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Should American Financial (AFG) Be in Your Portfolio Now?

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Shares of American Financial Group Inc. (AFG - Free Report) have been on an uptrend (gaining 4.5%) over the last few days following the announcement of its merger with National Interstate. In fact, the share price hit a new 52-week high of $81.12 on Nov 14.  About 0.4 million shares exchanged hands in the last trading session and the stock finally closed at $80.64, up 0.1%.

On Mar 4, the insurer proposed to acquire all of the outstanding common shares of National Interstate that are not currently owned by its wholly owned subsidiary, Great American Insurance Company (GAIC). Subsequently, the acquirer increased its offer price by $2 per share in its final bid in July.

American Financial declared that it will invest in a business that it is well acquainted with. Given that both American Financial and National Interstate are engaged in property and casualty (P&C) insurance, gaining stake in the latter would expand the insurer’s capabilities to serve clients better.

American Financial has an impressive growth story that is supported by strategic acquisitions. The company is actively involved in startups, small-to-medium sized acquisitions, and product launches. Over the past decade, the company has successfully completed 11 acquisitions and startups.

Though the bottom line missed expectations in the third quarter, earnings improved year over year. Higher operating earnings in the Annuity segment as well as net investment income in Specialty P&C insurance operations drove the upside. Based on strong results through the first nine months of 2016, the company expects earnings of $5.55–$5.75 per share in 2016. The long-term earnings growth rate is estimated to be 8% for this Zacks Rank #3 (Hold) P&C insurer.

American Financial has traditionally maintained moderate adjusted financial leverage of around 20%, with good cash flow and interest coverage ratio. With respect to capital deployment, the board of directors of the company declared a special dividend of $1.00 per share on Nov 1. This August, the company hiked its annual dividend for the eleventh consecutive year by 12%.  With excess capital was about $1.1 billion as of Sep 30, 2016, we expect the company to undertake more such effective capital deployment efforts to enhance shareholders value.

Attractive Valuation

Valuation is also attractive at present as the stock is currently trading at a forward P/E of 14.3x, a 27% discount to the peer group average of 19.8x. On a price-to-book basis, shares are trading at 1.3x compared with the peer group average of 22x.  American Financial has a trailing 12-month return on equity (ROE) of 9.7%, substantially higher than the peer group average of 6.7%.

Year to date, the stock has returned 11.85%, which is substantially above 6.67% returned by S&P 500.

Stocks to Consider

Some better-ranked P&C insurers are Alleghany Corporation (Y - Free Report) , Arch Capital Group Ltd. (ACGL - Free Report) , and Mercury General Corporation (MCY - Free Report) . Each of these stocks sports a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.

Mercury General, engaged in writing personal automobile insurance in the U.S., has returned 11.85% year to date that is substantially above 6.67% returned by S&P 500.

Alleghany, a provider of P&C reinsurance and insurance businesses in the U.S. and internationally, has returned 17.91% year to date – substantially above 6.67% returned by the S&P 500.

Arch Capital offers property, casualty, and mortgage insurance and reinsurance products worldwide, has returned 16.26% year to date – substantially above 5.36% returned by the S&P 500.

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