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Stocks You Can Buy Cheaper Than Bruce Berkowitz: AIG.WS, MBI, CSCO, C, GS

June 17, 2011 | About:
Holly LaFon

Holly LaFon

249 followers
Bruce Berkowitz is considered one of the greatest investors of our time. He manages the Fairholme Fund, which has returned 196% over the last 10 years, compared to the S&P 500 Index’s return of 16.4%. Even though Berkowitz tends to make excellent stock picks, sometimes gurus buy a little early. That is why GuruFocus has introduced the GuruFolio Report which highlights the stocks gurus recently purchased that have since gone down in price.

Right now, you can get the following stocks for even cheaper than Bruce Berkowitz did: (AIG.WS), (MBI), (CSCO), (C) and (GS), according to the GuruFolio Report for Bruce Berkowitz.

AIG Warrants (AIG.WS)

American International Group Inc. is a world leader in insurance and financial services. It is an international insurance organization with operations in more than 130 countries and jurisdictions. American International Group Inc. has a market cap of $53.18 billion; its shares were traded at around $28.04 with and P/S ratio of 0.8.

AIG is the top holding of Bruce Berkowitz, accounting for 10.76% of his portfolio. In addition to his common shares, he owns 23,722,000 AIG warrants. Technically, Berkowitz got the warrants for free, as they were issued by the company in January to existing shareholders. AIG issued the warrants in order to help recapitalize after coming to the brink of bankruptcy during the credit crisis of 2008.

The warrants are available to other investors and are listed on the NYSE. Each warrant entitles the holder to purchase one share of AIG’s common stock at an exercise price of $45 per share through Jan. 18, 2021.

Bruce Berkowitz received the warrants when they were trading around $15 per share. On Friday, AIG warrants traded for $9.14 per share.

AIG generated net income of $16.6 billion in 2010, down slightly from $18 billion in 2009. In the first quarter it lost $5.3 billion, mainly due to major expenses incurred by several natural disasters around the world. The company also had to pay the last $3.3 billion charge for paying back its debt to the Federal Reserve Bank of New York more than two years early. The government still owns more than 70% of AIG.

“If you can buy a great story name at half book value and a significant discount to tangible book value, well, what more do you need?” Berkowitz said of AIG on Bloomberg TV in June.

MBIA Inc. (MBI)

MBIA Inc. is a holding company with subsidiaries that provide financial guarantee insurance, fixed-income asset management and other specialized financial services to clients around the world. MBIA Inc. has an enterprise value of $22.5 billion; its shares were traded around $8 with a P/S ratio of 1.8.

Berkowitz has been adding to his MBIA stake since the second quarter of 2010, when the average price was $7.65. By the end of the first quarter of 2011 he owned 41,253,300 shares and average price was $11.27. Since he bought the purchase price has declined 28.7%.

Witney Tilson has made a significant profit on the price decline as he shorted the stock this year, he reported in his May letter.

The net loss to common shareholders for the first quarter of 2011 was $1.1 billion, or $5.68 per share, compared with a net loss of $1.5 billion, or $7.22 per share, in the first quarter of 2010. The net loss in the first quarter of 2011 was driven primarily by a $1.3 billion pre-tax unrealized net loss on the fair value of insured derivatives resulting primarily from an improved market perception of MBIA Corp.'s credit quality. MBIA also has a gross margin and operating margin of 74% and 32.2% respectively.

Cisco Systems (CSCO)

Cisco Systems Inc. is the worldwide leader in networking for the Internet. Cisco Systems Inc. has a market cap of $83.2 billion; its shares were traded at around $15.05 with a P/E ratio of 10.4 and P/S ratio of 2.1. The dividend yield of Cisco Systems Inc. stocks is 1.6%. Cisco Systems Inc. had an annual average earnings growth of 23% over the past 10 years. GuruFocus rated Cisco Systems Inc. the business predictability rank of 2.5-star.

Berkowitz bought shares of Cisco for the first time at about $19.50 per share in the first quarter 2011. The price has since declined 22.8% to $14.97. He owns 35,818,600 shares.

