Bruce Berkowitz's 5 Newest Portfolio Picks

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Includes: AGO, BAC, C, DTEGY, HSBC, JPM, LUK, MBI, PJC, VOD
by: Investment Underground

by Matthew Smith

Bruce Berkowitz is the founder and managing member of the Fairholme Fund. Over a ten year period from 2001 to 2011, the fund has generated an average annual return of 19.60%. Berkowitz is a value investor who favors investing in concentrated portfolios, holding a relatively small number of companies. He is currently quite bullish on financial companies, even though other investors are fleeing the sector. This article will review five recent stock purchases by Berkowitz in an attempt to uncover stocks that have been heavily undervalued by the market in order to maximize returns over the long term.

Citigroup Inc (NYSE:C)

Citigroup Inc has a market cap of $82.87 billion and a price to earnings ratio of 8.78. Its 52 week trading range is $21.40 to $51.50. Its last trading price was $28.40. It reported second quarter earnings 2011 of $17.24 billion, an increase from first quarter earnings of $16.54 billion. Second quarter net income was $3.34 billion, an increase from first quarter net income of $2.99 billion. Citigroup has quarterly revenue growth of 12.20%, a return on equity of 6.15%, and pays a dividend with a yield of 0.10%.

One of Citigroup´s closest competitors is HSBC Holding Plc (HBC). HSBC last traded at $41.63 and has a market cap of $146.80 billion. It has a price to earnings ratio of 9.90, quarterly revenue growth of 8.40% and a return on equity of 10.75%. It currently pays a dividend with a yield of 4.30%. Based on these key performance indicators, HSBC is performing on par with Citigroup, though its dividend yield is substantially higher.

Bruce Berkowitz holds 26,387,898 shares of Citigroup, buying 543,638 shares in second quarter 2011, adding to the 2,130,560 shares bought in the first quarter. The average purchase price per share was $45.33. Based upon the last trading price of $28.40, Berkowitz has made a return of -37.35%.

Citigroup’s second quarter 2011 balance sheet showed cash of $467.92 billion, an increase from first quarter cash of $452.57 million. In the second quarter 2011, it had net tangible assets of $138.35 billion, an increase from first quarter’s $137.42 billion.

Citigroup’s quarterly revenue growth of 12.2 %, versus an industry average of 17.10%, and a return on equity of 6.15%, versus an industry average of 6.7%, indicates that it is underperforming many of its peers.

The earnings potential of companies generating revenue from the banking sector remains poor in the short term, due to tight credit markets and the poor economic climate. This is indicated by a recent Goldman Sachs Economic Whitepaper that predicted U.S. second quarter growth to be 1% and forecasted the unemployment rate to remain above 7% until at least 2013.

In addition, Citigroup had a high exposure to sub-prime loans, and as a result of the Global Financial Crisis was forced to write down billions in bad debts, substantially impacting both its balance sheet and revenues. However, there has been a drop in provisions for credit losses, which has led to an improvement in results, as evidenced by the increase in second quarter earnings.

Citigroup has a strong management team dedicated to rebuilding the company, a broad and diverse global presence, solid performance indicators and growing quarterly revenues. When this is combined with the fact it is currently trading at a price below its book value of $60.33, it is understandable why Berkowitz has made a substantial investment in Citigroup. I rate Citigroup as a buy.

MBIA Inc (NYSE:MBI)

MBIA Inc. has a market cap of $1.53 billion, and no price to earnings ratio as it is operating at a net loss. For a 52 week period its trading range has been $5.99 to $14.96. Its last trading price was $7.75. It reported second quarter earnings for 2011 as $909.19 million, a substantial decrease from first quarter earnings of $2.08 billion. Second quarter net income was $450.85 million, a substantial decrease from first quarter net income of $1.29 billion. The company has quarterly revenue growth of -95.00%, a return on equity of -39.40% and doesn’t pay a dividend.

One of MBIA's closest competitors is Assured Guaranty Group (NYSE:AGO). Assured Guaranty last traded at $12.20 and has a market cap of $2.25 billion. It has a price to earnings ratio of 25.58, quarterly revenue growth of -81-80% and a return on equity of 2.33%. It pays a dividend with a yield of 1.50%. Based on these key performance indicators it is outperforming MBIA.

