Investment Review: Everest RE Group
An increase in Everest RE (RE) P/E ratio due to a reversion to historical levels promises the possibility of strong positive returns for investors buying at current share price levels and holding through the end of 2022. But those returns depend very heavily on analyst EPS estimates being met. Everest RE earnings have been severely impacted by catastrophe losses in the past and will likely be severely impacted again in the future. I believe analyst EPS estimates might not allow sufficiently for extraordinary catastrophic loss events such as have impacted the company in the past. Either that, or they have allowed an average over several years for extraordinary catastrophe losses, which is understandable. But that’s not how these extraordinary catastrophic events occur. So while potential returns are high, there’s also a considerable risk of poor returns due to the occurrence of one or more extraordinary catastrophic events over the next few years. And of course, the timing of these events are outside the control of company management, even if allowed for in premiums over the long term.
Looking for share market mispricing of stocks
What I’m primarily looking for here are instances of share market mispricing of stocks due to distortions to many of the usual statistics used for screening stocks for buy/hold/sell decisions. The usual metrics do not work when the “E” in P/E is distorted by the impact of COVID-19. And, if the P/E ratio is suspect, so too then is the PEG ratio similarly affected. The COVID-19 pandemic is affecting the operations of businesses, and consequently their revenues and earnings, and also sentiment toward individual businesses. The COVID-19 impact has been good for some businesses and bad for others. But, as King Solomon once observed, in respect of both good times and bad, “this too shall pass.”
How does a share investor make a decision on these statistics, distorted as they are by the impact of COVID-19?
In thinking how to get from this time of disruption to better times, I’m reminded of an old Irish joke about a tourist on a back road in Ireland asking a farmer how to get to Dublin, to which the farmer replied, “If I was going to Dublin, I wouldn’t start from here.” I feel a bit like that with P/E ratios at present, due to the disruption to earnings caused by the COVID-19 pandemic. I believe the answer is to start with data at the end of 2019, early 2020, pre COVID-19 and compare to projections out to end of 2022, when hopefully the impacts of COVID-19 will have largely dissipated. Summarized in Tables 1, 2, and 3 below are the results of compiling and analyzing the data on this basis.
Table 1 Detailed Financial History And Projections
Table 1 documents historical data from 2016 to 2019, including share prices, P/E ratios, EPS and DPS, and EPS and DPS growth rates. The table also includes estimates out to 2022 for share prices, P/E ratios, EPS and DPS and EPS and DPS growth rates (note estimates are shown for analysts EPS estimates out to 2024 where available but these are considered not as reliable). Table 1 allows modeling for target total rates of return. In the case shown above, the target set for total rate of return is 7% per year through end of 2022 (see line 12), based on buying at Oct. 23 closing share price level. The table shows, to achieve the 7% return, the required average yearly share price growth rate from Oct. 23, 2020, through Dec. 31, 2022, is 3.98% (line 41). This growth rate is lower than the target 7% return due to estimated dividends receivable. Everest RE has a current dividend yield of 2.93%. Table 2 below summarizes relevant data flowing from the assumption of a target 7% total return.
Targeting a 7% Return
Table 2 – Targeting a 7% returnTable 2 provides comparative data for Everest RE, assuming share price grows at rates sufficient to provide total rate of return of 7%, for buying at closing share price on Oct. 23, 2020, and holding through end of 2022. All EPS estimates are based on analysts’ consensus estimates per SA Premium.
Comments on Table 2 are as follows:
Part 1 – Consensus EPS (Case 1.1) (lines 1 to 12)
Part 1 shows the amounts the share price would need to increase to achieve a 7% rate of return through end of 2022. From Part 1, it can be seen that adding projected EPS growth rate to a dividend yield can give an approximation of potential total return, subject to changes in P/E ratio and growth in the dividend yield on cost.
Part 2 – Required change in P/E ratio to achieve Target 7% return (lines 21 to 23)
Part 2 shows the amount the P/E ratio would need to increase or decrease by, from buy date to end of 2022, to achieve the share price level at end of 2022 necessary to achieve the targeted 7% return. For Everest RE, the P/E ratio at buy date can decrease by 46.5% through end of 2022, and the 7% return will still be achieved. Being able to achieve a targeted return despite a reduction in the P/E ratio would normally be regarded as a positive. However, due to the distortions of earnings and sentiment, due to the COVID-19 pandemic, it’s difficult to judge whether the change in P/E ratio is a negative, or the result of a distorted starting point. To overcome this difficulty, in Part 3, I review the necessary change in P/E ratio from a different, pre COVID-19 starting point.