Cisco is a stock many gurus are piling into. In mid-2000, near its peak, Cisco traded around 120 times earnings and had the second largest market cap of any company in the United States at over $500 billion. Today its market cap is much smaller, but is still double that of its top 11 North American competitors.

Cisco is planning possibly the biggest round of layoffs in its history, cutting up to 4,000 jobs in an attempt to cut costs by $1 billion. It has maintained steady free cash flow and net income in the last several years. In 2010 it generated $9.2 billion, increased from $8.9 billion in 2009. Net income was $7.8 billion, also up from $6.1 billion in 2009. Nevertheless, on Cisco’s third-quarter 2011 conference call, CEO John Chambers said of earnings, “As a result, while Q3 met expectations, Q4 will continue to show weakness, while we do hard work behind the scenes to be able to execute these changes. And we will provide for Q4 guidance that reflects that lag.”

Chambers also noted that it will have to overhaul its business dramatically to maintain its market position, which will take time.

Citigroup (C)

Citigroup Inc., the global financial services company, has some 200 million customer accounts and does business in more than 100 countries, providing consumers, corporations, governments and institutions with a broad range of financial products and services, including consumer banking and credit, corporate and investment banking, securities brokerage, and wealth management. Citigroup Inc. has a market cap of $109.35 billion; its shares were traded at around $37.63 with a P/E ratio of 12.1 and P/S ratio of 1.3. The dividend yield of Citigroup Inc. stocks is 0.1%.

Citigroup is the fourth largest holding of Bruce Berkowitz. He bought 2,130,560 shares in the first quarter at an average price of $47.20 per share. The share price has declined 20.4%, and investors can now buy Citigroup stock for about $38.27.

The bank’s share price continues to fall due to various factors, including uncertainty as to when the financial sector will rebound and the ramifications of the end of QE2. Nobody can say for sure when bad loans will be off of the bank’s books, either.

“How can you not buy companies selling tangible book value that are essential to the country?” Berkowitz said of his financial stocks in a June interview with CNBC.

Citigroup generated $35 billion in free cash flow in 2010, dramatically increased from a loss of $50 billion in 2009. Net income was also up to $10.6 billion from a net loss of $1.6 billion in 2009. Citicorp end of period loans grew 10% year over year, with 6% growth in consumer loans and 16% growth in corporate loans.

The Goldman Sachs Group Inc. (GS)

Goldman Sachs is a global investment banking and securities firm, providing a full range of investing, advisory and financing services worldwide to a substantial and diversified client base, which includes corporations, financial institutions, governments, and high net worth individuals. The Goldman Sachs Group Inc. has a market cap of $70.46 billion; its shares were traded at around $136.09 with a P/E ratio of 12.3 and P/S ratio of 1.8. The dividend yield of The Goldman Sachs Group Inc. stocks is 1%. The Goldman Sachs Group Inc. had an annual average earnings growth of 9.8% over the past 10 years.

Bruce Berkowitz bought Goldman Sachs stock in the first quarter 2011 at $164.50 per share, and it has since declined 17.3% to $137.23. He has owned shares since the second quarter of 2010, when he paid approximately $148.40 per share.

Goldman Sachs had net income of $8.4 billion in 2010, down from $13.4 billion in 2009, but strong compared to its previous years. Operating earnings, which some analysts say are a good indicator of whether a bank is improving, have fallen every year since 2007, amounting to $19.7 billion in 2010.

The New York Times reported that Goldman plans to cut 10% or $1 billion of noncompensation expenses over the next 12 months, which will include layoffs.

The firm’s non-compensation expenses for the first quarter 2011 also increased 23% since the quarter prior. The increase compared with the first quarter of 2010 reflected the impact of impairment charges of approximately $220 million related to assets classified as held for sale during the first quarter of 2011, primarily related to Litton Loan Servicing LP, the firm’s residential mortgage servicing subsidiary. The remainder of the increase compared with the first quarter of 2010 generally reflected increased levels of business activity, including higher operating expenses related to the firm’s consolidated entities held for investment purposes. The first quarter of 2011 also included net provisions for litigation and regulatory proceedings of $24 million.

You can find more Bargain Candidates of Bruce Berkowitz or any other guru that we track at GuruFocus in our newly released GuruFolio Report. Premium members can download these reports for free; non-members can buy them for $9.99 per report.


