Give In To Peer Pressure, Buy American International Group

| About: American International (AIG)
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By Matt Doiron

All the cool kids are doing it. Tiger Cubs Andreas Halvorsen and John Griffin, as well as Dan Loeb, initiated new positions in American International Group Inc (NYSE:AIG) in the second quarter of 2012 (finishing June with stakes of 2.1 million, 10.4 million, and 2.3 million, respectively). Leon Cooperman's Omega Advisors more than tripled its position to 4.6 million shares, and billionaire Bruce Kovner's Caxton Associates increased its stake to 2.2 million. The stock has risen 36% this year as its business has improved and market sentiment remains divided between those who consider it a value stock- such as, apparently, the managers we have already mentioned and their teams- and those who remember AIG's disastrous 2008 and are wary of any company with a major shareholder who plans to sell a large number of shares and put downward pressure on the stock (in this case, the federal government).

In the second quarter of 2012, AIG reported net income of $2.3 billion, up 27% from the company's earnings in the second quarter of 2011. Revenue only increased slightly, so much of this gain came from higher margins. The gains in income were driven by insurance operations at both of AIG's main business segments - Chartis and SunAmerica Financial - as well as higher income from Direct Investments. Chartis's insurance products cover general liability, personal insurance, and commercial insurance among other varieties; operating income here was up 20% compared to a year ago. SunAmerica financial handles life insurance, annuities, and mutual funds, and this business unit experienced a 29% rise in earnings.

Past performance is no guarantee of future results, but even if AIG's income growth falls the stock could still be in a good position. AIG trades at 3 times trailing earnings, and so even with sell-side analysts predicting that 2013's income will drop compared to this year the forward P/E multiple is 10. Looking out over a longer time horizon, the five-year PEG ratio is 0.4, indicating that the company will have to significantly underperform going forward in order for the stock price to prove too high.

Alternatively, consider the book value of the company's equity. The current market capitalization of $58 billion represents a P/B ratio of 0.6, which is not unusual compared to larger banks that were hit by the financial crisis, but again gives the company quite a bit of latitude to eventually write down asset values and still be good value at current prices. Board Member Morris Offit bought shares in February, while we haven't recorded any insider sales so far this year. AIG also trades at an implied enterprise value of 4.3x trailing EBITDA.

Other property & casualty insurance companies include The Travelers Companies, Inc. (NYSE:TRV), ACE Limited (NYSE:ACE), Allstate Corporation (NYSE:ALL), and Chubb Corporation (NYSE:CB). These four companies all pay dividend yield between 2.3% and 2.9%, compared to AIG which is focusing its cash flow on buying back shares from the government. Allstate, with a trailing P/E of 9, is the only one of these four peers that does not carry a trailing earnings multiple of 12; this means that all four are priced well above AIG on that basis.

Looking forward to 2013, the four companies are priced between nine and twelve times expected earnings, placing AIG towards the middle of the range. None of them, however, match AIG's low PEG ratio and Allstate has the lowest EV/EBITDA multiple at 6.0x. In that sense, AIG is undervalued compared to its peers. In addition, Travelers, ACE, and Allstate have P/B ratios clustered very close to 1 (Chubb's is even higher at 1.3), so using this metric, AIG is underpriced by about 40% merely on the basis of its financial crisis woes.

Yes, it deserves a discount relative to its peers, but we would say that 20% or so, yielding a P/B of 0.8, would be more appropriate - which, at a constant book value, would indicate a rise of about 30% in the share price. Yes, the federal government owns shares, but a number of hedge funds had positions in AIG in the first quarter and they have now been joined by several big names in the industry. We're climbing onto the bandwagon too: AIG is cool again.

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

Business relationship disclosure: This article is written by Insider Monkey's writer, Matt Doiron, and edited by Meena Krishnamsetty. They don't have any business relationships with any of the companies mentioned in this article and they didn't receive compensation (other than from Insider Monkey and Seeking Alpha) to write this article.