Billionaire Richard Pzena's 5 Newest Portfolio Picks

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Includes: ABT, AIG, BEN, ETR, SKX
by: Investment Underground

by Matthew Smith

Richard Pzena is the Founder and Co-Chief Investment Officer of Pzena Investment Management, LLC, which has more than $24 billion under management. His investment philosophy is based on ranking companies from the cheapest to the most expensive on the basis of current stock price compared to normal long-term earnings power. Pzena takes a value approach when stock picking, focusing on making investments in good businesses that are undervalued by the market and have a low stock price when compared to their earnings potential. This has seen him take a relatively bullish position on financial sector stocks. Among his latest buys, here are the only ones selling at a discount to fair value:

American International Group (NYSE:AIG)

American International Group has a market cap of $42.35 billion with a price to earnings ratio of 5.41. Its 52 week trading range has been between $19.18 and $62.87, and at the time of writing it was trading at around $23. It reported third quarter 2011 earnings of $12.72 billion, a decrease from second quarter earnings of $16.68 billion. The income statement showed a net loss in the third quarter of $-4.11 million, a significant decrease from the second quarter net income of $1.84 million. It has quarterly revenue growth of -34.60%, a return on equity of 6.63% and does not pay a dividend.

One of AIG´s competitors is Allianz SE (OTCQX:AZSEY). Allianz SE has a market cap of $47.06 billion and is trading at $10.42. It has a price to earnings ratio of 8.19 and quarterly revenue growth of -1.60%. It generates a return on equity of 9.79% and doesn´t pay a dividend. This data indicates that Allianz SE is outperforming AIG.

Richard Pzena holds 7,718,609 shares of AIG, buying the entire holding in second quarter 2011. The average purchase price per share was $30.43. Based upon the last trading price around $23, he has made a return of -24.22%.

AIG´s cash position has worsened in the last quarter. Its balance sheet showed $1.54 billion in cash for the third quarter, a decrease from $2.59 billion cash in the second quarter. AIG’s quarterly revenue growth of -34.60%, versus an industry average of 2.70%, and a return on equity of 6.63%, versus an industry average of 7.90%, indicates that it is underperforming many of its peers.

The earnings outlook for the Property and Casualty Insurance industry is negative, primarily due to the poor economy, which has led many consumers and businesses focusing on reducing costs through removing what they perceive to be non-necessary expenditure. In many cases this is through allowing insurance policies to lapse, reducing cover or carrying the risk themselves. As Ernst and Young highlighted in a recent report, this has led to a reduction in net -premiums for property-casualty insurers, fostering declines in industry revenues and earnings.

AIG suffered significant losses as a result of holding large investments in toxic collateralized debt obligations (CDOs), which saw it brought to the brink of collapse during the GFC. This saw it become the subject of a U.S. Government bailout, in an attempt the keep the company solvent and allow it to continue to trade. In addition, it continues to face significant threats to its business model, customer base and distribution network as a result of volatile financial drivers and intense competition in the property and casualty insurance market.

When this is taken into account in conjunction with the negative industry outlook, its poor performance indicators decreasing net income and cash holdings, I prefer to take a wait and see approach. Accordingly, I do not agree with Pzena’s decision to purchase a stake in the company and rate AIG as a hold.

Franklin Resources Inc (NYSE:BEN)

Franklin Resources has a market cap of $21.54 billion with a price to earnings ratio of 12.48. Its 52 week trading range was between $87.71 and $137.56, and it is currently trading at around $104. It reported second quarter 2011 earnings of $1.84 billion, an increase from first quarter earnings of $1.74 billion. The second quarter net income was reported at $503.35 million, an increase from first quarter net income of $503.10 million. It has quarterly revenue growth of 20.20%, a return on equity of 22.01% and pays a dividend with a yield of 1.00%.

Franklin Resources’ closest competitors is Trowe Price Group (NASDAQ:TROW). Trowe has a market cap of $13.73 billion and is trading at around $54. It has a quarterly revenue growth of 15.90% and a price to earnings ratio of 18.61. It generates a return on equity of 24.52% and does not pay any dividend. Based on these indicators, Trowe appears to be slightly outperforming Franklin Resources.