Rating: 4.2/5 (16 votes)

Comments

dealraker
Dealraker - 3 years ago
I was an original investor in Fairholme but sold a few months ago. Didn't sell because of stock selection, but it seems- and I don't know for sure- that Bruce used to be in the investment business but he gravitated to the marketing business. It is a gut feeling only. So far it looks right.

Time will tell.

My guess is that now, with the huge inflows of investors, most investors with Bruce have lost money.
jonmonsea
Jonmonsea premium member - 3 years ago
I am adding to my Fairholme stake because the underlying securities have dropped in value and he is sitting on a lot of cash. My thinking is that he will not have to sell out of the financials until he turns a profit (BAC at $115 billion? In ten years, it could triple. Or not. But what is long-term downside when almost a trillion of deposits are on the balance sheet and inflation looks likely? 50% downside? Seems like a good bet. I'm curious to know what people think) and I am willing to wait. Aside from micro-caps, what offers better risk-reward than major financials?

rjstcr
Rjstcr premium member - 3 years ago
Dealraker, I also started investing when FAIRX was in the mid 12s on up to low 20s. I sold about 60% at about 33-34 this year. I really think he's good but I didn't like him taking up his time messing with St Joe. He had done so well with just sticking to his original investment plan I just didn't like him changing. He may do well in Joe but It's such a long term thing til housing, commercial prices get going again I think. Of course I guess you have to buy sometimes when blood is running.

I also put money into his fixed income fund. Saw he was only buying at this time dividend paying stocks. So I sold, saved the fee and bought some of them myself.

Jonmonsea, I agree with your thoughts on the financials. But why not buy them yourself? If you are willing to hold Fairholme that long because of them why not the individual one's? This type cycle with these has happened before. I bought BAC, C, and some small regionals that were knocked down and yet were pretty conservative. I've done this before.

Just like some years ago oil was down to $16.00 or so and nobody wanted them you could selectively buy, hold on and then wait. Or right now some are buying Japanese stocks. I'm not because it's over my head. But you don't have to have too many of these and then be patient.

Sivaram
Sivaram - 3 years ago


JONMONSEA: "Aside from micro-caps, what offers better risk-reward than major financials?"

I know a lot of value investors are overloading on financials but the big risk with them is that they may enter a secular decline due to a shrinking financial services sector. Americans (and others in many developed countries) are overloaded with debt and chances are they will cut back on debt. Banks made a lot of money from the increase in credit card debt, mortgages, auto loans, etc over the last 30 years but there is a real risk the whole consumer finance area will shrink. Although this is just a guess on my part, I do think it is a real possibility if interest rates start rising (i.e. bond market, which has been in a 30 year bull market, enters a bear market).
jonmonsea
Jonmonsea premium member - 3 years ago
Sivaram's point is what troubles me about FAIRX and I agree, but I think this may be a case of macro concerns clouding real value. If, for example, BAC has $115 billion in equity and it earns 8% on that equity and it is selling for $115 billion, should one not invest because the consumer is overleveraged? Won't people still have to borrow money and deposit it? Does that general macro scenario imply an erosion of pre-existing equity? I think the case is not strong over the long term for permenantly impaired financials. Don't Citi and Merrill Lynch have overseas offices? I think a more controversial position is MBIA, which I do not understand. Anyone feel strongly either way?
rgosalia
Rgosalia - 3 years ago
Sivaram,

There are many risks in investing in the big financials today, but the one you site, in my opinion is already discounted for at today's price.

Take the example of Bank of America which is trading at P/B of 0.5. Now, let's say that the situation you describe plays out and BAC's asset base halves from 2T today to 1T (is that drastic enough?)

Now, say that the new regulations limit bank's leverage to 10 to 1 (also quite drastic unless you believe that fractional banking system is going to die). I think that the banks have enough scale to ensure that their ROA stays at or above 0.8%.

At half the book of today, BAC will make 1T*0.008*10 = 80B. That is a 4% return on the book today of 2T, but a 8% return on your investment given that you are investing at 0.5 today's book. Essentially, the price you are paying already discounts the possibility that you are siting and some more. Do you really think that the financial sector is going to shrink to more than half the size today? How about it goes to quarter - you still get 4% return.

