With the ominous title “A Darkness on the Edge of Town,” David Schiff wrote in October 1998 about the singular popularity AIG had maintained among Wall Street and how AIG enjoyed an unjustifiably high multiple for an insurance company. Keep in mind that the insurance industry is supposed to be cyclical, is basically a commodity business, and has low barriers of entry.
Though there is no hint in the article that Schiff that AIG would fail in spectacular fashion, what I found interesting is that a full decade before AIG’s spectacular collapse, there was at least one person questioning AIG’s ability to command outlandish multiples and also questioning Wall Street’s belief that AIG’s consistent earnings would never disappoint. Below is just a snippet of the article:
Although Warren Buffett has said that he prefers a lumpy 20% return to a smooth 15%, many investors apparently prefer just the opposite: they prize consistency and predictability (or what they perceive as such), and are willing to pay more for it. Because AIG is a fine company with a powerful global presence, and because its earnings have compounded at a 14% rate over the past decade, investors believe it’s a perpetual money-compounding machine. They have bought the theory that AIG is a “growth” company (rather than a cyclical insurance or financial company) and as such deserves a significantly higher multiple than would otherwise be accorded. Although AIG’s stock has retreated from a recent high of 102 5/16, it’s still trading at 24 times earnings and more than three times book value….
Investors justify these multiples on the grounds that AIG is “safe”: its earnings won’t disappoint stockholders. In buying AIG, money managers are, in effect, paraphrasing an old expression once popular among purchasers of data-processing equipment: “Nobody ever lost his job buying AIG.”
Despite AIG’s achievements, two questions are worth asking: 1) What will happen to the company when Greenberg, who is 72, is no longer there? 2) How has AIG generated such consistent earnings growth, and what is the likelihood that this consistent growth will continue?
Obviously, no one knows the answer to the first question. It turns out that no one quite knows the answer to the second question, either. Some who follow AIG have told us that they can’t really analyze it. Others have said that they don’t even spend much time trying to do so-that, to a larger extent than they would for other companies, they take AIG’s numbers on faith.
Yes, a full decade before AIG’s collapse, analysts following AIG could not analyze AIG. They simply took AIG’s numbers on faith. This worked out for a while, but when it became clear that AIG’s own managers could not understand their own company in 2008, that should have been the clear signal to exit from the stock and issue that rare “Sell” recommendation.
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