EPS and DPS growth rates. The table also includes estimates out to 2025 for share prices, P/E ratios, EPS and DPS, and EPS and DPS growth rates (note - while estimates are shown for analysts' EPS estimates out to 2023, 2024 and 2025 where available, estimates do tend to become less reliable, the further out the estimates go. These estimates are only considered sufficiently reliable if there are at least three analysts' contributing estimates for the year in question). Table 1 allows modeling for target total rates of return. In the case shown above, the target set for total rate of return is 7.5% per year through the end of 2023 (see line 12), based on buying at the May 3, 2021, closing share price level. As noted above, estimates become less reliable in the later years. I have decided to input a target return based on 2023 year, which has EPS estimates from nine analysts, because it allows for the impact of longer-term EPS growth rates to be fully taken account of in the assessment of value of AIG shares. The table shows to achieve the 7.5% return, the required average yearly share price growth rate from May 3, 2021 through Dec. 31, 2023, is 4.89% (line 49). Dividends account for the balance of the target 7.5% total return. Table 2 below summarizes relevant data flowing from the assumption of a target 7.5% total return through end of 2023.

Targeting a 7.5% Return

Table 2 - Targeting a 7.5% return

Table 2 provides comparative data for AIG, assuming share price grows at rates sufficient to provide total rate of return of 7.5%, from buying at closing share price on May 3, 2021, and holding through end of 2023. All EPS estimates are based on analysts' consensus estimates per SA Premium.

Comments on Table 2 are as follows

Part 1 - Consensus EPS (Case 1.1) (lines 1 to 12)

Part 1 shows the amounts the share price would need to increase to achieve a 7.5% rate of return through end of 2023. The share price would need to increase by $6.66 from the present $49.05 to $55.71 at end of 2023, for the 7.5% rate of return to be achieved.

Part 2 - Required change in P/E ratio to achieve target 7.5% return (lines 21 to 23)

Part 2 shows the amount the P/E ratio would need to increase or decrease by, from buy date to end of 2023, to achieve the share price level at the end of 2023 necessary to achieve the targeted 7.5% return. For AIG, the P/E ratio at buy date could decrease by 48.5% through end of 2023 and the 7.5% return would still be achieved. Being able to achieve a targeted return with a large decrease in the P/E ratio would normally be regarded as a positive. However, due to the distortions of earnings and sentiment owing to the COVID-19 pandemic, it's difficult to judge whether the change in P/E ratio is a positive or the result of a distorted starting point. To overcome this difficulty, in Part 3, I review the necessary change in P/E ratio from a different, pre-COVID-19 starting point.

Part 3 - Projected change in P/E ratios from 2019 to 2023 (lines 31 to 46)

In Part 3, I start with the share price at Dec. 31, 2019, before the impact of the COVID-19 pandemic on earnings and market sentiment. The end point is projected share price at end of 2023, when it's assumed the market and earnings are no longer materially impacted by the pandemic, and EPS growth has brought the P/E ratio back closer to historical levels. For AIG, the share price needs to increase by $4.38 from $51.33 at Dec. 31, 2019, to $55.71 at end of 2023, and as detailed in Part 1, at $55.71, the targeted 7.5% rate of return would be achieved. For AIG, there are a number of givens in our assumptions. Using these givens, the change in the share price from Dec. 31, 2019, to end of 2023, can be expressed as mathematical formulae as follows:

(A) Change in share price, due to effect of EPS growth rate, equals share price at beginning multiplied by (1 plus average yearly Consensus EPS growth rate) to the power of number of years invested.

= $51.33*(1+4.9%)^4 = $62.04

(B) Change in share price due to change in P/E ratio equals share price adjusted for EPS growth rate multiplied by (1 plus/minus percentage change in P/E ratio).

= $62.04*(1-10.2%) = $55.71

The increase of $10.71 ($62.04 minus $51.33) due to the average yearly EPS growth rate is cumulative and share price will continue to increase the longer the shares are held and the growth rate continues. The decrease of $6.33 due to a change in the P/E ratio ($62.04 minus $55.71) has a one-off effect. A continuing high or low P/E ratio has no impact on future share price growth, only a change in P/E ratio affects share price, not the level of P/E ratio.

Next, rather than targeting a specific rate of return, I look at historical P/E ratios to see the potential impact on returns of a reversion to these levels of P/E ratio. First of all, I should explain a little about the Dividend Growth Income+ Club approach to financial analysis of stocks.

Understanding The Dividend Growth Income+ Club Approach

Dividend Growth Income+ Club logo Copyright: Robert Honeywill 2020

Total Return, Dividends, Share Price

The only way an investor can achieve a positive return on an investment in shares is through receipt of dividends and/or an increase in the share price above the buy price. It follows what really matters in share value assessment is the expected price at which a buyer will be able to exit shares, and expected cash flow from dividends.