Having said that, I am staying out of big financials, but not for the reason you site. It's easier to analyze the smaller banks that are also going at discount, so why mess with the ones that I do not understand.

- Rishi
rgosalia
Rgosalia - 3 years ago
Jonmonsea,

If you are willing to look at big financials, why not look at the small ones? Many of the thrifts that have recently undergone conversion are very attractive too. They are trading at deep discount to their book value too. Besides, they have fewer moving parts and are easier to understand - they borrow at 2, lend at 3, and go home at 4.

If you are not familiar with thrift conversions, I recommend you read Seth Klarman's Margin of Safety. He has has a few pages on his investments in thrift conversions in the early 90s.

This was a very active area for value investors in the 90s after the real-estate bubble burst. Then, as other discovered it, it became difficult to find value. However, this time around, the situation is different. Thrifts are converting because the thrift regulator is changing to a more stricter one. Also, by becoming public, bank executives who have been at these thrifts for all their life get a chance to monetize their efforts. Unlike the Pandora IPO where insiders benefit at the cost of outsiders, during a thrift conversion, the IPO price is quite undervalued to the book value. So, even outsiders can benefit.

Why would everyone not jump in? These banks are usually small - so institutions are not very interested especially because even the big banks are at discount and they can put a lot of money to work in the big financials. Good for us who have smaller capital to work with.

I don't want to make recommendations - the daily volume on these banks is very low and I am still acquiring my position - but I would be happy to answer any general questions that you may have.

- Rishi
gurufocus
Gurufocus premium member - 3 years ago
Peter Lynch discussed small banks (S&L) is his books, too. Those are great books.
Sivaram
Sivaram - 3 years ago


JONMONSEA: " If, for example, BAC has $115 billion in equity and it earns 8% on that equity and it is selling for $115 billion, should one not invest because the consumer is overleveraged? Won't people still have to borrow money and deposit it? Does that general macro scenario imply an erosion of pre-existing equity? "

I don't really follow financials and am not too knowledgeable about any speficific ones. Having said that, to answer your questions...

The fact that people have to borrow money and deposit it doesn't mean much. Banks make money off lending and other related activities. Everyone could still be using banks for basic chequeing/deposits/etc and I can see the banks' profits dropping if consumer debt usage declines. People in Japan still use banks as others in developed countries but Japanese banks haven't done so well in the last decade (yes, their problems were far worse and I'm not saying the same thing is going to happen here but just pointing out that loans are what matter).

I think the big risk for banks is twofold. First of all, their equity may or may not have enough cushion to absorb future losses, say from bad credit card loans, or foreign losses (e.g. Greece -- some estimates say indirect American bank exposure (probably due to writing CDS and the like) is around billion. Imagine bigger countries). This is a judgement call you need to make. The market is pricing many banks at or below book value so there is some cushion there but I don't know how good the reported book value is.

Even if the asset base is sufficient to absorb losses, which may be the case for some banks, the other risk I see is that the return on equity can drop. If you look at Bank of America, its ROE was around 17% pre-2007 and if it drops to 8% permanently, how is the market going to treat that? If you buy it at a price/book of 0.5, you will still earn 16% but I suspect the valuation for the company, which is really a leveraged black box, will remain lower.

I'm not arguing that finacials are necessarily a bad purchase here; all I'm saying is that they are not as obvious as some value-oriented investors make them out to be.



JONMONSEA: "I think the case is not strong over the long term for permenantly impaired financials."


If I'm not mistaken, this is the argument Bruce Berkowitz and a few others have made. I agree that it is hard to see limping banks if the economy recovers. But the problem with this argument is that it is quite possible that USA and other developed countries--we haven't even seen what's going to happen in Europe--don't recover strongly for several years. The current problems are unlike what happened during the Savings & Loan crisis from the late 80's/early 90's yet many are assuming a repeat of that is going to occur.

