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The Market Is Running From This Value Stock: Should You Buy It?

By Courtney Carlsen – Nov 19, 2021 at 7:10AM

Key Points

  • Allstate's stock price dropped more than 10% after the insurer missed on third-quarter earnings.
  • The insurer saw elevated claims costs due to more drivers on the road and increased costs for repairs.
  • Allstate can raise its premiums to balance out the impact of rising costs.

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Allstate's stock skidded after its third-quarter report, which opens a buying opportunity for long-term investors.

As a long-term investor, one of the hardest things to do is not let day-to-day or week-to-week fluctuations in stock prices affect your outlook and investing strategy. Particularly during earnings season, share prices can jump notably or sell off hard if quarterly results miss expectations.

Case in point, consider Allstate (ALL -0.02%). The company, which is best-known for selling car insurance, was punished by traders after it missed third-quarter earnings per share estimates by more than 50%. Following the release of that disappointing report on Nov. 3, the market promptly sent the insurer's share prices down by 10%.

Allstate did face higher insurance claims than expected during the quarter. Still, in my opinion, the sell-off was overdone.

A mechanic reviews car damage with a customer.

Image source: Getty Images.

Higher claims that were more expensive to resolve

Allstate's revenue grew by 17% year over year in the third quarter to $12.5 billion. However, its net income declined by 54% to $531 million. That decline can be traced to higher claims expenses -- those rose by 36% to $8.2 billion. 

Two factors specifically led to the increase in claims at Allstate during the quarter. First, the total number of incidents was up because more drivers were on the road than there were during the prior-year period. In 2020, overall mileage driven took a nosedive due to the pandemic, which drastically reduced claims costs for car insurers. In fact, many car insurers gave customers partial refunds on their premiums because of how little driving there was last year. Now, the miles-driven metric has returned to a level close to its pre-pandemic norm.  

The other factor that led to an increase in payouts was a higher severity of claims. Severity is a measure of how much it costs the company to resolve a claim. When a car is totaled, it means replacing the car or covering its fair value. When it's damaged, the insurer pays for the cost of repairs, including parts and labor. 

Supply chain disruptions hurt the insurer

Supply chain disruptions have caused headaches across the world, and insurers are far from immune to their impacts. For example, according to the Bureau of Labor Statistics, used car prices have risen by almost 40% since March 2020, in part due to a reduction in new car availability. The total number of passenger vehicles manufactured in the U.S. fell 23% in 2020, and it's on track to drop another 8% in 2021. Less production means a smaller supply of cars for consumers to purchase, driving up their prices. Not only that, but car parts have gone up in price as well. These two factors cut into the profits of auto insurers like Allstate and Progressive last quarter.

As a result, Allstate's auto coverage hit a combined ratio of 102.3%. This is a crucial metric in the insurance industry. A combined ratio below 100% indicates that a company is underwriting generally profitable policies. A ratio above 100% means the company is taking an underwriting loss, and needs to make some adjustments in response. 

Allstate is increasing customers' premiums

One thing about the insurance business is that companies can adapt to a changing cost environment relatively quickly by the simple method of raising the premiums they charge their customers. Allstate is currently doing just that to restore its profitability. Over the course of the third and fourth quarters, it will raise its rates in 20 states. According to Glenn Shapiro, president of Allstate Personal Lines, as of Nov. 1, it had raised its rates by an average of 6.7% in eight states.

Allstate currently trades at a price-to-earnings ratio of 10.7, but its real valuation is actually cheaper than that when you dive into the details. Allstate's P/E ratio was boosted by the sale of its life insurance businesses in the first quarter. Allstate sold those to Blackstone Group and Wilton Re for $3 billion total. As a result, Allstate incurred a $3.8 billion loss from discontinued operations in the first quarter. Factoring out that loss and focusing on its continuing operations, Allstate has a trailing-12-month P/E ratio of 5.3, making the insurer's stock ridiculously cheap

In addition, Allstate's combined ratio through the first nine months of this year was a solid 94.8%, which really puts the weak third quarter in perspective. Not only that, but the insurer has a history of solid profitability: Its combined ratio has only gone above 100% only once in the past 15 years. The company has done well adapting to tough environments, and this time should be no different. Viewed from that perspective, it's not a bad time to buy the dip on Allstate.

Courtney Carlsen owns shares of Progressive. The Motley Fool recommends Progressive. The Motley Fool has a disclosure policy.

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