At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.
Buy the old and true, or shiny and new?
When searching for investing ideas in the insurance industry, investors face a plethora of choices. Heading up the "classic value" class is, of course, Berkshire Hathaway (NYSE: BRK-A ) (NYSE: BRK-B ) . This amalgamation of everything from trains to candy to insurance is Buffett-owned and operated and "smarter than a caveman." Best of all, Berkshire boasts a sterling 92.2 combined ratio, meaning that for every $1 it takes in as premiums on its insurance contracts, it pays out barely 92 pennies in claims. That's better than Travelers (NYSE: TRV ) can boast, better than W.R. Berkley (NYSE: WRB ) , and only a few points behind industry leader Hartford Financial (NYSE: HIG ) .
And yet, presented with all these obvious money makers, and Buffett besides, what does Wall Street go and do this week? They tell you to eschew the old and true, and instead buy something shiny and new: the newly re-IPO'd AIG (NYSE: AIG ) .
Wall Street takes a shine to AIG
Bank of America launched a new buy rating on AIG stock this morning, following in the footsteps of Deutsche Bank, which yesterday told us to buy it, and Barclays Capital, which told us "not yet." All three bankers say AIG is worth more than it's selling for today -- Barclays slaps a $31 price target on the stock and Deutsche Bank says $34. Barclays worries that continued selling of AIG shares by the government may depress the share price for some time, but thinks that a share buyback program beginning "in 2013 ... could be a positive catalyst."
Deutsche doesn't want to wait that long, and believes now's the time to buy "the industry leader in P&C insurance markets, aircraft leasing and ... a formidable competitor in the U.S. life and retirement market." It's particularly impressed with AIG's plans to deliver 10% return on investment and midteens earnings growth by 2015.
But Bank of America is most enthusiastic of all. Writing this morning, the analyst cited AIG's valuation at 60% of book value as a key reason for buying these shares early and often. After all, Travelers and Prudential (NYSE: PRU ) both sell for nearly full book value, while AIG trades at a 40% discount. (in case you're wondering, Berkshire gets a "Buffett premium" P/B ratio of 1.2). According to B of A, if all we get out of AIG going forward is "a lack of any material bad news," that valuation gap should close on its own.
AIG: An Interesting Guess
To my Foolish way of thinking, though, guessing that AIG will avoid making any flubs seems a bit risky, given its history. So instead of just taking conflicted IPO underwriters' words for it that AIG's a "buy," what say we take a look at a few numbers on our own?
At first glance, AIG does look attractive. Beginning with the discount to book value, it's entirely likely that if AIG improves its business as planned, it will begin to close the valuation gap with its peers. That said, I do wonder if that prospect may already be priced into the stock.
Consider: AIG sells for a bit more than nine times earnings, and nine times forward earnings as well. The stock pays no dividend, and analysts on average have AIG pegged for 10% long-term growth. To me, this suggests only a slight undervaluation to the stock; not the deep-discount bargain that its P/B ratio may suggest.
What's more, AIG may deserve to trade at a discount to its peers. I mean, even leaving aside its serious stumble in the mortgage market, AIG's core property and casualty business just doesn't look up to par with its peers. In fact, according to Capital IQ, AIG is very close to being "worst of breed" in the insurance industry. It's combined P&C ratio for the past year is a disheartening 116.8.
Foolish takeaway
In other words, while Berkshire & Co. are generally in the business of taking in more premiums than they pay out in claims, AIG actually pays out nearly $1.17 in claims for every dollar it collects in insurance premiums. Now, maybe the bankers are right. Maybe AIG can fix this problem. It's certainly big enough that they can't miss seeing it.
Individual investors, however, have been burned by this company before. We've "trusted" AIG; perhaps now it's time to "verify" before buying back in.
Do you trust the bankers' advice? Add AIG to your Fool Watchlist and see how it pans out.
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