To sum up, if you do believe in a strong recovery then banks are a good bet. Otherwise I just don't see banks doing so well for the next decade or longer.
Sivaram
Sivaram - 3 years ago
RGOSALIA: "At half the book of today, BAC will make 1T*0.008*10 = 80B. That is a 4% return on the book today of 2T, but a 8% return on your investment given that you are investing at 0.5 today's book. Essentially, the price you are paying already discounts the possibility that you are siting and some more. Do you really think that the financial sector is going to shrink to more than half the size today?"

In the gloomy scenario you outlined (50% shrinking) then a leveraged company, which is largely in a black box, earning 8% is that attractive. Given how returns on bonds and several other assets are really low, some relative value investors may buy those companies but as a standalone investment, they are not attractive.

I don't know if the financial sector is going to shrink 50% but I do think it will be smaller 10 years from now than now.
rjstcr
Rjstcr premium member - 3 years ago
One more point about banks. I'm reading up because I'm not terribly knowledgeable. It looks like whenever inflation picks up and we don't know that point. But initially banks seem to benefit because they can raise rates faster than their costs go up. But first they have to go up faster to compensate for the additional defaults the higher rates cause in addition to what they are already working off.

Then as inflation grows because they are creditors the inflation rate cuts their profit because instead of having assets that grow in value, main asset, (Cash instead of hard assets) depreciates.

Also does it seem that government is keeping rates low among other reasons to let these institutions work off bad debts as well as back door doing a currency adjustment with China since they don't adjust their currency up, but they continue to buy a falling $ which helps our trade balance?

Last question. If we say that the financial sector is going to shrink. Then where is the money going to come from and who from to fund the growth in the economy? Or will the shrinkage actually be total numbers of bank shrinkage but the big ones (BAC, C, JPM,) etc actually continue to get bigger and more profitable?
rgosalia
Rgosalia - 3 years ago
Sivaram,

I am not saying investing in large financials is attractive. I agree that its a black box and equity could get wiped further. I am only disagreeing with the financial sector shrinking risk that you pointed in your first message. All I am saying is that this possibility is already factored in the discount.

Although unrelated, let me point you to an example of a small bank called Trinity Bank based in Fort Worth TX. (It's trading at 1.5 BV so its not attractive as an investment, and I don't mind talking about it) It's run by a very smart operator - Jeffrey Harp. The bank is ultra conservative in it's lending. It has had almost 0% non-performing loans in its entire operating history! It is among the very few banks in the country that has grown earnings every year since 2005.

If you read their shareholder letters (here), Mr. Harp points out that there is essentially no demand for loans among the good borrowers. Although not exactly the same as you point out (shrinkage in financial sector), but very similar. So, what is the bank doing with the extra capital it has on hand. It is buying back stock. Why does this make sense? If you have 20M of excess capital that could be lent, but due to lack of demand, its idle and earning 1%. Now, you take this excess capital and purchase stock that is at 1.5x BV. The bank earns after-tax 12% ROE, so when you purchase the stock, the capital deployed does not quite earn 12% but earns 8.5% after tax, instead of 1% pre-tax. They just improved their return on the excess capital by a huge margin! If demand for loans becomes weak and portfolios run-off, the excess capital can be used to buy back stock and boost margin.

Now take this example and apply it to a thrift that just went through conversion. If you look hard and deep, you'll find ones that are trading at 0.5 BV, have 10% ROE, have lots of excess capital that could be used for buybacks, and have activist investors who are keeping the executives on a leash to make sure that they don't piss away the money on poor lending or dumb acquisitions. Over 5 years, the BV discount should go away - 15% IRR on your investment. I know of not many places to put my capital in low risk and high return situations like this.

- Rishi

Sivaram
Sivaram - 3 years ago
Hi Rishi,

I'm not disagreeing with you about some opportunities that may exist out there. As you point out, some companies may be able to create wealth with better capital allocation. But as a whole, I think the financial sector isn't as attractive as many value investors are making it out to be. I don't know how much the market has already priced in but the fact that banking bellwhethers like Bank of America, Citigroup, Wells Fargo, and JP Morgan are trading almost at a two year low kind of makes me think that market hasn't fully priced everything in. Anyway, let's see how this situation evolves.
Sivaram
Sivaram - 3 years ago
rjstcr: "Then as inflation grows because they are creditors the inflation rate cuts their profit because instead of having assets that grow in value, main asset, (Cash instead of hard assets) depreciates."