Changes in Share Price

Changes in share price are driven by increases or decreases in EPS and changes in P/E ratio. Changes in P/E ratio are driven by investor sentiment toward the stock. Investor sentiment can be influenced by many factors, not necessarily stock-specific.

"Equity Bucket"

Earnings are tipped into the "Equity Bucket" for the benefit of shareholders. It's prudent to check whether distributions out of and other reductions in the "Equity Bucket" balance are benefiting shareholders.

AIG's Projected Returns Based On Selected Historical P/E Ratios Through End Of 2023

Table 3 below provides additional scenarios projecting potential returns based on select historical P/E ratios and analysts' consensus, low, and high EPS estimates per Seeking Alpha Premium through end of 2023.

Table 3 - Summary of relevant projections AIG

Table 3 provides comparative data for buying at closing share price on May 3, 2021, and holding through the end of years 2022 through 2025. There's a total of nine valuation scenarios for each year, comprised of three EPS estimates (SA Premium analysts' consensus, low and high) across three different P/E ratio estimates, based on historical data. AIG's P/E ratio is presently 19.46. Present P/E ratio is in line with the historical median P/E ratio for 2016 to 2019. Table 3 shows potential returns from an investment in shares of the company at a range of historical level P/E ratios This analysis, from hereon, assumes an investor buying AIG shares today would be prepared to hold through 2023, if necessary, to achieve their return objectives. Comments on contents of Table 3, for the period to 2023 column follow.

Consensus, low and high EPS estimates

All EPS estimates are based on analysts' consensus, low and high estimates per SA Premium. This is designed to provide a range of valuation estimates ranging from low to most likely, to high based on analysts' assessments. I could generate my own estimates, but these would likely fall within the same range and would not add to the value of the exercise. This is particularly so in respect of well-established businesses such as AIG. I believe the "low" estimates should be considered important. It's prudent to manage risk by knowing the potential worst-case scenarios from whatever cause.

Alternative P/E ratios utilized in scenarios

1. The actual P/E ratios at share buy date based on actual non-GAAP EPS for FY 2020.
2. A modified average P/E ratio based on 18 quarter-end P/E ratios from Q4 2016 to Q4 2020 plus current P/E ratio in Q2 2021. The average of these P/E ratios has been modified to exclude the three highest and three lowest P/E ratios to remove outliers that might otherwise distort the result.
3. A median P/E ratio calculated using the same data set used for calculating the modified average P/E ratio. Of course, the median is the same whether or not the three highest and lowest P/E ratios are excluded.
4. The actual P/E ratio at Feb. 21, 2020, share price, based on 2019 non-GAAP EPS. The logic here is the market peaked around Feb. 21, 2020, before any significant impact from COVID-19 became apparent. This makes the P/E ratios at Feb. 21, 2020, reflective of most recent data before distortion of P/E ratios by the impact of the coronavirus pandemic.

Reliability of EPS estimates (line 17)

Line 17 shows the range between high and low EPS estimates. The wider the range, the greater disagreement there is between the most optimistic and the most pessimistic analysts, which tends to suggest greater uncertainty in the estimates. There are nine analysts covering AIG through end of 2023. In my experience, a range of 8.2 percentage points difference in EPS growth estimates among analysts is high, and suggests a degree of uncertainty, and thus reduced reliability.

Projected Returns (lines 18 to 39)

Lines 25, 32 and 39 show, at a range of historical P/E ratio levels, AIG is conservatively indicated to return between 2.4% and 14.4% average per year through the end of 2023. The 2.4% return is based on analysts' low EPS estimates and the 14.4% on their high EPS estimates, with an 8.2% return based on consensus estimates. Those are the lowest of the returns under the consensus, low and high EPS scenarios. At the high end of the projected returns for AIG, the indicative returns range from 29.4% to 44.9%, with consensus 38.6%. The difference between best and worst cases is primarily related to the use of a 10.57 P/E ratio for the lowest returns, and a 20.55 P/E ratio for the highest returns. The 10.57 P/E ratio is based on P/E ratio at Feb. 21, 2020, and the 20.55 P/E ratio is based on historical average P/E ratio. Any P/E ratio between these two levels will likely result in highly favorable total returns.

Review Of Historical Performance For AIG

AIG : Historical Shareholder Returns

In Table 4 below, I provide details of actual rates of return for AIG shareholders investing in the company over the last six years.

Table 4

For many stocks where I create a table similar to Table 4 above, I find a wide range of returns indicating a degree of volatility and risk. Table 4 above shows the results for AIG were positive returns, ranging from 0.3% to 62.3%, for three of eight different investors, each investing $3,000 over the last six years and holding to the present. The remaining five investors had negative returns, ranging from (0.5)% to (4.0)%. These rates of return are not just hypothetical results. They're very real results for anyone who purchased shares on the various dates and held through to May 3, 2021. In the above examples, the assumed share sale price is the same for all investors, illustrating the impact on returns of the price at which an investor buys shares.

