Thesis: Allstate Started Life in 1931

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Allstate started life in 1931 as a part of Sears, Roebuck & Co. The company was spun off in a public offering in 1993, and Sears sold off the last of its shares in 1995. Allstate's customer base is estimated to be 17 million strong, serviced by a national network of over 14,000 agents. Allstate's vision is to "reinvent protection and retirement for the consumer." Allstate does not have a mission statement but does have a statement of corporate goal: "We will grow the value of our company for our customers, our associates, our shareholders, our communities and society."

Allstate is a provider of personal property and casualty insurance. They operate four main businesses: Protection, Financial, Discontinued Lines and Coverages, and Corporate/Other. Protection is the insurance component, and the source of most of Allstate's revenues. Insurance premiums were worth $29 billion in each of the past three years. The Financial division, Allstate's investment business, generated $6.4 billion last year and is a major component of Allstate's revenue improvements in the past five years. Allstate's main insurance lines are private passenger auto, homeowners', residential fire, boat owners', landlords', renters' and other personal insurance products.

An analysis of Allstate's financial information indicates that they have stable operations in relation other firms in the insurance industry, and that they generally outperform their peers. Allstate is more profitable that most insurance companies, in part due to strong earnings growth over the past five years (30.36%). Profitability, however, has been variable, with substantial hurricane losses in 2005 and further losses in 2007 contributing to profit volatility. Allstate's profit margins are lower than those of their peers, but so is its tax rate, and the two almost offset one another. Allstate has strong efficiency ratios. Their five-year average ROA is 2.38% while the sector's is 1.25%. They have a five-year average ROE of 16.79%, compared with a sector average of 9.23%. As further evidence of Allstate's efficiency, their revenue per employee is around one-quarter of the sector average, but their net income per employee is 62% of the sector average.

Competition in the insurance industry is intense, and highly fragmented. Every segment of the market is densely populated by several dozen competitors. There are high exit barriers for firms in the industry and low produce differentiation. While there are some switching costs, they are not significant in the long run. There are no readily-available substitutes. The result is a highly competitive industry where firms compete on the slenderest of differentiation points. The industry is marked by cyclical rounds of price competition that squeezes margins.

In each segment, there are strong competitors, but only State Farm matches Allstate in terms of the number of segments in which they are a major player. State Farm is significantly larger than Allstate, and is Allstate's main rival. Among Allstate's key markets, they are #2 in homeowners' insurance (11.9% share); #2 in auto insurance (11.1% share); and #13 in life insurance. Homeowners' and auto are both saturated markets. Allstate and market leader State Farm are the only firms in the top five of both homeowners' and auto. The life insurance industry has many players that do not compete in other insurance sectors, diminishing the market dominance of State Farm and Allstate.

Overall, the industry is mature, and cyclical. The cyclicality results from firms engaging in price competition in order to gain market share. This results in an increase in premiums written, which eventually eliminates profits to the point where no new capital enters the market. Rates then increase. This is the stage of the cycle that the industry is in right now, and can be expected based on past cycles to last for several more years.

The subprime crisis has somewhat interrupted the normal cycle of business in the insurance industry. One of the nation's largest insurers, AIG, required a multi-billion dollar government bailout in order to remain solvent. The insolvency, however, was at the holding company level, not with the insurance subsidiaries. Exposure to subprime risk has put industry profitability into question, and investors have become skeptical of insurance companies. Allstate, however, does not have significant subprime exposure.

Allstate's international operations are limited to Canada. Allstate operates 900 agencies in Canada, offering a similar range of products. This presence is facilitated by similarities shared between the Canadian and American insurance industries. Further international expansion is made difficult by a lack of similarities in other countries. Domestic expansion is hampered by market saturation and nationwide penetration by Allstate.

Since 2003, Allstate's stock price had remained on a slight incline until July of 2005 when it hit $62.26. The stock remained rangebound between $50 and $60 until the fall of 2006. Allstate stock pushed into a slightly higher range the end of April 2007. The next five quarters saw, steady decline in the share price to $44.15. Allstate's stock began a more precipitous dip in the early part of the summer of 2008. With the onset of the financial crisis, Allstate's stock has plummeted in recent weeks. It ended the week of September 15th at $47.54 and in the five weeks since has fallen to $25.18. Allstate stock hit its lowest level in the entire study period, $22.30, on the morning of Tuesday October 27th.

In the past ten weeks, Allstate's stock began with a steady slide towards the end of the summer. There was no major company news that precipitated this slide, only concerns that the subprime crisis was going to trigger a wider financial crisis. The slow but steady downward trend based on these fears was continued until the end of September. Allstate's October collapse was in excess of the collapse in the Dow Jones, the S&P 500 or close competitors such as Berkshire Hathaway (GEICO) and the Traveler's Group. Yet there was no specific company news or analyst downgrade to precipitate such a decline. Allstate has a beta of 1.22, which explains some of the excess decline, but Allstate's stock over the past month has been more volatile than would have been expected, and has done so in the absence of major news.

Analysts are lukewarm on Allstate. Out of 20 major analyst recommendations, 13 are at "hold," 2 are at "outperform" and 5 are at "buy." The outlook for the insurance industry is moderate. The property/casualty business does not have as much exposure to the subprime mortgage crisis as other sectors of financial services. The industry is suffering some ill effects, but firms such as Allstate are not believed to bear any significant amount of risk. Much of the profit reductions this year are attributable to cyclical factors rather than the financial crisis.

A recommend a buy on Allstate, for a few reasons. First, the stock is near its low for the past five years. It has been subject to a strong selloff this past month that is unjustified based on its exposure to the financial crisis. There have been no significant news events that could have precipitated such a strong selloff. Therefore, I feel the selloff is likely overdone. Allstate's financials are strong and it has consistently outperformed many rivals. The insurance industry as a whole has a near 200-year track record of weathering all manner of crises, and this one is not believed to be a threat to the industry or firms such as Allstate that have limited subprime exposure. Given Allstate's strong fundamentals, lack of subprime exposure, and low price I believe that it represents a solid buy at its present levels.

From this experience, I have learned about the many steps that go into analyzing a company. I was able to analyze a firm's industry and understand its standing within the industry. I learned how to analyze a firm's financials, across time and against competitors. Financial services firms have unique fundamentals relative to most companies, which was an added element of knowledge that I acquired. I learned how to analyze fundamentals, and to synthesize these qualitative factors with the quantitative knowledge from the financial statements. This exercise has also taught me some basic about how the stock markets work, and the risks in investing even in solid, blue-chip companies like Allstate.

This project can be applied to my personal financial outlook by taking to heart the lessons I have learned. When the stock market is going up, it looks compelling. Yet, when it goes down even strong companies go down with it. This exercise has highlighted the risk of investing clearly. In adapting that into my personal outlook, it compels me to learn more about the ways to invest safely. I am curious about different instruments, and hedging techniques. It is not enough to merely invest in a firm with a familiar name. You must study them and their industry carefully, and then gauge where the market is going as well. The exercise has also highlighted the fact that stock market investing requires a long-term approach, as volatility in inherent.

I can think more critically about investing by realizing that it requires intense study… [END OF PREVIEW]

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"Allstate Started Life in 1931."  Essaytown.com.  October 30, 2008.  Accessed July 19, 2019.
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