This Just In: Upgrades and Downgrades

At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.

And speaking of the best...
It may not be the "best" company in the insurance business, but there's no doubt American International Group (NYS: AIG) is cheap. Priced at an intriguingly low eight times estimated 2012 earnings, AIG can't help but draw glances on Wall Street. Yesterday, the glancer in question was Evercore Partners, which took one look at AIG's income statement and declared, "Buy!"

Not only is AIG once again a profitable operation ($4.5 billion earned pre-tax over the past 12 months), but it's likely to get even more profitable over time. StreetInsider.com quotes Evercore praising the "improving" profit margins at AIG's Chartis commercial and consumer insurance division, while SunAmerica (life and retirement) is on a path toward "sustained earnings."

Evercore sees these two divisions leading the path to "solid" earnings growth and better return on equity in years to come. (Wall Street has the company pegged for 21% annualized long-term earnings growth).

What's the catch?
Of course, with numbers as good as these, the question naturally arises: How did AIG get so cheap in the first place?

Well, the answer is that it made a series of poor business decisions in the middle of the national mortgage-investing fiasco. Chief among these, the decision to let Goldman Sachs and other investment banks pay it a pittance to insure collateralized mortgage obligations that were doomed to go bust. This resulted in more than $110 billion in losses for AIG over the course of 2008 and 2009, followed by an ignominious bailout by the federal government.

Oops
Oops, indeed. But that was then, and this is now. So how is AIG doing now?

As I suggested up above, the mortgage fiasco left AIG scarred. It's no longer the best insurer in the business -- not even close. Survey the ranks of property and casualty insurers, and you'll find any number of better firms out there. For example, the key metric used when evaluating an insurer's underwriting is its "combined ratio" -- the percentage of money collected as premiums in a year that the insurer has to turn around and pay back out to satisfy insurance claims.

Currently, AIG's ratio is an unattractive 109 (i.e., it pays out 9% more in claims than it takes in as premiums). That compares unfavorably to the 102 combined ratio at Markel (NYS: MKL) , the 96.3 ratio at Berkshire Hathaway (NYS: BRK.A) (NYS: BRK.B) , and the downright brilliant business that is Alleghany (NYS: Y) -- combined ratio: 93.4.

But on the other hand, while AIG isn't performing quite at the level of these competitors these days, neither does it suffer from their high price tags. Despite being in the same boat with AIG (paying out more than it takes in), Markel sells for a premium share price of more than 25 times expected earnings. Benefiting from the halo effect of Warren Buffett's chairmanship, Berkshire's hardly much cheaper at 17 times earnings, and even at the much lower P/E ratio of 12.6, Alleghany sells for around a 40% premium to what AIG shares fetch.

Foolish takeaway
Is AIG the best insurer in the business? No. Alleghany is better. So is Berkshire. So is Markel. (And if you want to find out what stock is our best pick for 2012, read our free report: "The Motley Fool's Top Stock for 2012.")

But the question you really need to ask yourself isn't whether these companies are "better" than AIG. You need to ask whether AIG is so much worse than its rivals that it should sell for a share price just three times the amount of profit it earns in a year. I don't think it should, and that's why today I'm publicly recommending the shares on Motley Fool CAPS. Think I'm wrong? Follow along.

The article This Just In: Upgrades and Downgrades originally appeared on Fool.com.

Fool contributor Rich Smith does not own shares of, nor is he short, any company named above. You can find him on CAPS, publicly pontificating under the handle TMFDitty, where he's currently ranked No. 339 out of more than 180,000 members. The Motley Fool has a disclosure policy.The Motley Fool owns shares of Markel, Alleghany, and Berkshire Hathaway. Motley Fool newsletter services have recommended buying shares of Berkshire Hathaway, Markel, Alleghany, and American International Group.We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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