Betting That P/E Stocks Will Bounce Back

Includes: BX, KKR
by: Benjamin Goldman

In such a down market, there are three possibilities for why Carlyle Group would file for an IPO in early 2012: It needs to raise capital, it believes private equity firms are currently overvalued, or it believes that private equity firms will recover from their recent price downturns. Optimists have to take a look at how private equity firms like Blackstone (NYSE:BX) and KKR are performing in the current market and view Carlyle’s move as an opportunity to gain returns.

The Blackstone Group, which is structured as an MLP, paid 62 cents per share in dividends over the past 12 months, which is about a 5 percent yield at Blackstone’s current stock price. On an adjusted basis, Blackstone is expected to grow its earnings by 51.6 percent in 2011 and by 7.3 percent in 2012, which would cause Blackstone to trade at an adjusted P/E of 6.10 if it continues trading at $12.50 at the close of 2012. With a beta of 2.36, Blackstone shares can experience huge growth if the market rebounds any time soon. For those who think there is little to no possibility of a double dip recession, Blackstone is great to have in your portfolio. However, I believe it is best to hold back on Blackstone Group shares until the market becomes more stable.

KKR and Company is a much better example of how private equity firms may be undervalued on the current market. KKR currently has a 6.9 percent dividend yield and trades at a P/E ratio of only 6.01. A lot of this stems from KKR’s expected shortfalls in 2011, with analysts expecting earnings per share to decrease by 45.6 percent to $1.54. However, KKR should be able to bounce back. KKR is a good investment because of its high dividend yield, low earnings multiple, and low leverage compared to other stocks in the financial sector.

Carlyle must have good reason to file for an IPO. With the market already trading at very low multiples, Carlyle may very well expect stocks to bounce back before Carlyle's IPO. For fundamental investors, now may be a good time to buy KKR to add an undervalued stock to a portfolio. For high risk investors, an investment in The Blackstone Group can provide huge returns if the market bounces back but can substantially drop in price if the financial sector continues to crash.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.