Published by Nick McCullum on July 18th, 2017
The Dividend Achievers are a group of solid dividend stocks with 10+ years of consecutive dividend increases. You can see the full list of Dividend Achievers here – there are currently more than 200.
200+ shareholder-friendly companies present many potential investment opportunities. However, not all of these businesses will make a compelling investment at any given time. Some will be overvalued, while others will be undervalued.
American Equity Investment Life Holding Company (AEL) is currently the Dividend Achiever with the most attractive valuation, based on an average index of price-to-earnings, price-to-book, and price-to-cash-flow ratios.
Since the company is trading at such an attractive valuation, it is likely that it will make a rewarding investment moving forward.
This article will analyze the investment prospects of American Equity Investment Life in detail.
Business Overview
American Equity Investment Life Holding Company 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 Company American Equity Investment Life Insurance Company of New YorkAltogether, 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 can be seen below.
Source: American Equity Investment Life March 2017 Financial Overview, slide 4
American Equity Investment Life benefits from being a leader in its industry.
The company has been a top 3 fixed index annuity producer by annual sales for 16 out of the past 17 years and has a focus on recruiting and marketing insurance agents that sell more than $1 million in annual premiums.
American Equity Investment Life also has a conservative investment portfolio for its float, with 89% of the firm’s 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 Life’s ‘golden goose’ is fixed index annuities, which compose 95.5% of its total account value.
These fixed index 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 Life 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 twelve-year period but had much less volatility than the underlying index. Importantly, the annuity also had no negative returns, which helps these products to appeal to retirees and other highly conservative investor bodies.
Growth Prospects
American Equity Investment Life’s largest growth prospect will be the aging U.S. population.
As we’ve seen, the products offered by this life insurance company are highly conservative, which help them to appeal to retirees and other older investors.
As the baby boomers age and the domestic population continues to grow older, this will provide a tailwind for this 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 ~55%.
Source: American Equity Investment Life March 2017 Financial Overview, slide 12
Competitive Advantage & 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 2 index annuity provider by sales in the past 2 years, and the top three for at least the past 5 years.
Source: American Equity Investment Life March 2017 Financial Overview, slide 14
As a life insurance company, American Equity Investment Life’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, American Equity Investment Life 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 Life 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 & Expected Total Returns
American Equity Investment Life’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 $0.24 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 for 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 American Equity Investment Life’s dividend is unappealing is that it is only paid once per year (rather than the more typical quarterly distribution schedule).
For these reasons, other insurance companies such as Aflac (AFL) or Cincinnati Financial (CINF) may have more appeal for income investors.
Because of its low dividend yield, the majority American Equity Investment Life’s future returns will be composed of growth in its per-share net worth and valuation changes.
Over the past 8 years, American Equity Investment has compounded its per-share book value at a rate of ~13% per year.
I believe that slower growth is likely going forward, although investors can still reasonable expect 7%-10% annual book value growth from this insurer.
While 7%-10% growth is impressive, it is still outshined by the most attractive aspect of this company: it’s rock-bottom valuation.
Since insurance company’s 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-to-book 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 at $27.7, or a price-to-book ratio slightly above 1.0.
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 in the Sure Dividend database, American Equity Investment Life’s current price-to-book ratio of 1.0 is slightly above its long-term average of .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 Life 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.
They are also trading at a very attractive valuation, right around book value. Importantly, American Equity Investment Life currently has the lowest valuation of any Dividend Achievers when using a weighted index of price-to-book value, price-to-earnings, and price-to-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%.