By Gavin Magor, TheStreet.com

 

The direction of American International Group (AIG) for speculative investors rode largely on third-quarter results. Now that they're in, here's the verdict: Dump the stock.

 

AIG is overpriced, and the risk is no longer factored in. It should be a $10 stock, not one that sells for $36. Zombies have become a theme in books, movies and publicly traded companies, but AIG is one zombie stock to avoid.

 

When the government bailed out AIG, investors should have bailed. Some day traders have made a killing, as the stock alternately rose and fell 50% from one day to the next.

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Aside from the fact that AIG isn't performing as well as the headline profit figure would have you believe -- and we will look at that in a minute -- the insurer's stock is selling at an incredible 96% of book price, according to SNL Financial. That's completely inappropriate for a stock with this level of risk exposure.

 

Until the third-quarter figures were crunched, AIG's problems weren't so obvious. The price-to-book-value last week was about 34%, arguably an appropriate level for this stock, reflecting the risk inherent in owning it.

 

Now, the book value has been reduced significantly, and the price-to-book-value has risen exponentially. Even after a drop of close to 10% on Friday (and a 2% increase yesterday), the price-to-book-value of 96% yesterday should send a "sell" signal to anyone still holding the stock.

 

How did the book value plunge so much? It's down to the bailout funding. AIG can't avoid the fundamental fact that TARP and other government equity rose by $24.9 billion in the third quarter. Coupled with a drop in common equity of $10.1 billion, the book value has dropped off a cliff.

 

AIG's stock should be priced at least around 30% to book. That would mean a fair price would be $10 or $11.

Remember that the stock traded at 33 cents in March before AIG completed a 20-for-one reverse split, or $6.60. On that basis, even $10 looks good and reflects a more than 50% increase. Analysts' consensus price target is only $23.50, 35% lower than the current price.

 

To put things in perspective, the average price-to-book-value of insurance stocks traded on the New York Stock Exchange is 86%. The indication is that AIG is worth more 62% of all insurers. Those worth less include such names as Allstate (ALL), MetLife (MET) and Prudential Financial (PRU). That makes little sense.

 

Another preposterous fact: AIG has a price-to-earnings ratio of 13? Illustrious companies with lower P/E ratios include Aetna (AET), Prudential and Travelers.

 

Third-quarter results weren't as impressive as they seemed.

Liberty Mutual chief executive Edmund Kelly complained about "extremely aggressive" actions, indicating his displeasure at issuing unheard of multi-year policies and "ridiculously low pricing."

AIG policy income was down more than $1.7 billion in the third quarter, translating to a drop of 10% from the previous quarter and 24% since the end of 2008. Policy income is crucial to AIG, providing cash flow and investment funding.

 

Operating income also was off, down 66% from the end of June, and cash and cash equivalents fell by $845 million, even as AIG revealed in a 10Q filing last week that it intends to dig into the government's coffers to borrow $2.1 billion to help restructure two units.

 

AIG's future looks uncertain. But one thing's for sure: Get out of the stock now.

 

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