Richard Pzena holds 523,616 shares of Franklin Resources, buying the entire holding in second quarter 2011. The average purchase price per share was $125.32. Based upon the last trading price of $104, he has made a return of -17.01%.

Franklin Resources’ cash position has increased with $4.72 billion in cash for the second quarter 2011-- an increase from $4.67 billion cash in the first quarter. The net tangible assets have increased to $6.60 billion in the second quarter from $6.33 billion in the first quarter. Franklin Resources’ quarterly revenue growth of 20.20%, versus an industry average of 22.70%, and a return on equity of 22.01%, versus an industry average of 10.30%, indicates that it is outperforming many of its competitors.

The outlook for the Asset Management industry is currently quite positive, with asset managers having improved their earnings capability. This is coupled with the view that they are less exposed to regulatory reform than other sectors within the Financial Services industry, thus lessening their exposure to costly operational structural changes. This is supported by Moody’s who have revised their overall outlook for the industry from negative to stable on this basis. However, the current market volatility triggered by the eurozone crisis and weak U.S. economy is affecting portfolio valuations and creating negative investor sentiment, which is having some impact on the asset management value chain and affecting future profitability.

Based on the relatively positive industry outlook, coupled with solid performance indicators and the slight increase in its net income and cash holdings, I understand Pzena’s decision to invest in this stock. Accordingly, I rate the company as a buy.

Skechers USA Inc (NYSE:SKX)

Skechers USA has a market cap of $618.14 million and does not have a price to earnings ratio. Its 52 week trading range has been between $12.81 and $23.75 and it is trading at around $12.50. Third quarter 2011 earnings of $412 million were reported, a small decrease from second quarter earnings of $434 million. The third quarter net income was $8.29 million, a significant increase from the second quarter net loss of $29.92 million. It has quarterly revenue growth of -25.70%, a return on equity is -0.65% and doesn´t pay a dividend.

One of Skechers USA’s closest competitors is Steve Madden Ltd (NASDAQ:SHOO), which has a market cap of $1.5 billion and last traded at $35. It has a quarterly revenue growth of 70.50% and a price to earnings ratio of 16.86. It generates a return on equity of 23.30% and does not pay a dividend. Based on this data, Steve Madden is outperforming Skechers USA Inc.

Richard Pzena holds 2,259,820 shares of Sketchers USA, buying the entire holding in the second quarter 2011.The average purchase price per share was $17.43. Based upon the last trading price of $12.58, he has made a return of -27.82%.

Skechers USA’s cash position has declined with the balance sheet showing $247.97 million in cash for the third quarter, a decrease from $250.78 million in the second quarter. The net tangible assets have slightly decreased from $904.96 million in the third quarter 2011 to $901.96 million in the second quarter. Skechers USA’s quarterly revenue growth of -25.70%, versus an industry average of 9.20%, and a return on equity of -0.65%, versus an industry average of 19.90%, indicates that it is underperforming many of its competitors.

The earnings outlook for the Textiles and Footwear Apparel industry is subdued due to the poor economic climate, high unemployment and negative consumer sentiment. However, despite the negative industry outlook, Sketchers USA has reported a significant increase in net income in a difficult operating environment. However, due to its poor performance indicators, I do not feel that the company has strong earnings growth prospects until there is a substantial uplift in the economy. On this basis, I do not agree with Pzena’s decision to invest in the stock . I would recommend taking a wait and see approach prior to making any investment in this company. Accordingly I rate the company as a hold.

Abbott Laboratories (NYSE:ABT)

Abbott Laboratories has a market cap of $83.05 billion, it has a price to earnings ratio of 18.81. Its 52 week trading range has been between $45.07 and $55.61 and it’s trading at around $54. It reported third quarter 2011 earnings of $9.82 billion, an increase from second quarter earnings of $9.62 billion. Third quarter net income was $303.18 million-- a significant decrease from the second quarter net income of $1.94 billion. It has quarterly revenue growth of 13.20%, its return on equity is 19.71% and it pays a dividend of 3.50%.