Part 3 – Projected change in P/E ratios from 2019 to 2022 (lines 31 to 46)
In part 3, I start with the share price at Dec. 31, 2019, before the impact of the COVID-19 pandemic on earnings and market sentiment. The end point is projected share prices at end of 2022, when it’s assumed the market and earnings are no longer materially impacted by the COVID-19 pandemic. For Everest RE, the share price could decrease by $43.74 from $$276.84 at Dec. 31, 2019, to $233.10 at end of 2022, and, as detailed in Part 1, at $233.10, the targeted 7% rate of return would be achieved. For Everest RE, there are a number of givens in our assumptions. We know the EPS for FY 2019 was $21.35, and SA analysts’ consensus EPS estimate for 2022 is $25.81, which gives an average yearly EPS growth rate estimate of 6.5%. We know the share price at end of 2019 $276.84 and EPS $21.35, which gives a P/E ratio of 12.95. We know the share price at end of 2022, to achieve a 7% return is $233.10, and consensus EPS estimate $25.81, which gives a required P/E ratio of 9.03 at end of 2022. The indicated P/E ratio of 9.03 at end of 2022 is (30.4)% lower than the P/E ratio of 12.97 at end of 2019. All of these figures can be seen in Part 3 of Table 2 above. The change in the share price for Everest RE can be expressed as mathematical formulae as follows:
(A) Change in share price due effect of EPS growth rate equals share price at beginning multiplied by (1 plus average yearly EPS growth rate) to the power of number of years invested
= $276.84*(1+6.5%)^3 = $334.67
(B) Change in share price due change in P/E ratio equals share price adjusted for EPS growth rate multiplied by (1 plus/minus percentage change in P/E ratio)
= $334.67*(1-30.4%) = $233.10
Note especially, the $57.83 increase ($334.67 minus $276.84) due to the average yearly EPS growth rate is cumulative, and share price will continue to increase the longer the shares are held and the growth rate continues. The increase of $101.57 due change in P/E ratio ($334.67 minus $233.10) has a one-off effect. A continuing high or low P/E ratio has no impact on future share price growth, only a change in P/E ratio affects share price, not the level of P/E ratio.
Next, rather than targeting a specific rate of return, I look at historical P/E ratios to see the potential impact on returns of a reversion to these levels of P/E ratio. First of all, I should explain a little about the Dividend Growth Income+ Club approach to financial analysis of stocks.
Understanding The Dividend Growth Income+ Club Approach
Total Return, Dividends, Share Price
Undertaking exercises to determine the current value of a stock is a waste of time when the market continually provides the only current value that matters when it comes to buy a stock. The only way an investor can achieve a positive return on an investment in shares is through receipt of dividends and/or an increase in the share price above the buy price – the only way. It follows what really matters in share value assessment is the expected price at which a buyer will be able to exit shares, and expected cash flow from dividends.
Changes in Share Prices
Changes in share price are driven by increases or decreases in EPS, and changes in P/E ratio. Changes in P/E ratio are driven by investor sentiment toward the stock. Investor sentiment can be influenced by many factors, not necessarily stock-specific. Such factors include perceived quality of a stock, Warren Buffett or another well-known investor acquiring or disposing of a position, an event such as Brexit or the COVID-19 pandemic, expected future earnings growth for the stock, and the state of the economy, now and in the future.
Earnings are tipped into the “Equity Bucket” for the benefit of shareholders. It’s prudent to check whether distributions out of, and other reductions in the “Equity Bucket” balance are benefiting shareholders.
Everest RE’s Returns Based On Selected Historical P/E Ratios Through End Of 2022
Table 3 below provides additional scenarios projecting potential returns based on selected historical P/E ratios and analysts’ consensus and low EPS estimates per Seeking Alpha Premium through end of 2022.
Table 3 Summary of relevant projections Everest RE
Table 3 provides comparative data for buying at closing share price on Oct. 23, 2020, and holding through the end of 2022. There are a total of 12 valuation scenarios, comprised of three EPS estimates (consensus, low and high) across four different P/E ratio estimates. Comments on contents of Table 3 follow.
Consensus, low and high EPS estimates
All EPS estimates are based on analysts’ consensus, low and high estimates per SA Premium. This is designed to provide a range of valuation estimates ranging from low to most likely, to high based on analysts’ assessments. I could generate my own estimates, but these would likely fall within the same range and would not add to the value of the exercise. This is particularly so in respect of well-established businesses such as Everest RE. I believe the “low” estimates should be considered important, in case analysts, overall, have not sufficiently taken account of potential ongoing impact of COVID-19 in their 2022 EPS estimates. It’s also prudent to consider potential worst-case scenarios from whatever cause.
Alternative P/E ratios utilized in scenarios
- The actual P/E ratios at share buy date based on actual non-GAAP EPS for June 30, 2020 TTM.
- A modified average P/E ratio based on 16 quarter end P/E ratios from Q4-2016 to Q3 2020 plus current P/E ratio in Q4-2020. Average of these P/E ratios has been modified to exclude the three highest and three lowest P/E ratios to remove outliers that might otherwise distort the result.
- A median P/E ratio calculated using the same data set used for calculating the modified average P/E ratio. Of course, the median is the same whether or not the 3 highest and lowest P/E ratios are excluded.
