(Published by Nick McCullum on July 18)
The Dividend Achievers are a group of over 200 solid dividend stocks with at least 10 years of consecutive dividend increases.
These shareholder-friendly companies present many potential investment opportunities. Not all of these businesses will make a compelling investment at any given time, however. Some will be overvalued, while others will be undervalued.
American Equity Investment Life Holding Co. (AEL, Financial) is currently the Dividend Achiever with the most attractive valuation based on an average index of price-earnings (P/E), price-book (P/B) and price-cash flow ratios.
Since the company is trading at such an attractive valuation, it is likely it will make a rewarding investment moving forward.
Business overview
American Equity Investment operates in the development, marketing, issuance and underwriting of annuities and life insurance products in the United States.
The company operates through two operating subsidiaries:
- American Equity Investment Life Insurance Co.
- American Equity Investment Life Insurance Co. of New York
Altogether, American Equity Investment Life’s insurance is delivered to customers through 35 national marketing organizations and 25,000 independent insurance agents.
Details about the company’s business model are below.
Source: American Equity Investment Life March 2017 Financial Overview, slide 4
American Equity Investment benefits from being a leader in its industry.
The company has been a top three fixed index annuity producer by annual sales for 16 out of the past 17 years. It has a focus on recruiting and marketing insurance agents that sell more than $1 million in annual premiums.
The company also has a conservative investment portfolio for its float, with 89% of its capital invested in high-quality, fixed-income instruments.
Source: American Equity Investment Life March 2017 Financial Overview, slide 5
By and large, American Equity Investment’s golden goose is fixed index annuities, which compose 95.5% of its total account value.
These annuities provide the policyholder with a portion of the upside of some related equity index, while minimizing its downside.
Source: American Equity Investment Life March 2017 Financial Overview, slide 7
To get a sense of how fixed index annuities provide value to policyholders over time, consider the following chart which shows the growth of the S&P 500 compared to the growth of an American Equity Investment S&P 500-linked fixed index annuity.
Source: American Equity Investment Life March 2017 Financial Overview, slide 9
The annuity ended up with a smaller account value at the end of the 12-year period, but had much less volatility than the underlying index. Importantly, the annuity also had no negative returns, which helps these products appeal to retirees and other highly conservative investor bodies.
Growth prospects
American Equity Investment’s largest growth prospect will be the aging U.S. population.
As we have seen, the products offered by this life insurance company are highly conservative, which helps it appeal to retirees and other older investors.
As baby boomers age and the domestic population continues to grow older, it will provide a tailwind for the insurance company.
For context, only 1.2% of the company’s policyholders are under the age of 40.
Source: American Equity Investment Life March 2017 Financial Overview, slide 11
The financial effect of the aging domestic population can already be seen in aggregate annuity sales volumes. Since 2012, index annuity sales have grown from $39.3 billion to $60.9 billion, a cumulative increase of approximately 55%.
Source: American Equity Investment Life March 2017 Financial Overview, slide 12
Competitive advantage and recession performance
American Equity Investment’s largest competitive advantage comes from the company’s leadership in the index annuity market.
The company has ranked in the top two index annuity providers by sales in the past two years, and the top three for at least the past five years.
Source: American Equity Investment Life March 2017 Financial Overview, slide 14
As a life insurance company, American Equity Investment’s underwriting performance is not highly correlated with the effect of the broader economy.
Instead, the company will be adversely effected if the domestic death rate spikes. This will drive claims higher and will likely cause the company to operate at an underwriting loss for a period of time.
From an investment income perspective, the company is likely to perform quite well during a recession because of its conservative investment portfolio.
The majority of the company’s funds are invested in fixed-income securities, with 60% in corporate debt specifically.
Source: American Equity Investment Life March 2017 Financial Overview, slide 28
All said, I would expect American Equity Investment to perform reasonably well during recessions, but quite poorly during any environment that causes the death rate – and life insurance claims – to increase (such as war, disease or some widespread natural disaster).
Valuation and expected total returns
American Equity Investment’s future total returns will be generated by its dividend yield, book value per share growth and valuation changes.
The insurance company currently pays an annual dividend of 24 cents per share, which yields 0.9% on the company’s current stock price of $27.70.
There are two reasons why American Equity Investment Life’s dividend is unappealing ro income investors.
The first is its very low dividend yield of 0.9%. For context, the S&P 500 has an average dividend yield of 1.9% right now, so investors can generate more than twice the income by just investing in an S&P 500 index fund.
The second reason why the company's dividend is unappealing is it is only paid once per year (rather than the more typical quarterly distribution schedule).
For these reasons, other insurance companies like Aflac (AFL, Financial) or Cincinnati Financial (CINF, Financial) may have more appeal for income investors.
Because of its low dividend yield, the majority of American Equity Investment Life’s future returns will be composed of growth in its per-share net worth and valuation changes.
Over the past eight years, the company has compounded its per-share book value at a rate of approximately 13% per year.
I believe slower growth is likely going forward, although investors can still reasonably expect 7% to 10% annual book value growth from this insurer.
While this growth is impressive, it is still outshined by the most attractive aspect of this company: its rock bottom valuation.
Since insurance companies' earnings tend to bounce around depending on the rate of catastrophe and other claim-inducing events, the best way to value stocks in this industry is to use the price-book (P/B) ratio.
In the most recent quarter, American Equity Investment Life reported a per-share book value of $27.48. The company’s stock is currently trading around $27.7, or a P/B ratio slightly above 1.
The following diagram compares the insurer’s current valuation to its long-term historical average.
Source: YCharts
Despite being pessimistically low relative to other companies, American Equity Investment Life’s current P/B ratio of 1 is slightly above its long-term average of 0.89.
However, the company still holds appeal for long-term investors.
Buying insurance companies at book value is a fantastic way to build long-term wealth as these businesses tend to compound this metric at satisfactory rates over long periods of time.
Thus, American Equity Investment is a buy based mostly on its valuation and leadership in the index annuity industry.
Final thoughts
American Equity Investment Life is one of the leaders in the domestic life insurance industry, particularly with regards to fixed annuity products.
It is also trading at a very attractive valuation, right around book value. Importantly, American Equity Investment Life currently has the lowest valuation of any Dividend Achiever when using a weighted index of P/B value, P/E ratio and price-cash flow.
Accordingly, this stock is a buy based on its market leadership and compelling valuation. Income investors should look elsewhere as this stock’s yield is well below 1%.
Disclosure: I am long AFL.
