Redeeming the Punished: Under the Radar

Arthur J. Gallagher's stock was dumped after the company missed earnings estimates by just 1 cent. That suggests investors may push up the stock on the first sign of good news.
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"Under the Radar" uncovers little-known companies worthy of investors' consideration. Check out the rest of this week's picks

BOSTON (

TheStreet

) --

Arthur J. Gallagher & Co.'s

(AJG) - Get Report

stock sold off sharply this week after missing analysts' third-quarter earnings estimate by just 1 cent a share. Despite being shunned by Wall Street and punished by the stock market, the company deserves a spot on your watch list.

Arthur J. Gallagher, based in Itasca, Illinois, mainly sells insurance but has gradually shifted its focus from sales to consulting, a strategy that benefits clients and bolsters the company's reputation as a prudent adviser. Arthur J. Gallagher helps individuals and organizations manage all varieties of risk.

The company's third-quarter net income rose 10% to $42 million, but earnings per share declined 7% to 41 cents due to a higher share count. Revenue inched up 1% to $440 million. Arthur J. Gallagher's gross margin rose from 19% to 21% and its operating margin ascended from 15% to 16%.

The stock trades at a trailing price-to-earnings ratio of 17, a discount to the market and insurance peers. But investors dumped the shares during Wednesday's sharp sell-off, sending the stock price down nearly 7% during the trading session. Large insurers, such as

MetLife

(MET) - Get Report

and

Hartford Financial

(HIG) - Get Report

, also tumbled.

The reason: growth expectations. Arthur J. Gallagher has achieved a modest three-year growth rate of 4.6% for revenue and 3.7% for earnings. Given economic pressure, these numbers aren't too bad. But analysts expect slower earnings growth for the foreseeable future.

To make matters worse, Arthur J. Gallagher is trading at a 35% premium to insurance-broker peers based on projected earnings and a 143% premium based on book value.

The one thing anchoring shares is the company's hefty dividend. At its current share price, Arthur J. Gallagher pays a dividend yield of 5.7%, higher than the

S&P 500

average of 2.8%. But its payout ratio, a measure of dividend safety, is over 100%. In the fourth- and first-quarters, dividend payouts weren't funded by earnings alone.

Still, the company has a stable business and retained profitability during the recession. Its balance sheet has a liquid tilt, with $790 million of cash, compared with $531 million of debt. A quick ratio of 0.9 is lower than ideal. But a debt-to-equity ratio of 0.6 is below the industry average, indicating restrained leverage.

Arthur J. Gallagher has fallen 14% this year, underperforming major U.S. indices. If the market sell-off accelerates, this is a company to watch since it will likely be excessively punished and become even more of a bargain.

-- Reported by Jake Lynch in Boston.