- The actual P/E ratios at Feb. 21, 2020, share prices based on FY 2019 non-GAAP EPS. The logic here is the market peaked around Feb. 21, 2020, before any significant impact from COVID-19 became apparent, and after FY 2019 results had been released. This makes the P/E ratios at Feb. 21, 2020, reflective of most recent data before distortion of P/E ratios by the impact of the coronavirus pandemic.
Reliability of EPS estimates (line 17)
Line 17 shows the range between high and low EPS estimates. The wider the range, the greater disagreement there is between the most optimistic and the most pessimistic analysts, which tends to suggest greater uncertainty in the estimates. The range of 12.6% for Everest RE indicates opinion among the 13 analysts covering Everest RE is wide apart, indicating considerable uncertainty.
Projected Returns (lines 18 to 39)
Lines 25, 32 and 39 show, at a range of historical P/E ratio levels, Everest RE is conservatively indicated to return between 16.5% and 36% average per year through end of 2022. The 16.5% return is based on analysts’ low EPS estimates and the 36% on their high EPS estimates, with a 28.2% return based on consensus estimates. Those are the lowest of the returns under the consensus, low and high EPS scenarios. At the high end of the projected returns for Everest RE, the indicative returns range from 35.5% to 58.2%, with consensus 49%. The wide difference between best and worse cases is an indication of a degree of uncertainty in analysts’ estimates and the instability of historical P/E ratios. While the current P/E ratio is 16.87, the historical P/E ratios (lines 5 to 7) range from 13.58 to 19.08.
Review Of Historical Performance For Everest RE
Table 4Comments on Table 4 are as follows –
Part 1 – EPS – Actual and Projections (lines 1 to 16)
Part 1 shows that analysts’ expectations are for future EPS growth of 20.9% for the three years ending 2022, compared to actual EPS growth rates of negative (10)% from 2016 to 2019. This reflects some instability in earnings in the past, adding to the concerns expressed in relation to the wide range of analysts estimates projected for the future.
Part 2 Share price (lines 21 to 27)
From 2016 to date, Everest RE share price has decreased by (1.1)% (line 27), resulting in generally poor returns for shareholders, as illustrated in Table 5 below. What is discouraging here is the share price growth rate decrease of (1.1)% compares to the 2016 to 2019 EPS growth rate of negative (10)%. That means, despite the decrease in share price EPS has declined at a faster rate.
Part 3 Equity (lines 31 to 57)
Outstanding shares (lines 31 to 37) have shown little change since 2016, as a result of share repurchases slightly more than offsetting issues for staff compensation. Net book value (equity) (lines 51 to 57) has grown by $1.21 billion since 2016, due mainly to excess of earnings over dividend payments and share repurchases.
Part 4 Market Cap
Market value is 0.92 times book value, a level that does not raise concerns.
Part 5 Debt metrics
Everest RE currently has total debt of $621 million, which is more than offset by cash of $923 million to give a net cash position of $302 million.
Reviewing Everest RE’s Historical Shareholder Returns
In Table 5 below, I provide details of actual rates of return for Everest RE’s shareholders investing in the company over the last six years.
Table 5 shows returns have been poor for investors buying shares in Everest RE over the last six years. For purchases prior to end of 2019 returns are in the low to mid single digits. Subsequent to end of 2019 returns for buyers have been negative. There has been little opportunity to benefit from share price increases and a significant part of the returns that have been achieved has come from dividends. These rates of return are not just hypothetical results. They are very real results for anyone who purchased shares on the various dates and held through to fourth quarter 2020. In the above examples, the assumed share sale price is the same for all investors, illustrating the impact on returns of the price at which an investor buys shares.
Everest RE: Ratings Summary From SA Premium
SA Quant rating is neutral, and the stock is infrequently covered by SA contributors. Wall Street analysts are bullish, possibly based on this press release from Everest RE, published by SA on Oct. 22:
It’s notable Everest RE share price opened at $205.76 on Oct. 22 and closed at $214.02 on Oct. 23, an increase of 4.01%.
Summary and Conclusions
The market appears to be having difficulty with rationally setting share prices at present due to the distortion of usual market metrics by the impacts of the COVID-19 pandemic. An increase in Everest RE P/E ratio due to a reversion to historical levels promises the possibility of strong positive returns for investors buying at current share price levels and holding through end of 2022. But those returns depend very heavily on analysts EPS estimates being met. Everest RE earnings have been severely impacted by catastrophe losses in the past and could be severely impacted again in the future. I believe analysts EPS estimates most likely do not allow sufficiently for extraordinary catastrophic loss events such as have impacted the company in the past. I say this because the estimates for 2021 and 2022 show none of the extreme lumpiness of historical results.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. I do not recommend that anyone act upon any investment information without first consulting an investment advisor and/or a tax advisor as to the suitability of such investments for their specific situation. Neither information nor any opinion expressed in this article constitutes a solicitation, an offer, or a recommendation to buy, sell, or dispose of any investment, or to provide any investment advice or service. An opinion in this article can change at any time without notice.