Berkowitz holds 46,832,270 shares of MBIA, purchasing 5,578,370 shares in second quarter 2011, adding to an existing holding of 41,253,900 shares. The average purchase price per share was $8.73. Based upon the last trade price of $7.75, he has made a return of -11.23%.

MBIA’s cash position has improved, its second-quarter 2011 balance sheet showed $1.36 billion in cash, an increase from $987.5 million in the first quarter. Its quarterly revenue growth rate of -95.00% is substantially lower than the industry average of 2.10%, and its return on equity of -39.40%, is greater than the industry average of 7.90%. Based on these performance indicators, MBIA is substantially underperforming many of its peers.

The earnings potential of companies generating revenue from the insurance and finance industries remains poor in the short term, due to tight credit markets and the worsening economic climate. Recently the U.S. Federal Reserve decided to keep interest rates extremely low for two more years, saying it expected the economy to remain weak for that period.

MBIA had a high exposure to collateralized debt obligations (CDOs) that it had insured and underestimated the probability of defaults on, undervaluing its insurance policies. The Global Financial Crisis forced MBIA to cover a large number of failed mortgage backed securities, directly affecting its balance sheet and profitability. As a result, MBIA is involved in costly litigation due to this and its decision to split its business between performing and non-performing assets.

However, MBIA is now the world's largest bond insurer, and financial guarantee company. If MBIA is able to successfully reduce its exposure to this litigation and capitalize on its dominant market position, there is a good chance that it can return to profitability. It is also currently trading at less than its book value per share of $9.56, representing an opportunity to invest in a substantially undervalued company. Any investment in MBIA is risky given its current financial situation, but I understand the calculated risk taken by Berkowitz. Accordingly, I rate MBIA as a speculative buy.

Vodafone Group Plc (NASDAQ:VOD)

Vodafone has a market cap of $142.35 billion and a price to earnings ratio of 11.55. Its 52 week trading range has been $24.31 to $29.75. Its last trading price was $27.60. It reported second quarter 2011 earnings of $18.33 billion, an increase from first quarter earnings of $17.80 billion. Second quarter net income was $335.5 million, a substantial decrease from first quarter net income of $5.94 billion. This can be attributed to a substantial write down in goodwill to the value of 4.72 billion, which was offset against income in the second quarter. Vodafone has quarterly revenue growth of 2.50%, a return on equity of 8.82%, and pays a dividend with a yield of 7.00%.

One of Vodafone’s closest competitors is Deutsche Telekom (OTCQX:DTEGY). Deutsche Telekom last traded at $12.91 and has a market cap of $56.16 billion. It has a price to earnings ratio of 31.88, quarterly revenue growth of -3.30 % and a return on equity of 3.75%. Deutsche Telekom doesn’t pay a dividend. Based on current performance indicators, Vodafone is performing on par with Deutsche Telekom, although it’s paying a higher yielding dividend.

Berkowitz holds 280,000 shares of Vodafone, having purchased the entire holding in second quarter 2011 at an average price of $28.00 per share. Based on the last trading price of $27.60, a return of -1.43% has been made.

Vodafone’s cash position has improved, the second quarter balance sheet showed $9.85 billion in cash, a substantial decrease from $14.35 billion for the first quarter. Vodafone’s quarterly revenue growth rate of 2.50% is less than the industry average of 22.30%, and its return on equity of 8.82%, is less than the industry average of 13.30%. This indicates that Vodafone is underperforming many of its peers.

The earnings growth outlook for the wireless communications industry remains positive even when considering the current economic uncertainty, low economic growth and high unemployment. This is primarily because it is a major infrastructure product for both developed and emerging countries. Accordingly, the industry is seen as a major driver of economic recovery through increased capital expenditure on key infrastructure. Vodafone also holds a dominant position in this industry as it is the largest industry participant by market cap. This provides it with the opportunity to use this size to leverage revenue growth. But historically it has consistently failed to leverage earnings growth from its dominant size.

Based on the poor performance indicators combined with the substantial drop in net income, I don’t agree with Berkowitz’s decision to purchase the stock. I believe there are better investment opportunities in the market sector and rate Vodafone as a hold.

