Pick Up Undervalued Financials - Barron's Interview

Barron's interviews Richard Pzena, founder of newly-public Pzena Investment Management (PZN). Shares of Pzena are down nearly 43% since going public two months ago, at least partially due to its fondness for financial stocks. Undaunted, Pzena says the current opportunity in financials is "as good as it gets."

Pzena says beaten government-sponsored mortgage lenders Fannie Mae (FNM) and Freddie Mac (FRE) are selling for a mere 25-30% their worth; he sees 3-4 fold upside once the market recovers from its mortgage-lender jitters. He notes the relative ease with which the firms were able to raise capital when needed, and says they stand to earn 25-40% on equity they issued at 8-9%.

While conceding consumer credit companies' earnings will drop on bigger loss provisions, he sees value in Capital One (COF), which today trades at "as good as it gets" 4-6x normal (non-crisis) earnings.

Among banks, Pzena questions whether Citigroup (C) should have lost $120 in market cap on an $8B CDO writedown. He notes the firm's strong international credit-card franchise. Investors willing to stomach short-term risk are getting a "really spectacular risk/reward trade." The same could be said about Bank of America (BAC). Lehman Brothers (LEH) and Morgan Stanley (MS) also look interesting.

Finally, he likes Alcatel-Lucent (ALU). Once the current price war on telecom equipment abates, and the company successfully integrates, "there is a lot of earnings power here."

Comments

[EffHugh:]

Does he back his conjecture with anything other than opinion? At some point he will be right but he's playing a dangerous game of bottom fishing. I think he underestimates the level of greed within these finance companies in terms of the bad positions in which they find themselves today. C is trying to sell white elephants to raise capital. Guess we'll see who's right. Myself I'm thinking of a short of the entire market as deflation is now starting to set in.

2007 Dec 30 05:20 PM

[Phil Anthropy:]

The only question is where the bottom will come. As a practical matter, the U.S. and the rest of the world cannot permit major financial institutions to go into Chapter 11. It would disturb the sacred cash cow. Therefore, the financials will indeed improve over the next few years, and probably very well, but I think it is important to take a cautious approach to putting on a position. I have tried unsuccessfully on several occasions recently to catch a bottom in Citigroup (C), and have taken losses in the process (could have been worse, but wasn't fun). The Cramer strategy of putting on 25% and then adding in increments (dollar cost averaging down, essentially) as the stock falls is one method. Another is to use technical indicators and charts to try and hit the bottom with precision, and then put in most of the marbles at that point, in hope of a rapid rally early next year. It is clear that tax loss selling will weigh on the financials throughout December. However, if they don't trend upwards in early January, then there is cause for concern that the recovery may take a long time, in which case there could be other investments with better returns and less risk.

2007 Dec 31 01:32 AM

[lefty:]

It will take years of profit just to pay the interest on citigroup's emergency bailout loan. Remember the terms?

2007 Dec 31 06:03 AM

[NARSpin:]

It's funny watching all the bottoom fishers for financials,commercial real estate and the such. The streets will be "littered with corpses" of these bottom fishers as the air slowly leaks out of the baloon.

2007 Dec 31 06:16 PM

[tjschoenlein:]

The way I see it you got the risk takers.. no risk takers and the fence riders.
It's true, the risk takers are often early to the party..
the no risk boys are always late.. and the fence riders are frozen to the fence and can't make a move.
Somebody is going to lose money.. the early boys will lose at first light and then make the big money.
The no risk boys will make some money but bail out to soon.. (make a little money )
The fence riders.. they just jaw bone waiting to fall off the fence and hope they make some money. ( seldom happens )
Me.. I like the early worm.

2007 Dec 31 08:03 PM

[miltyboy:]

ten different opions? seems prudent to do nothing.

2008 Jan 01 11:43 AM

[NoFate:]

There has not been a recent deal that didn't dilute stock price. Either there were additional incentives or the stock was just sold below market price. When big players start picking financials at market price with no side deals I might believe its a bottom. They are just trying to stay solvent at the moment.

The other thing to watch is the ARM resets. The worst 6 months just started ...after more foreclosures we will see how bad their mark to model calculations really are. Until then you are bottom fishing in the dark (...don't grab a shark!).

Three words if you believe this article ..."Sold to YOU!"

2008 Jan 01 09:37 PM

[SmartGuySto...:]

Agreed. When the main thesis is "the government won't let these companies go bust," we are still going down because supporters are simply saying "these companies are not allowed to go to die and go to zero." But there's a lot of numbers in between today's prices and zero ... why take a guess when the turnaround will provide enough trading gains for everyone patient enough to wait?

For more rebuttal of Pzena's pass-the-bag puff piece in Barron's and related issues, please check out my latest article:

smartguystocks.com/?p=...

2008 Jan 03 02:40 PM

[pochovilla:]

Let's see. Take the advice of Penza, lose 43% of your "investment" and this is a good as it gets. Where do I sign up?

2008 Mar 04 08:02 AM