By Guan Wang
Bruce Berkowitz's Fairholme was one of the best performing funds in 2012 (check out the whole list of best performing funds). Berkowitz, who had founded Fairholme in 1999, managed to outperform the market every year except in 2003, until 2010. Thanks to his consistently strong performance, he was named "Stock Manager of the Decade" by Morningstar. Berkowitz suffered a huge loss of 34.9% in 2011, a year the whole hedge fund industry struggled, but he has started to reverse his loss over the past few months.
Recently, Berkowitz released his 13F holdings as of March 31, 2012 (check out Bruce Berkowitz's top stock picks). Is he likely to continue beating the market and other hedge funds in the year ahead? Let's take a closer look at his large bullish bets.
The largest positions in Berkowitz's portfolio have not changed much when compared with his holdings at the end of the previous quarter. The largest three positions at the end of March were the same as at the end of December - American International Group (AIG), Sears Holdings Corp (SHLD), and Bank of America Corp (BAC).
AIG is Berkowitz's largest holding. As of March 31, 2012, Berkowitz had $2.82 billion invested in AIG stock and $261 million in AIG warrants, with an exercise price of $45. Hedge fund interest in AIG has been growing. At the end of March, there were 45 hedge funds with AIG positions in their 13F portfolios, up from 21 hedge funds at the end of 2011. Leon Cooperman's Omega Advisors initiated a new $45 million position in AIG during the first quarter (see Leon Cooperman's top stock picks). Israel Englander and Larry Robbins are also bullish about AIG.
In addition to hedge fund managers, corporate insiders are also purchasing AIG stocks. In early May, three insiders collectively bought over 20,000 shares of AIG at prices ranging from $31.68 to $31.82 per share. Currently, AIG is trading at $29.62 per share, so these insiders have lost some money so far, but we think their purchases will outperform the market over the long term.
We think the market is over-concerned about AIG's high risk and lack of flexibility of cash usage as it has to pay back government bailout loan. Right now, AIG is trading at 8X its 2012 earnings, versus the industry average of 10. The company has also been continuously reducing its debt by buying back its shares from the Treasury. In early May, the Treasury announced that it plans to sell another $5.8 billion of AIG shares, reducing its stakes in AIG to 61%.
Bank of America Corp is another large financial position in Berkowitz's portfolio. At the end of the first quarter, Berkowitz had $984 million invested in BAC stocks and another $45.5 million invested in its warrants with an exercise price of $13.3. BAC is one of the most popular financial stocks amongst the hedge funds we track. In fact, there were 87 hedge funds with BAC positions at the end of the first quarter.
Besides Berkowitz, John Paulson and David Tepper are also bullish about BAC. Paulson had $147 million invested in this stock at the end of March while Tepper initiated a new $71 million position in the company during the first quarter (check out John Paulson's top stock picks).
Like AIG, BAC is well-favored by corporate insiders. For instance, Director Donald Powell purchased 10,000 shares of BAC stocks in early May at around $8 per share. Most financial stocks have not done well over the past few weeks, including BAC - it is now trading at $7.09 per share - but we think it is a good option for long-term investment. Analysts expect the company to make $0.64 per share in 2012 and $1.08 per share in 2013. The estimation is somewhat conservative, but it still leads to a low 2013 P/E ratio of 6.56. Additionally, we believe the stock is not as risky as most people think. The company's capital ratios and credit quality are both steadily improving. For the first quarter of 2012, the company reported Tier 1 common equity ratio of 10.78%, up 92 bps from the same quarter last year.
Berkowitz also had over $1 billion invested in Sears at the end of March after he boosted his stakes in the company by 4% during the first quarter. Sears has returned a stunning 79% so far this year, beating the market by 73 percentage points. Despite that, we do not recommend investors purchase Sears. The company is expected to experience lower sales over the next few years and continue to produce negative earnings. Analysts estimate its 2012 EPS to be -$1.94 and its 2013 EPS to be -$3.33.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.