One of the Most Hated Stocks in America is a GREAT Deal

Insurance giant American International Group (NYSE: AIG), or AIG for short, has had a tumultuous few years, to say the least. Right now, a handful of investors literally hate the stock and refuse to buy it.

That’s their loss…

As counterintuitive as it sounds, emotionally-charged negativity toward certain stocks can be an extremely bullish indicator. It follows the old “buy them when they’re hated” mantra. And it’s made smart investors money time and time again.

Anyone interested in learning the details behind AIG’s spectacular fall from grace to take an estimated $182 billion government bailout should definitely read Roddy Boyd’s Fatal Risk: A Cautionary Tale of AIG’s Corporate Suicide. Boyd’s book is a fascinating read that details the divisions that got caught up in credit-default swaps, mortgage insurance and nearly everything that became toxic during the credit debacle. I was able to speak with Roddy recently about his research efforts and have come away convinced that there is considerable value in AIG’s stock.

I won’t go into many details about AIG’s past. As with all successful investing, it’s not recapping the past, but rather discerning the future that is important for making money.

All you need to know is that, on Jan. 14, 2011, AIG was officially recapitalized and allowed to start repairing its business. Since the crisis, AIG has been in the process of paying back the government, which has meant selling off divisions such as global insurance arms AIG and Alico. But it has also been fast at work focusing on its remaining core operations, which still qualify it as one of the largest insurers in the world.

A massive global network

The two key units are Chartis and SunAmerica. Chartis offers nearly every type of insurance across the globe, including property and casualty, and specialty insurance to individuals and commercial entities. SunAmerica sells annuities and life insurance, primarily in the United States. AIG also operates a leading aircraft-leasing business, which it’s considering selling or spinning off to shareholders.

For all of 2011, AIG was still a massive insurer. It reported total revenue of $64.2 billion to make it roughly twice the size of other large domestic rivals, including Travelers (NYSE: TRV) and Allstate (NYSE: ALL). And while these rivals operate primarily in North America, AIG spans the globe. Half of Chartis’ $35 billion in premiums written resides outside the United States and Canada. A significant portion (33%) resides in Asia and developing international economies.

SunAmerica specializes in selling to banks, broker-dealers and other large entities such as independent marketing organizations. It boasts annuity sales at more than 600 banks and through about 70,000 independent financial agencies. Its own advisor group totals more than 5,000 individuals.

The point of detailing this massive network is to demonstrate that it is very difficult for rivals to break into these distribution channels. A key competitive advantage that AIG held prior to the crisis and maintains to this day is its global network of business relationships. 

The numbers…
Turning to AIG’s financials, the past few years were obviously a mess, given the losses it had to take and because of the restructuring moves it’s currently making. This fiscal year is likely to bring about a big step forward to stabilization. Analysts project minimal revenue growth, and earnings of $2.62 per share. This would put return on book value (also known as shareholder’s equity) at about 4.7%.

AIG ended 2011 with a reported book value of $55.33 per share. The average return on equity (ROE) in the industry is 11.5%. Before the credit crisis hit, AIG consistently posted a double-digit ROE. It turned as high as 15.2% in 2006 and is starting to trend upward again. An eventual ROE back to 10% equates to earnings of $5.53 (you can calculate this figure simply by multiplying the ROE by the book value).

It will take several years for AIG to return back to this level of profitability, but it demonstrates that there is a significant earnings upside for its businesses. Right now, the stock price of about $30 a share is at only about 55% of book value. Currently, the industry average is about 80%, so the stock is certainly cheap.

There are two takeaways from AIG’s depressed book value multiple. For starters, as investors regain faith in its operations, the multiple should trend toward the industry average. In its heyday before the credit crisis, AIG traded at a significant premium to industry averages. Back in 2000, its share price was nearly five times stated book value. It will likely never again trade at such a premium, but there are still well-respected business units that solid profit generating potential.

The second point is that the industry overall trades at depressed levels. The credit crisis has made many investors fearful of nearly all financial institutions. A past rule of thumb in the industry was to buy a financial stock when it was trading right at book value and then sell it when it reached two times book value. The fact that the entire industry is trading below book value suggests many of the leading players are good deals at current levels.

Risks to Consider: Clearly, investor sentiment on AIG, along with most of its archrivals, is negative. This could continue to persist, but there is significant value in AIG that should eventually be realized by the market. A key part of this realization is that management continues to deliver on its turnaround efforts and grow AIG overall in the coming years.
Action to Take –> AIG’s stock has been hovering around a 50% discount to book value since last fall, when European sovereign debt concerns began to adversely affect the stock market as a whole. This represents a good entry point into the stock, which I fully expect to trend up toward book value within the next couple of years. If the stock eventually trades at a slight premium to stated book value, then it suggests the stock can double from current levels — and this doesn’t even consider the fact that book value and earnings can grow from here on out. The stock is a “buy” for investors willing to wait for these events to play out.