Checking AIG's "Equity Bucket"

Table 5.1 AIG Balance Sheet - Summary Format

Over the 4 years end of 2016 to end of 2020, AIG's Net Assets Used In Operations decreased by $4,993 million, and debt net of cash increased by $4,945 million, resulting in a decrease of $9,938 million in shareholders' equity. Net debt as a percentage of net debt plus equity increased from 26.7% at end of 2016 to 33.1% at end of 2020. Outstanding shares reduced by 133.7 million from 995.3 million to 861.6 million, over the period, due to share repurchases partially offset by shares issued for stock compensation. The $9,938 million decrease in shareholders' equity over the last four years is analyzed in Table 5.2 below.

Table 5.2 AIG Balance Sheet - Equity Section

I often find companies report earnings that should flow into and increase shareholders' equity. But often the increase in shareholders' equity does not materialize. Also, there can be distributions out of equity that do not benefit shareholders. Hence, the term "leaky equity bucket." I look for evidence of this in my analysis of changes in shareholders' equity.

Explanatory comments on Table 5.2 for the period end FY-2016 to end FY-2020.

• Reported net income (non-GAAP) over the four-year period totals to $9,386 million, equivalent to diluted net income per share of $10.48.
• Over the four-year period, the non-GAAP net income excludes a significant $18,123 million of net expense items, which are included in arriving at GAAP net income. GAAP net income excludes $11,867 of income which is included in comprehensive income. The magnitude of these items relates largely to the accounting requirements for insurance companies.
• Amount taken up in equity to account for shares issued to staff over the 4 years is $512 million. This compares to an estimated market value of $714 million at the time of issue for these shares. The difference of $202 million is not considered material.
• By the time we take the above mentioned items into account, we find, over the four-year period, the reported non-GAAP EPS of $10.48 ($9,386 million) has decreased to $2.55 ($1,904 million), added to funds from operations available for distribution to shareholders.
• Dividends of $4,527 million, and share repurchases of $8,514 million were not covered by the $1,904 million generated from operations, resulting in a $11,137 million net decrease in equity from operations.
• Equity issues to staff of $714 million and preference issues of $485 million, reduced the $11,137 deficit from operations to the $9,938 million decrease in shareholders' funds per Table 5.1 above.

AIG: Summary and Conclusions

With a current dividend yield of 2.6%, share price below book value, and prospects for double-digit returns over the next four years, AIG appears to be a suitable stock for DGI investors.

Analyst’s 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.

Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. I do not recommend that anyone act upon any investment information without first consulting an investment advisor and/or a tax advisor as to the suitability of such investments for their specific situation. Neither information nor any opinion expressed in this article constitutes a solicitation, an offer, or a recommendation to buy, sell, or dispose of any investment, or to provide any investment advice or service. An opinion in this article can change at any time without notice.

Comments

[Riskman]

Great news post close today for AIG long term investors!

[kalu0003]

AIG is dead money. It has gone nowhere over the last years! No need to touch this deadly animal AIG! My 2 cents.

[PHILIP MAX]

tHEIR BOOK VALUE HASN'T CHANGED MUCH IN THE LAST 2 YEARS, YET ,THEY LET THE WARRANTS EXPIRE BY DELIBERATELY UNDERSTATING THE COMPANY'S TRUYE VALUE. NOW, 6 MONTHS LATER, WE FIND THAT THIS COMPANY IS A GEM? FRAUD/ ME THINKS SO!

[jasonjones]

Too big to fail, government welfare queen with executives rewarded for failure. No thanks.

[hksche2000]

All insurance cos are crooked but AIG takes the crown. If there is something like a "legacy crook", AIG is it.

[Abigsoxfan]

Nobody knows what their book value is because nobody knows how under-valued their loss reserves are. Hence, valuing this company based on book value is a fruitless effort. And the market appears aware of this as it has valued the stock well under book for quite some time.

[Equity Educator]

@Abigsoxfan that’s the case for any and all insurance companies. So insurance companies are uninvestable? I think not! ACGL and CB, among others have been great performers over time. Your thesis of ten years ago is stale. AIG should be a 65 dollar stock even is reserves are 15% deficient

[federmanevan]

@Abigsoxfan it might be time to move on to a different company. The same thing is said on each alert on the company

[Abigsoxfan]

@Equity Educator Other insurance companies do not have AIG's record. Other insurance companies do not have a verifiable track record of under reserving losses by several billions of dollars. Other insurance companies did not rely on a $182 billion bail-out to still be here today. No, AIG stand far and above the mismanagement of themselves much more than any other insurance company.