By Matt Doiron
David Tepper is the manager of $16 billion Appaloosa Management and one of the Forbes 400. Appaloosa makes many of its equity investments in value stocks, as we noted in our analysis of the fund's 13F filings for the second quarter (see Appaloosa's favorite stocks). A number of the fund's top positions were remarkably low priced compared to their trailing earnings. We have gone through our database and found three stocks which trade at trailing P/E multiples of more than 20, but Appaloosa reported a position worth over $50 million in anyway, implying that the fund considers them undervalued:
Appaloosa added slightly to its stake in Broadcom (BRCM), a semiconductor and chip company which contributes to broadband, wireless, and Ethernet communications systems. The fund now owns 2.5 million shares. Broadcom's margins fell in its most recent quarter compared to the same period in the previous year, and as a result the company's 10% gain in revenue became a 9% decrease on the bottom line. Wall Street analysts believe that the company is in for strong performance, and the forward price-to-earnings multiple is only 11 with the five-year PEG ratio being 0.8. Given this, it's possible to understand why Tepper and his team are buying the stock: they have looked at it and their outlook matches those of the sell-side analysts, and so they expect future growth to prove the current stock price too low. Billionaire Jim Simons has a large position in BRCM (see Jim Simons' top holdings).
The fund's holdings of EMC (EMC) increased 66% in the second quarter to 2.7 million shares. EMC is a $55 billion market cap data storage and information security company, and again sell-side expectations are that if pricing holds constant the P/E multiple will slip into value territory in the medium-term future: based on earnings projections for 2013, the company's forward P/E is 13. Looking out over the longer term, earnings estimates imply a reasonable five-year PEG of 1.1. In this case, EMC has been delivering on this growth: earnings last quarter rose 19% compared to a year ago, driven about equally by margin expansion and 10% revenue growth. EMC has at least met earnings expectations for four quarters in a row, potentially making investors more confident in the future numbers.
Masco (MAS), a home improvement manufacturer, was another moderately-sized Appaloosa position which doesn't conform to value orthodoxy in terms of its price compared to historical financials. The company's products include cabinets, faucets, and showerheads, and other segments of the company engage in activities such as installing these products or providing paint and primer. The fund reported owning 3.8 million shares of the stock at the end of June. Possibly because of its exposure to the housing market as well as demand for home renovations (the stock's beta is 1.9), the sell-side is not as optimistic about this one at a forward P/E of 25. However, investors have been pushing up stock prices of housing-related companies such as homebuilders and Masco, up 26% this year, is not an exception. Billionaire Louis Bacon initiated a new position in MAS during the second quarter (see Louis Bacon's new stock picks).
There seem to be strong expectations, both within Appaloosa and on the Street, that Broadcom will bounce back harder than these other two companies. However, we think that EMC is actually the best buy as it is already on a growth track, and certainly we would likely be able to come up with a number of traditional value stocks that provide better investment opportunities than Broadcom solely based on current financials. Masco looks overpriced thanks to its rally thus far in 2012 but it has not risen as much as homebuilders. Perhaps a close evaluation of housing-dependent stocks would generate opportunities to pair trade Masco against other companies with similar demand drivers but higher valuations.