Alternative Investments And Calculated Underwriting Propel Insurance Giant To New Heights

Key Takeaways

• Strategic underwriting and capital management efforts are poised to enhance underwriting margins, shareholder value, and EPS.
  
• Projected growth in net written premiums and net investment income indicates solid foundations for future revenue growth.
  
• Exposure to volatility in alternative investments and fixed markets, alongside risks from social inflation, climate events, and business cycles, may affect profitability.

Catalysts

An insurance holding company, provides specialty property and casualty insurance products in the United States.

• The expectation for annualized returns averaging 10% or better from the alternative investment portfolio signals potential significant impact on overall investment income growth, enhancing future earnings potential.
  
• An increase in Property and Casualty net investment income by 15% year-over-year due to higher rates and higher balances of invested assets positively impacts net investment income, providing a solid foundation for revenue growth.
  
• The strategic underwriting actions to manage exposures in the most social inflation exposed businesses are aimed at improving underwriting margins, which could lead to an improved combined ratio and net margins.
  
• The strategy of effective capital management, including the possibility of special dividends or share repurchases, is expected to improve shareholder value and EPS.
  
• A healthy 7% growth in net written premiums projected for the full year 2024, driven by a combination of new business opportunities, increased exposures, and a good renewal rate environment, suggests a positive impact on revenue growth.

Assumptions

• Analysts are assuming American Financial Group's revenue will decrease by -0.1% annually over the next 3 years.
• Analysts assume that profit margins will increase from 11.6% today to 14.6% in 3 years time.
• Analysts expect earnings to reach $1.1 billion (and earnings per share of $12.86) by about September 2027, up from $891.0 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 11.9x on those 2027 earnings, down from 12.7x today. This future PE is lower than the current PE for the US Insurance industry at 14.1x.
• Analysts expect the number of shares outstanding to decline by 1.13% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 5.91%, as per the Simply Wall St company report.

Risks

• The annualized return on alternative investments in the P&C portfolio decreased significantly from the previous year, highlighting potential volatility and risk in returns from these investments, affecting overall investment income.
  
• A notable portion of the portfolio is invested in the fixed maturities market, where interest rate fluctuations could impact the yields obtained on these investments, affecting net investment income.
  
• Exposure to social inflation and proactive underwriting actions to manage this risk could limit growth in net written premiums and underwriting profits, especially in social inflation exposed businesses.
  
• Dependence on the cyclical nature of crop business premiums and potential for adverse development in certain casualty businesses, which could impact underwriting profitability.
  
• Challenges posed by climate-related events, such as hurricanes, which while currently managed, could present significant risks to property exposures and result in increased claim costs.

Valuation

• The analysts have a consensus price target of $139.4 for American Financial Group based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $155.0, and the most bearish reporting a price target of just $128.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $7.7 billion, earnings will come to $1.1 billion, and it would be trading on a PE ratio of 11.9x, assuming you use a discount rate of 5.9%.
• Given the current share price of $135.12, the analyst's price target of $139.4 is 3.1% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.