John Paulson, founder and president of Paulson & Co. Inc. – a New York based hedge fund, got the fame by betting on U.S. housing prices collapse and making billions in the process during 2008-2010. Founding PCI in 1994 with a capital of $2 million and one employee, he was able grow his fortunes in leaps and bounds. As at March 2011, assets under his management stand at a staggering $36 billion with himself included in the Forbes list as the 39th richest man in the world with a net worth of $16 billion. This is even more than his hedge fund counterpart George Soros.
Paulson carried out significant purchase transactions during the first quarter of 2011 which included taking new positions in some stocks while substantially increasing his holding in some of his existing ones. These stocks are currently being considered as his top picks for 2011 and we take a critically rational look at the top five picks to ascertain the sagacity of his investment ideas in light of their underlying fundamentals:
Transocean Limited (RIG) is an offshore contract drilling services providing company with operations all around the world from Far East to Middle East to Canada. The company specializes in the most difficult sectors of offshore drilling business with a particular focus on harsh environment and deep water drilling. Despite having a sound business model, the company’s exposure to international energy prices and economic cycles is clearly evident from its earnings pattern during the last four years with 2010 earnings being unusually low due to a large asset writedown. This has resulted in trailing variables like net margin and ROE to depict steep downward differences against industry averages. However, the recent drag in RIG’s share price has landed the stock in a very attractive landscape and at a leading P/E multiple of 9.9x, a comparison implies a hefty 39% discount to the industry average. Moreover, the company is trading at a P/B multiple of 0.9x (a discount of 59% to industry average) which is a reflection of its strong balance sheet. These incongruities are bound to be corrected and 2011 earnings [without any extraordinary item from British Petroleum (BP) as in 2010] should be a trigger.
Hewlett-Packard Company (HPQ) is perhaps one of the oldest and most diversified Information Technology (IT) companies of the world. Founded in 1939, the company is a household name in our opinion, and has one of the most established brands in the world. The recent financial performance of the company has been impressive with earnings growing by 14% in 2010. However, the company lags behind in terms of profitability as its net margin is four-fifths of the industry average, which includes chief competitor Dell (DELL), and only half of its other closest competitor, IBM (IBM). The situation is not better in terms of ROE also as HPQ’s 2010 ROE was only two-thirds of the industry average and one-third of the IBM’s. However, even withstanding the above arguments, the current leading P/E multiple of 6.5x is unjustifiably lower than the industry average of 17.6x given the solid earnings profile and qualitative factors discussed above.
XL Group (XL) is a global insurance and reinsurance company. The company operates through three segments: Insurance, Reinsurance, and Life Operations. The Insurance segment provides commercial property, casualty, and specialty insurance. Property and casualty products are typically written as global insurance programs for multinational companies and institutions. The investment case for XL is truly compelling. In an industry which is consolidating its position after a turbulent two-year span in the aftermath of global financial crisis, all investment variables of the company are reflecting significant discounts to industry averages and the likelihood of XL’s stock price catch-up with its peers is high. In addition to significant discount of 53% to the industry average in term of P/E multiple, the P/B multiple (better for use in case of a financial services company) of the company at current level denotes an even greater 60% discount to the industry average. This premise is further substantiated by the better-than-industry dividend yield which stands as 17% superior to the industry average. Dividend yields aside, we prefer the capital allocation abilities at Markel (MKL) and Leucadia (LUK), which have better in-house investment advice.
International Paper Company
International Paper Company (IP) is engaged in the business of paper and packaging. The span of IP’s operations covers the lengths and breadths of the world through three operating segments: industrial packaging, printing papers and consumer packaging. Moreover, the company owns and manages around 200,000 acres of forestlands and development properties, primarily in U.S. During the last four years the company has achieved net growth in its revenues and operating profits. Being in a capital intensive business, net earnings are usually substantially affected by asset writedowns/impairments and gains/losses on sale of assets but the operational characteristics of the company seem resonant.
During the last four quarters, IP’s earnings have consistently exceeded consensus expectations which suggest a rather “unique” knack. With net margin of the company inline with the industry average, all investment fundamentals point towards considerable value in the stock. In addition to notably better ROE and P/B multiple than the industry average, it is the catchy dividend yield (40% higher than industry average) and extensive discount to the industry (54%) in terms of P/E multiple that makes the stock a must buy.
Weyerhaeuser Company (WY) is a forest product company which grows and harvests trees and produces wood products from them. It harvests trees for lumber, pulp and paper, and recently got into manufacturing homes. The company now manages 20.5 million acres of forests. It also sells timber; minerals, and oil and gas to construction and energy markets. Mainly correlated to the housing industry which suffered heavily in the wake of credit crunch in the US markets, the company witnessed substantial shrinkage in its topline during 2008 and 2009 with the bottomline turning red. The stock price of WY echoed these developments, reaching a trough of $7 per share in March 2009 against a high of $28.57 per share, two years ago. It rose back to normalization in 2010 with a green bottomline (21% net margin compared to industry average of 4%) and stock price near to pre-crisis level. Going forward, with most of the industry still riling through the “post-crisis trauma,” expectation of continuation of the expansionary monetary stance of Federal Reserve bodes well for the housing market in general and WY in particular. Attractions of the stock include a steep 57% discount to the industry in terms of P/E multiple and an efficient capital structure as reflected in massively higher ROE than industry average (32% vs. 2%) and a slight premium to the rest of the industry in terms of P/B multiple.