Aflac - AFL
It's time for that Duck.
Before I start assaulting your eyes with an aggressive amount of charts, let's talk about what Aflac is in case you've never seen an ad with their iconic duck quacking out the company name. Aflac (American Family Life Assurance Company) was founded on November 17, 1955, in Columbus, Georgia. While they provide numerous types of insurance, their primary products are supplemental insurance policies, primarily covering cancer, accidents, and critical illness. These policies work in a very simple manner and aren't fundamentally different from one another, except in the health problems they are designed to cover.
Take cancer insurance, for example. If someone is insured by Aflac and diagnosed with cancer, they receive a lump sum payment. The policyholder then receives smaller payments throughout the course of treatment depending on the treatments they are receiving. The same goes for accidental injury insurance. If you broke your leg, Aflac would pay you a lump sum for the broken leg. If you had to be taken in an ambulance, you would get money for that, and if there is an MRI or an X-ray, Aflac would pay more money to the policyholder. Then, let's say the injured policyholder has to stay in the hospital—well, Aflac would pay the policyholder for each day in the hospital. Aflac is also unique in that it is not health insurance; the payments do not go to the healthcare provider but directly to the policyholder. If the policyholder has health insurance covering their medical bills, the payments from Aflac essentially become replacement income for days missed at work. The money the policyholder receives can be spent on anything.
Now, here's where things get interesting: about 70% of Aflac's revenue comes from Japan. There is currently a video on Aflac's investor relations page that provides a history of Aflac's business in Japan.
https://investors.aflac.com/home/default.aspx
In the 1970s, the founder of Aflac noticed during a trip to Japan that many people wore masks as a precaution during cold and flu season. He saw an opportunity in how health-conscious the Japanese people were. Cancer was, and remains, the leading cause of death in Japan. There is a moment in the video titled “Get to know Aflac Japan” on Aflac’s investor relations page, about eight minutes and ten seconds in, that is quite wild. An Aflac employee mentions that, due to the stigma around cancer, doctors used to avoid telling their patients they had cancer. This placed Aflac insurance representatives in a difficult position, where they had to find ways to pay policyholders without revealing that the money was compensation for cancer. Apparently, cancer was seen as a death sentence, and discussing it was highly taboo. If I understand that part of the video correctly, it's incredible that this was the norm in Japan until the last 20 or 30 years.
Anyway, what Aflac (Ticker: AFL) does isn’t very complicated or difficult to understand. Now, onto the charts:
AFL vs. S&P 500 over the last ten years:
AFL vs. S&P 500 last five years:
AFL vs. S&P 500 last three years:
AFL vs. S&P 500 over the last year:
AFL vs. S&P 500 going as far back as I have data:
AFL vs. The S&P 500 during the dot com bubble:
and just in case it wasn’t already clear Aflac has plenty of momentum:
Purely based on performance, Aflac has been outstanding. However, Aflac doesn’t always consistently outperform the S&P 500 at all times. For instance, it was slower to recover after the COVID crash of 2020. But soon after, it returned to outperforming the S&P 500. Its outperformance has been so reliable for so long that it’s hard to view a drop in AFL’s share price as anything other than an attractive buying opportunity. As I’ve said before, performance is what matters most. If the investment doesn’t perform, it doesn’t matter how interesting the company is and Aflac has even beaten the S&P 500 during times of utter mania over tech stocks.
Now, let’s examine how Aflac is returning value to shareholders, along with its financial strength and valuation:
Operating and Free Cash Flow:
It’s amazing how close those two lines are to each other. Essentially, all of AFL’s cash from operations translates into free cash flow, allowing them to return an enormous amount of money to shareholders. At first glance, it’s concerning that the lines are trending downward. However, I’ll explain what’s going on when we dive into the 10-K.
Here is that inverse correlation that I like so much:
If the professional investment bankers of the world thought Aflac was making a mistake by buying back shares instead of reinvesting in the business, then these two lines wouldn’t form such a perfect X. Additionally, we can see that Aflac doesn’t have a habit of diluting shareholders’ ownership by issuing more shares. The number of shares outstanding has steadily decreased over the last decade.