Jeffries Group Inc (JEF)

Jeffries Group Inc has a market cap of $2.74 billion and a price to earnings ratio of 8.34. Its 52 week trading range has been $11.00 to $27.12, and its last trading price was $12.28. The company reported third quarter earnings 2011 of $1.17 billion, a substantial increase from second quarter earnings of $970 million. Third quarter net income was $68.30 million, a substantial decrease from second quarter net income of $80.60 million. This drop in net income can be attributed to an increase in interest expenses. The company has quarterly revenue growth of -12.20%, and is not generating a return on equity. Jeffries Group pays a dividend with a yield of 2.30%.

One of the Jeffries Group’s closest competitors is Piper Jaffray Companies (NYSE:PJC). Piper Jaffray’s last traded at $19.35, has a market cap of $307.01 million, and a price to earnings ratio of 10.82. It has quarterly revenue growth of 5.90%, a return on equity of 4.19% and doesn’t pay a dividend. Based on these performance indicators it is outperforming the Jeffries Group.

Berkowitz holds 4,123,711 shares of Jeffries Group, with 4,123,711 shares purchased in second quarter 2011. The shares were purchased at an average price per share of $22.58. Based on the last trade price of $12.28, this is a return of -45.62%.

Jeffries Group’s cash position has increased, its third quarter balance sheet showed $2.01 billion in cash, an increase from second quarter cash of $1.16 billion. With quarterly revenue growth of -12.20%, versus an industry average of 21.90%, and no return on equity, versus an industry average of 3.50%, it is substantially underperforming many of its peers.

The earnings outlook for companies operating in the investment management and financial advisory industry remains poor in the short term, due to the worsening economic climate, poor investment returns and high unemployment rate. Jeffries Group is currently trading at a price lower than its book value per share of $14.21, which does make it an enticing investment. When this is considered in conjunction with the increase in balance sheet cash and the recent drop in the stock price, which has created a buying opportunity, I agree with Berkowitz’s decision to purchase the stock. I rate Jeffries Group as a buy.

Bank of America Corporation (NYSE:BAC)

Bank of America Corporation has a market cap of $62.73 billion and does not currently have a price to earnings ratio as it is operating at a net loss. Its 52 week trading range is $5.13 to $15.31. Its last trading price was $6.19. It reported second quarter earnings 2011 of $19.04 billion, a substantial decrease from first quarter earnings of $32.62 million. Second quarter net income was -$8.83 billion, a substantial decrease from first quarter net income of $2.05 billion. It has quarterly revenue growth of -52.60% and a return on equity of -6.73%. Bank of America pays a dividend with a yield of 0.60%.

One of Bank of America´s closest competitors is JPMorgan Chase and Co (NYSE:JPM). JPMorgan last traded at $31.29 and has a market cap of $120.57 billion. It has a price to earnings ratio of 6.67, quarterly revenue growth of 3.60% and a return on equity of 11.28%. It currently pays a dividend with a yield of 3.10%. Based on these key performance indicators, it is outperforming Bank of America.

Berkowitz holds 99,647,755 shares of Bank of America, purchasing 6,999,040 shares in second quarter 2011, adding to an existing holding of 92,648,715 shares. The total share holding was purchased at an average price per share of $14.69. Based on the last trade price of $6.19, this is a return of -57.86%.

Bank of America’s second quarter 2011 balance sheet showed cash of $685.76 billion, an increase from first quarter cash of $662.37 billion. It has net tangible assets in the second quarter of $141.93 billion, a decrease from the first quarter of $147.45 billion.

Bank of America’s quarterly revenue growth of -52.60% versus an industry average of 10.40%, and a return on equity of -6.73% versus an industry average of 0.0%, demonstrates that it is under performing the majority of its peers.

Its stock price is currently being pushed lower by the market due to the poor outlook for the U.S. economy, with the U.S. Federal Reserve recently deciding to keep interest rates extremely low for two more years, saying “it expected the economy to remain weak for that period.” Bank of America’s stock price is also being punished by the market because of its troubled mortgage division, which has racked up billions of dollars in legal bills and is facing a nationwide investigation into its foreclosure practices. On face value it appears that any investment in Bank of America is risky.

However, Bank of America possesses a strong national franchise and is the largest bank in its industry by market cap. Its net tangible assets per share of $14.05 and book value per share of $20.29 are greater than its last trading price, indicating that Bank of America is heavily undervalued by the market and representing a good value investment opportunity. On this basis I agree with Berkowitz’s decision to invest in Bank of America, and rate it as a buy.

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