Another big, boring company
It's common knowledge that since 2000, small caps have trounced large caps by about 60% if you compare the Russell 1000 and Russell 2000 indices. Well-known large caps such as Wal-Mart (NYSE:WMT) and Johnson & Johnson (NYSE:JNJ) have been flat even as their earnings grow.
Buying stocks with good fundamentals that are temporarily out of favor seems like a good idea, so here's a stock that's worth considering: American International Group (NYSE:AIG), the world's largest insurer. Since its high of over $100 in 2000, the stock has fluctuated around the $60- to $65-per-share range, making it seem like a stock that's doing nothing. But a peek at the fundamentals reveals a different story.
Strong corporate performance
In recent years, AIG's revenues have been going up at about 15% per year, and its earnings have been growing even more rapidly. AIG has a long, proven track record of consistently growing both the top and bottom line, and although I don't necessarily expect revenue and earnings growth to continue at that pace in the future, the important thing about recent growth is that it has made AIG a good buy, according to various metrics.
First, the current price-to-earnings ratio is about 10, or, to put it another way, the earnings yield is almost 10%. AIG is returning some of that money to shareholders in the form of share buybacks and dividends, and using the rest of it to fund growth. A stable company that will earn you 10% on your investment now, and more in the future, seems like a good buy to me. Even a short-term fall in earnings would still leave value.
Just as importantly, the price-to-book ratio is back down to a level that hasn't been seen since the early '90s. Especially in a competitive industry such as insurance, high P/B ratios imply a high (and often unrealistic) expectation that a company will be able to earn very high returns on its capital. A P/B ratio back at or below historic norms argues that AIG no longer suffers an overvaluation penalty, and its stock price can resume growing with its earnings.
Subprime jitters?
Worries about undisclosed subprime-related losses may also be holding AIG down. In fact, it dropped noticeably after the revelation that Merrill-Lynch (NYSE:MER) was hit hard in this area. The worst-case figure I've quoted would be an approximate $10 billion loss, but even that would be manageable for the gigantic AIG, and is likely already factored into the current stock price.
A global advantage
To me, the most interesting aspect of AIG is its reach as a truly global insurer. About a third of its revenues are non-domestic, and that third is distributed across all of the continents of the world (well, not Antarctica!), giving it a significant presence in not only the developed but developing markets. For example, AIG is one of the largest insurance companies in both Pakistan and Turkey, and has a strong presence throughout Asia, including India and China. Insurance is a product that's purchased in significantly larger amounts, as people increase their incomes and wealth, and AIG's strengths in these areas could add a very significant boost to its income over the foreseeable future. It also provides a nice indirect hedge diversification out of pure U.S. Dollar holdings.
Digging deeper
AIG recently had several years when its combined ratio exceeded one, meaning it had to use some capital from its investments to pay claims. This is common for the average insurer, but rare for historically disciplined AIG. The most recent full year had a much better combined ratio, and I think the previous years' poor combined ratios will, in retrospect, turn out to be a statistical fluke. If you wanted to dig deeper into this stock, looking at the combined ratio would be a good place to start, because it's just Foolish to look at the most obvious concerns first.
My take ...
I'm not embracing it with both arms, but I have purchased some AIG, and will continue to follow the stock actively. After all, what could be more enticing than an insurance company that might pay you even when you don't have an accident?
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