Shares outstanding as a percentage:
Growing shareholder equity:
Aflac has McDonald's beat in this regard. While MCD has consistently had negative equity, AFL has not only generated a significant amount of free cash flow but has also been paying off its debt.
EV to EBIT:
Enterprise Value (EV) = Market Cap + Total Debt - Cash
EV is meant to provide a full picture of what you, the shareholder, are buying. During the Great Depression, Benjamin Graham would find companies whose EV was greater than their Market Cap. Think about that—what a great time to be an investor. Anyway, you’ll notice that AFL’s EV to EBIT is a negative number, which indicates that Aflac is currently heavily undervalued. It’s kind of crazy to see a business valued at less than its debt. It’s almost as if the market is saying the business is doomed and won’t be able to pay its bills.
Historical PE:
Valued purely on its earnings, AFL is still underpriced. A business that has been outperforming the S&P 500 for decades deserves a PE ratio above 15, and very likely closer to 20. This would reflect the reality that the share price is likely to rise further in the future. However, as you can see, this has never been the case for Aflac. The stock market rarely rewards certain industries with high PE ratios. Typically, these are industries considered "boring" and don’t lend themselves to new, exciting narratives that capture people's enthusiasm. Insurance simply doesn’t get people’s blood pumping. As a result, Aflac is usually a good deal compared to many other stocks. AFL is currently at a high PE ratio, but only when compared to its own price history. That being said, I view this as a good entry point for Aflac, given its strong track record of performance.
Current Ratio:
AFL’s PE ratio spiked so dramatically that it overshadows the rest of the graph. For reference, its current ratio was 17 in 2020, which is extremely high. Most financially sound corporations have a current ratio between one and two. The current ratio is calculated as Current Assets ÷ Current Liabilities. “Current” refers to assets and liabilities that will be realized or due within one year. A current liability is a debt the corporation must pay within a year, while a current asset is something that will become cash within a year. Current assets include cash, receivables, inventories, etc. A receivable is money owed to the corporation that it expects to collect within the year.
For example, if you have an Aflac policy, Aflac would total up your premiums for the year and log them as a receivable. As you pay your premium each month, that receivable moves over to the cash column. Current ratio is important because it measures whether or not a business can pay its bills. However, you must look deeper than just the number itself. A current ratio made up entirely of inventory is meaningless. The equation I use is:
(Cash and Short-Term Investments + Receivables) ≥ (Payables and Accrued Expenses * 1.2)
Unfortunately, YCharts doesn’t allow me to graph that.
A quick story about current ratios: I lost a lot of money on an investment in 2020. I had invested heavily in a mall REIT that was making an impressive turnaround. However, it was heavily debt-laden and lacked significant current assets. It would have been fine, but when the government shut down every shopping center in the country, the business folded. Since then, I’ve paid close attention to the current ratio—it’s protection against unforeseen events.
As for AFL, being an insurance company, it has to comply with government regulations. Insurance companies are legally required to maintain a certain amount of "float," which consists of premiums collected from policyholders that the company must keep in reserve to pay future claims. This float is why your insurance company never says, “Your claim is approved, but we won’t have the money to pay you until the end of the year.” Float is extremely important and is also how Warren Buffett made so much money. But I’ll get into that when we discuss the 10-K.
For now, all that matters is that Aflac has a large amount of cash on hand relative to its liabilities. It’s hard to imagine a catastrophe that would put Aflac out of business in the short term.
Debt to Equity:
More good news, this is further confirmation that Aflac has a modest amount of debt.
Revenue:
Yen to Dollar exchange rate:
Remember way back at the beginning when I mentioned that I didn’t care that cash from operations was dropping? Well, I also don’t care that revenue is dropping. Now, let’s dive into the 10-K and explain why that’s the case:
https://s24.q4cdn.com/367535798/files/doc_financials/2024/ar/AFL-12-31-23-10-K.pdf
Also here’s the link to the investor relations homepage for Aflac:
https://investors.aflac.com/home/default.aspx
When I reference page numbers in the 10-K PDF files, I’m referring to the page number at the bottom of the page, not the page number displayed by the PDF reader.