One of Abbott Laboratories' main competitors is Merck & Co Inc (NYSE:MRK). Merck & Co has a market cap of $110.82 billion and last traded at $35.97. It has quarterly revenue growth of 8.10% and a price to earnings ratio of 26.37. It does not generate a return on equity and pays a dividend with a yield of 4.30%. Based on these indicators Abbott Laboratories is marginally outperforming Merck & Co.

Richard Pzena holds 6,320,870 shares of Abbott Laboratories, buying 4,306,477 shares in the second quarter 2011, adding to the 2,014,393 shares bought in the first quarter 2011. The average purchase price per share was $50.47. Based upon the last trading price around $55, he has made a return of 7.35%.

Abbott Laboratories' cash position has improved. The balance sheet showed $5.05 billion in cash for the third quarter 2011, an increase from $4.08 billion in the second quarter. The net tangible assets have decreased to $-2.42 billion in the third quarter 2011 from $-2.12 billion in the second quarter. Abbott Laboratories' quarterly revenue growth of 13.20%, versus an industry average of 10.50%, and a return on equity of 19.71%, versus an industry average of 15.80%, indicates that it is outperforming many of its competitors.

The earnings outlook for companies in the drug manufacturing industry is currently subdued, due to the poor economy and high unemployment. Moody’s has stated; “that many drug manufacturers have found 2011 to be a challenging year, although they have been able to offset declining revenue growth with price increases in the U.S. and revenue from emerging markets.” Moody’s believes that 2012 will be an even more challenging year for participants in this industry.

Despite Abbott Laboratories' solid performance indicators, I do not agree with Pzena’s decision to make a further investment in the company due to its substantial decrease in net income and the negative industry outlook. Accordingly, I rate Abbott Laboratories as a hold.

Entergy Corporation (NYSE:ETR)

Entergy has a market cap of $12.12 billion, it has a price to earnings ratio of 8.83. Its 52 week trading range has been between $57.60 and $74.50, and it is trading at around $70. It reported third quarter 2011 earnings of $3.40 billion, a significant increase from second quarter earnings of $2.80 billion. The third quarter net income was $628 million a very large increase from the second quarter net income of $316 million. It has quarterly revenue growth of 1.90%, a return on equity of 15.51% and pays a dividend with a yield of 4.70%.

One of Entergy Corporation’s main competitors is American Electric Power Company (NYSE:AEP) which has a market cap of $19.08 billion and last traded at $39.52. It has quarterly revenue growth of 6.60% and a price to earnings ratio of 10.51. It generates a return on equity of 10.83% and pays a dividend with a yield of 4.80%. Based on these indicators, Entergy and American Electric are performing on a par.

Richard Pzena holds 2,747,956 shares of Entergy, buying 2,633,431 shares in the second quarter 2011, adding to the 114,525 shares purchased in the first quarter. The average purchase price per share was $68.22. Based upon the last trading price around $70, he has made a return of 2.26%.

Entergy’s cash position has almost doubled in the last quarter. The balance sheet showed $1.03 billion in cash for the third quarter of 2011, an increase from $563.80 million in the second quarter. Entergy quarterly revenue growth of 1.90%, versus an industry average of 7.50%, and a return on equity of 15.51%, versus an industry average of 7.10%, indicates that it is outperforming many of its competitors.

The earnings outlook for the Electric Utilities industry has been forecast as stable as the demand for energy by business and consumers is relatively inelastic, although obviously-- as some businesses reduce production due to a drop in demand triggered by the poor economic outlook, consumption will decrease. This positive outlook is further supported by low prices, abundant supplies of natural gas and power, low interest rates, and open capital market conditions, keeping costs low and supporting earnings growth.

Based upon the substantial increase in quarterly net income and balance sheet cash combined with the positive industry outlook, I agree with Pzena’s decision to increase his holding in Entergy. Accordingly, I rate the company as a buy.

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