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Buy This Undervalued Stock Before the Market Discovers It

Markets are quite efficient. However, sometimes companies will fly under the radar at a valuation that is head-scratching. Temporary conditions can result in companies getting beaten down, but when those conditions regress, the prospects for future growth can be strong.

One undervalued company going unnoticed right now is Allstate (NYSE: ALL). Amid the pandemic last year, Allstate benefited from fewer drivers on the road. However, its premium growth was minimal, and it had a hard time generating decent investment income due to the low interest rate environment.

The insurer should benefit as more drivers hit the road and as interest rates increase in the coming years. Allstate has also undergone a facelift in the past year, selling off less profitable businesses while adding others in an effort to grow its market share.

Image source: Getty Images.

The pandemic cast a shadow on the industry

Allstate traded at bargain-bin prices last year. At one point, the insurer's stock traded near a price-to-earnings (P/­E) ratio of 6. The stock was so cheap because of ultra-low interest rates combined with an uncertain outlook for the insurance market.

While fewer drivers on the road resulted in fewer claims, it also meant lackluster premium growth. Last year, written premium growth was nearly flat, up less than 1%. Allstate also saw its life insurance division struggle with growth, due to increased claims from increased deaths due to COVID-19. In 2020, the company reported a $159 million net income from its life insurance segment, a decrease of nearly 36% from the year before.

Not only that, but with interest rates at record low levels, it was difficult for the insurer to generate decent returns on its excess capital. As a result, net investment income declined last year by 9.7% to $2.85 billion.

The stock is cheaper than it appears

Allstate's P/E ratio around 12 at Friday's prices makes it more expensive than its closest competitor, Progressive, which sports a P/E ratio under 10. However, Allstate's P/E ratio is higher due to the company's sale of its life insurance businesses in the first quarter, which it sold for a loss to Blackstone Group and Wilton Re for $3 billion total.

The sale of these businesses resulted in a $3.8 billion loss from discontinued operations on Allstate's books in the first quarter. The sale resulted in a loss of $12.38 per diluted share, and resulted in a total diluted loss per share of $4.60 in the quarter. Backing out this loss gives Allstate a trailing-12-month P/E ratio around 6, making the insurer look ridiculously cheap.

Allstate's exit of its life insurance businesses was due to payouts stemming from the COVID-19 pandemic. CEO Tom Wilson stated that the company's ultimate focus is to eliminate less profitable operations while directing its attention toward what it does really well -- writing auto and homeowners insurance policies.

To carry out this mission, the company also acquired National General for $4 billion last July and closed this transaction in early January. The acquisition boosts Allstate's market share by 1%, bringing its total to 10%.

The company likes National General's independent agent-facing technology and sees the acquisition as a chance to grow its personal lines of insurance. It also likes its presence in non-standard auto insurance and sees the acquisition as a key part of its plans to roll out new insurance products later this year.

Cheap valuation and economic tailwinds should benefit the insurer

In an environment where inflationary pressures pick up, interest rates will also likely move higher. This helps those companies that rely on interest rates to generate excess returns, such as those in the insurance industry. Rising rates will serve as a tailwind for those companies' interest income in the process.

While I like Progressive due to its stellar long-term growth, Allstate is a worthy competitor not to be ignored. Last year, Allstate generated 6.4% of its revenue from investment income compared to Progressive's 2.2%. Allstate's heavier reliance on investment income means it would likely benefit from interest rates more than competitor Progressive.

While Allstate's combined ratio has been higher than Progressive's in previous years, indicating less profitable underwriting, last year the insurer actually posted a combined ratio of 87.6%, edging out Progressive's 87.7%. That stellar performance has continued into the first quarter, with Allstate posting a combined ratio of 83.2% compared to Progressive's 89.3%.

Despite the stock's 58% run-up since its recent lows in late October, Allstate is still undervalued, in my opinion. I like the company's acquisition of National General and its disposal of its less profitable life insurance businesses, as it allows the company to focus on its auto and homeowners insurance products. These strategic business moves, coupled with tailwinds from rising interest rates, make Allstate worthy of a higher valuation.

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Courtney Carlsen owns shares of Progressive. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.


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