‘Cats’ Haunt Ameriprise Numbers
As the Chief Investment Strategist for Personal Finance, I am happy to report that most of the holdings in our Growth Portfolio have performed well lately despite increasing stock market volatility. That’s in large part due to the inherent bias of my IDEAL Stock Rating System towards companies that pay a high dividend, are growing their cash flow, and are already priced at a discount to their sector peer group. But every once in a while one of them under performs the market, with the most recent culprit being financial services giant Ameriprise Financial (AMP).
Last Tuesday Ameriprise released its quarterly earnings report, which pretty much missed the mark on everything except top line revenue growth. So on Wednesday morning the stock dropped nearly 5%, and has meandered a bit lower since then. Of course, I’d much rather talk about my better performing stocks than a rare dud like this one, but there is a valuable lesson to be learned from Ameriprise since I think we will see similar situations in the months to come.
For a long time the name of the game for most companies has been growing top line revenue, at almost any cost. Amazon.com has been getting away with it for years, currently trading at more than 600 times trailing earnings. It now has a market capitalization near $400 billion, making it one of the most valuable publicly-traded companies in the world, even though it generates little profit and pays no dividend. However, tech stocks play by a different set of rules where capturing market share today can (hopefully) be turned into profits tomorrow.
But for a stodgy financial services company like Ameriprise where technology has limited ability to leverage results, future profits are sometimes valued at less than current earnings since they must be discounted to offset inflation. And that’s where Ameriprise committed a major error. In its rush to capture market share, Ameriprise may have priced some of its insurance products too low, forcing it to take some large impairment charges against earnings this quarter.
Ameriprise added $19 million to its long-term care reserve adjustment, which amounts to 2% of its total operating earnings for the quarter. In addition, the company wrote off “catastrophe losses” of $29 million against its auto and home insurance portfolio, compared to only $8 million in the same quarter last year. There goes another 3% of earnings down the drain. Either a whole lot of people suddenly got sick, crashed their cars and accidentally burned their houses down all at the same time, or somebody at Ameriprise did a poor job of pricing these policies in the first place.
In a conference call with analysts after Ameriprise released its earnings, company CEO Jim Cracchiolo downplayed the spike in catastrophe (“cat”) losses with this sorry excuse: “In line with many industry players we had higher-than-expected cat losses. We’re making systemic changes to lessen the impact of cats on our results, including improving cats-related pricing and strengthening the team handling cats claims, including adding more field adjustors. Overall, we are making good progress (and will) bring the business back to historical profitability.”
As someone who spent nearly 30 years as a registered investment advisor and licensed insurance agent, that description is code for “we charged to little in premiums to acquire these long-term care, auto and home insurance policies in the first place, and didn’t have the resources necessary to service those policies once they were in place.” That he says the other industry players are apparently afflicted with the same disease doesn’t make the management failure any less.
The lesson of Ameriprise for all publicly traded companies, and for the shareholders that own them, is to avoid increasing top line sales revenue at the expense of the bottom line. Businesses that can grow revenue profitability, even at a modest pace, will be rewarded in this slow-growth economy. But those that can’t will be quickly punished, as Ameriprise discovered this week.
(I’d also add that when you have a lousy quarter and your numbers show the cat’s out of the bag, first admit you messed up instead of trying to spin red ink into black.)
The good news for AMP is that it now appears cheap, and could be ripe for a strong rebound when the next set of quarterly numbers comes out in January. Barring a disaster, almost all of its operating metrics should look good in comparison to this quarter. And now trading at only 9 times forward earnings, even a slight gain in that multiple combined with a bump in profits could boost its share price back above the $100 level where it was less than a month ago.