On Page 35, management explains that the falling revenue is due to changes in the exchange rate between the Yen and the Dollar, since 70% of Aflac’s revenue comes from Japan. As we can see, the Yen-to-Dollar exchange rate mirrors AFL’s revenue. A strong Yen is good for AFL’s business. Normally, I wouldn’t invest in a company with falling revenue. However, in this unique situation, it’s not a sign of a failing business. I won’t go into detail about the Japanese economy, but I’ll say that I have no concern about Japan collapsing as a country, and I expect the Yen to recover in the future. When that happens, Aflac will benefit immensely.
Circling back to the concept of float—the large amount of money insurance companies must retain to have the liquidity to pay out future claims—it doesn’t just sit in a savings account losing value to inflation. Insurance companies are allowed to invest their float, which essentially amounts to an interest-free loan from policyholders. Berkshire Hathaway’s core business is insurance, and Warren Buffett has famously used his company’s float to generate enormous returns.
On Page 110, we can see what Aflac is doing with its float. Unlike Warren Buffett’s bold approach of buying companies, Aflac is being very risk-averse and conservative, with the majority of its float invested in government bonds. On Page 86, we learn that in 2023, Aflac brought in $14.1 billion in premiums and earned $3.8 billion in income from its invested float, resulting in a total net income of $4.6 billion. Aflac is playing it safe with its float and still bringing in a solid return. Frankly, given how well AFL performs compared to the S&P 500, I’m comfortable with their conservative approach.
Now lets go through Hamilton Helmer’s 7 Powers:
Scale Economies: Cost advantages that a company gains due to an increased level of production. Larger scale often results in lower costs per unit, making it hard for smaller competitors to match prices or achieve similar profitability.
Nope, there’s no scale economy for Aflac. Larger insurance companies don’t necessarily offer cheaper insurance.
Network Economies: The value of a product or service increases as more people use it. Examples include social media platforms or payment networks where the network itself creates increasing value for users.
Nope, a lot of people having Aflac doesn’t improve the product for everyone else.
Counter-Positioning: A strategy where an incumbent is unable to respond effectively to a new competitor's superior business model because doing so would undermine their existing operations.
I’d say Aflac is the incumbent in its field, making it impossible to be counter-positioned against itself.
Switching Costs: Costs that customers incur when switching from one product or service to another. High switching costs make it difficult for customers to change providers, thereby providing a competitive edge to the company.
I don’t think insurance has much of a switching cost. The only potential switching cost would be a cancellation fee.
Branding: The power derived from customers' perception of your brand. Strong branding creates a loyal customer base and makes it hard for new entrants to compete effectively, even if their product or service is similar.
Yes, Aflac has a very strong brand. In fact, I believe if you asked anyone to name a company that provides this type of insurance, they would say Aflac.
Cornered Resource: Having exclusive control over a critical resource—whether it’s a physical asset, intellectual property, or a specific talent—gives a company a strong advantage.
Nope, insurance from one business is fundamentally the same as any other.
Process Power: The ability to develop superior processes that others cannot replicate easily. These processes lead to better efficiency, lower costs, or higher quality, giving the company a distinct competitive advantage.
Maybe there aren’t many insurance companies that provide the same products Aflac does. On top of that, Aflac has been in business since 1955. Underwriting is the critical part of the insurance industry. An insurance company can get wiped out if they underestimate risk, don’t charge enough in premiums, and then struggle to pay policyholders when an unexpected number of claims arise. Aflac has a lot of experience underwriting policies for this type of supplemental insurance, giving them decades of data to pull from when estimating how much to charge. This accuracy is a big advantage, as it allows them to be very precise and confident in their projections. An insurance company that can do this is able to offer lower prices than its competitors. If any company in this space can do that, it’s Aflac.
While Aflac has a fairly narrow moat, it does have some advantages over its competitors and a huge track record of success. The drop in revenue is purely related to the exchange rate between the Yen and the Dollar and has nothing to do with Aflac’s underlying business. I own stock in Aflac, and I see their massive amount of free cash flow as the driving force behind their past performance, with no reason to believe that will change anytime soon.
My Portfolio:
JPM, MCD, VLO, AFL, ITB, PPA, MOAT
*Disclaimer*
You can and will lose money in the stock market. You can lose all of your money. I can and will be wrong. I have been wrong in the past. I have lost money in the past. Investing in stocks is risky and should never be considered safe. Invest at your own risk.