First American Financial currently trades at $61.18 per share and has shown little upside over the past six months, posting a middling return of 0.7%.
Is now the time to buy First American Financial, or should you be careful about including it in your portfolio? Get the full stock story straight from our expert analysts, it’s free.
Why Is First American Financial Not Exciting?
We're swiping left on First American Financial for now. Here are three reasons you should be careful with FAF and a stock we'd rather own.
1. Long-Term Revenue Growth Disappoints
In general, insurance companies earn revenue from three primary sources. The first is the core insurance business itself, often called underwriting and represented in the income statement as premiums earned. The second source is investment income from investing the “float” (premiums collected upfront not yet paid out as claims) in assets such as fixed-income assets and equities. The third is fees from various sources such as policy administration, annuities, or other value-added services.
Unfortunately, First American Financial’s 1% annualized revenue growth over the last five years was weak. This fell short of our benchmarks.
2. Net Premiums Earned Hit a Plateau
When insurers sell policies, they protect themselves from extremely large losses or an outsized accumulation of losses with reinsurance (insurance for insurance companies). Net premiums earned are:
- Gross premiums - what’s ceded to reinsurers as a risk mitigation and transfer strategy
First American Financial’s net premiums earned was flat over the last five years, much worse than the broader insurance industry. This shows that policy underwriting underperformed its other business lines.
3. EPS Barely Growing
Analyzing the long-term change in earnings per share (EPS) shows whether a company's incremental sales were profitable – for example, revenue could be inflated through excessive spending on advertising and promotions.
First American Financial’s weak 1.8% annual EPS growth over the last five years aligns with its revenue performance. This tells us it maintained its per-share profitability as it expanded.
Final Judgment
First American Financial isn’t a terrible business, but it isn’t one of our picks. That said, the stock currently trades at 1× forward P/B (or $61.18 per share). This valuation is reasonable, but the company’s shakier fundamentals present too much downside risk. We're fairly confident there are better stocks to buy right now. We’d recommend looking at one of Charlie Munger’s all-time favorite businesses.
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