Do Low Expectations Mean There Is Upside in This Stock?

Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Call me an optimist, but it seems like the market isn’t giving enough credit to AFLAC's (NYSE: AFL) management. At the present time, this company that has historically grown both earnings and its dividend and an admirable pace is selling for a lower forward P/E ratio then several of its competitors. Concerns over the company’s exposure to the Yen, and questions about the company’s ability to grow its investments seem to be holding the stock back. While the shares have rallied over the last few months, it seems that investors are still undervaluing the power of this brand.

Low Expectations = Upside Surprise?
In just a few weeks, AFLAC will report earnings and investors will get a glimpse into how the company is doing. Last quarter, the company reported reasonable growth that was hampered by unfavorable exchange rates. I would argue that investors need to take a longer-term approach and look for organic strength in the company’s business as opposed to focusing on short-term exchange rate challenges.

There’s no question that AFLAC can improve its operations, but for long-term investors these challenges might be seen as an opportunity to improve results in the future. One of the issues facing the company is analysts have cut their earnings growth estimates over the last few years from a historic norm of between 10% and 15% growth, in today’s growth expectations of just less than 7%.

By comparison, competitors such as Allstate (NYSE: ALL) and The Travelers Companies (NYSE: TRV) are both expected to see earnings growth of around 8% to 9% over the next few years. The formerly troubled American International Group (NYSE: AIG) is actually expected to outperform its peers by growing earnings at a more than 12% rate. As you can see, analysts don’t expect much from AFLAC and these low expectations could provide room for an upside surprise.

Organic Growth and a Relatively Low Valuation
When I look at earnings reports from any company, I try to ignore short-term currency fluctuations and look for growth in their core products. AFLAC Japan saw organic revenue increased 9.7%, premium income jumped by 9.8%, and net investment income increased by 7.3%. While AFLAC U. S. didn’t perform as well, the company still saw a 3.9% increase in revenue backed by a 4% increase in premium income. As you can see, last quarter AFLAC did grow its business, but currency fluctuations caused earnings per share to decrease by 2.87%.

With clear organic growth, I’m more comfortable with AFLAC’s projected P/E ratio of about 9.6. Relative to its peers, Allstate and The Travelers Companies will sell for about 11 times projected earnings. AIG at present sells for roughly 12 times projected earnings, and this lower valuation from AFLAC means investors are expecting much. If the exchange rate between the U. S. dollar and the Japanese Yen improves, AFLAC’s results would change dramatically.

Pricing Power or Opportunity for Growth?
If you’re looking for strength in AFLAC’s business model, one number that nearly jumps off the page at me is the company’s operating margin. In the last quarter, AFLAC’s operating margin was nearly 22%. For point of comparison, the only competitor to perform better was AIG at 23.6%. The Travelers Companies reported a margin of 19.28%, and Allstate's margin came in at 13.3%. It’s possible that AFLAC’s relatively high operating margin could be successfully lowered to generate better growth.

This would be a delicate balance for management to strike, as the company would need to reduce pricing to generate more sales that would offset the difference in their margin. That being said, AFLAC has readily acknowledged that the U. S. marketplace is a long-term project that won’t be won over just a few quarters. It’s possible that being slightly more price competitive could increase this division’s growth rate and thus benefit the company’s overall results.

A Value That Is Hard to Beat
While AFLAC’s stock might not look like a tremendous value today, investors need to realize that this is a company that has been growing earnings and its dividend by double digits for many years. It’s very likely that AFLAC will continue increasing its dividend at a reasonable rate, and with a current yield of around 2.4%, investors are already collecting a decent payout.

By comparison, only The Travelers Companies has a similar yield at about 2.4%, and Allstate's yield at the present time is less than 2%. Since AIG pays no dividend, income focused investors would do well to stick with one of the first three names.

When you add up the combination of historically strong growth in the dividend, low expectations for growth in earnings, and the lowest P/E ratio of its peer group, AFLAC looks like a value that is hard to beat. Long-term investors looking for both growth and income should add AFL to their Watchlist to see if this duck can swim against the current and give them something to quack about.

Chad Henage owns shares of Aflac. The Motley Fool recommends Aflac and American International Group. The Motley Fool owns shares of American International Group and has the following options: long January 2014 $25 calls on American International Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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