By Michael Brush, MarketWatch
American International Group
A few years back, the insurer AIG /zigman2/quotes/203700638/composite AIG -1.67% suffered from poor underwriting standards. Then, two years ago, Brian Duperreault stepped in as CEO. This caught Finn’s attention because Duperreault had delivered such good performance at Chubb /zigman2/quotes/209397502/composite CB +1.69% and Marsh & McLennan /zigman2/quotes/208419097/composite MMC +0.89% . “He already demonstrated he could turn insurance companies around,” says Finn.
So AIG checked the quality management box.
Under Duperreault, a new management team fixed the underwriting issues at AIG. The timing couldn’t be better: Pricing is improving a lot for companies offering property and casualty insurance. Despite the progress, AIG stock still trades below book value — significantly lower than quality property and casualty insurers such as Chubb and Travelers /zigman2/quotes/206313935/composite TRV +2.09% . AIG trades for 0.74 times book, compared with 1.3 to 1.5 times at Chubb and Travelers.
“The problems at AIG have been largely addressed, and it is just in time for a good pricing cycle to happen,” says Finn.
So it doesn’t make sense that AIG’s stock trades at such a discount. The discount should close, pushing AIG stock up 30% or more from here, he says.
The California wildfires did more than just rip through neighborhoods and destroy homes. They also damaged investor sentiment toward California electric utilities, since they sparked the blazes.
One that was hit hard: Edison International. Its stock /zigman2/quotes/206923834/composite EIX +0.51% has been recovering, but its value is still below that of the typical utility. Edison International sells for 15.9 times forward earnings, compared with 18 at Southern /zigman2/quotes/208000495/composite SO +4.51% , 24 at NextEra Energy /zigman2/quotes/200558509/composite NEE +3.77% and 19.7 at Entergy /zigman2/quotes/208005291/composite ETR +3.06% .
Edison is “meaningfully cheap compared to most other regulated utilities,” says Finn, yet the California regulatory issues have been resolved, and the company has raised capital to fund related insurance costs.
“It’s just going to take awhile for that taint to come off,” says Finn. “I am willing to wait. When you are late in the economic cycle like this, it is not easy to find a highly defensive company that is trading at a cheap multiple. The controversy has been solved, and you can still buy at a cheap price.”
courtesy T. Rowe Price
DIY investors: Avoid value traps
If you try shopping in the scratch ’n’ dent aisle on your own, a basic rule is to avoid the stuff that is so damaged it’s not worth buying. Sometimes this comes down to understanding sector trends.
Finn cites energy as an example. Energy stocks got crushed a few years ago when oil prices plummeted because the Saudis turned on the spigot to try to wash leveraged frackers out of the business in the U.S. Although energy stocks got dirt cheap, Finn has remained cautious on the group.
“As a value manager, anywhere along the way you could have been lured into owning energy,” he says. Wall Street analysts regularly pushed them. Finn says he never took the bait because exploration and extraction technologies have been improving so much that the cost of production is plummeting. This increases supply, which pushes down the price of oil, hurting shares in the group.
Many energy stocks have performed OK along the way, in between bouts of volatility. But the Energy Select Sector SPDR /zigman2/quotes/206420077/composite XLE +9.16% has underperformed the S&P 500 /zigman2/quotes/210599714/realtime SPX +2.28% since oil hit its most recent low in February 2016. “This is a picture of what happens when a commodity experiences a dramatically flattening cost curve. And this was through an economic expansion. What’s going to happen when economy begins to slow?”
With talk of recession getting more common, many investors are banking on central banks to stave off problems. “I’m a little more skeptical,” says Finn. “In my mind it’s not clear that the economy is set to reaccelerate,” he says, citing weakness in leading economic indicators. As a result he’s conservatively positioned, but “not in the bunker.”
Translation: Finn is overweight defensive names in areas like utilities, and underweight economically sensitive names in groups like financials, energy and consumer discretionary.
At the time of publication, Michael Brush had no positions in any stocks mentioned in this column. Brush is a Manhattan-based financial writer who publishes the stock newsletter Brush Up on Stocks. Brush has covered business for the New York Times and the Economist Group, and he attended Columbia Business School in the Knight-Bagehot program.