I'm not too knowledgeable about banks either but I don't think cash (I'm assuming you are talking about deposits here) is an asset for them. Deposits (cash) is a liability for banks. If cash depreciates, I don't think banks really care too much.

Instead, what matters for conventional banks is the net interest margin spread (NIMS), which is the spread between the interest they pay on deposits and what they earn on loans. The interest charged on loans is higher than that paid on deposits and that's how conventional banks make money. If consumer debt usage shrinks, then the banks will have less opportunity to make money off loans.

Having said all that, the big banks also make money off capital market operations and that is driven by other factors (consumer debt shrinkage isn't really a big factor here--at least not directly).

rjstcr: "Last question. If we say that the financial sector is going to shrink. Then where is the money going to come from and who from to fund the growth in the economy? "

The first question is a very good one. Some people who lean towards deflation, including me (I don't think there will be outright deflation but do think inflation will be very low), are concerned about economic growth. If consumer debt shrinks, growth has to come from elsewhere or the economy will contract. Right now, governments throughout the world have been spending money to counter-balance the retrenching consumer. If you look at macro numbers, you'll see consumer debt declining and consumer savings rate going up, while the government spending is doing the opposite (the other element is the corporate sector and that is largely neutral, at least in America).

I'm more of the gloom & doom type and have been completely wrong for a few years now so take it for what it's worth... My feeling is that economic growth will be weak for the next 5 years (up to 10 more years) in developed countries (particularly USA), precisely because of the shrinkage in consumer debt usage and increase in savings. Governments with strong balance sheets will continue to spend as much as they can to counter-balaned the consumer shift but it still won't be enough. Overall, I think USA, and most developed countries, will see low growth. Investors are oblivious to what I'm saying because corporate profits have been so good in the last few years; but if you look at unemployment rates in USA and Europe, things are closer to the slump-scenario I outlined.

rjstcr: "Or will the shrinkage actually be total numbers of bank shrinkage but the big ones (BAC, C, JPM,) etc actually continue to get bigger and more profitable?"

My guess is that the financial sector as a percentage of GDP in USA will be lower in 2010 than now. I don't know if this means that the big banks get bigger and wipe out the small ones; or if some of the big ones shrink and dissapear. If you are an investor in this sector, this is a call you have to make: is a wobbly bank like Citigroup going to crush the little regional ones or is Citigroup itself going to keep shrinking?

Having said all that, value investors shouldn't really invest based on macro speculations so don't let me influence you :) Remember, one, in the 1970's or early 80's, could have made very gloomy predictions about the tobacco industry, all of which turned out to be true, yet one of the best performing stocks during that period was Philip Morris.
jonmonsea
Jonmonsea premium member - 3 years ago
Thanks, Rgosalia. I would love to know more about finding out about thrift conversions. I am actually reading Margin of Safety now, and looked for the thrift conversion section. It seems like a smart place to play! Where does one get started?

Thanks!

Jon
rgosalia
Rgosalia - 3 years ago
Jon,

Sorry for the late response. I was on a two week vacation.

Here are some resources to get you going:

(1) Manual of Ideas publication of Oct 2010 on "Value Opportunities in Banks" http://manualofideas.com/members/moi201010.pdf

(2) Martin Friedman published a paper on "Investing in Small and Mid-Cap Banks" dated Mar 2010 (http://www.box.net/shared/nyds8rj7t5x21ah2pysy)

(3) Joseph Stilwell is an activist investor in this space. Read one of his recent SC 13D filing:

http://www.sec.gov/Archives/edgar/data/1397076/000089291711000050/stil13defc110330am1.htm

(4) Jim Grant published an article on thrifts on Nov 2010: "Thrifts on the Cheap". One of the ideas mentioned on this article is Oritani. The thesis has played out mostly so it isn't attractive anymore. But to get an idea on how to think about these thrifts, you can search for a write-up submitted on Oritani on valueinvestorsclub, if you have access to it: http://www.valueinvestorsclub.com/value2/Idea/ViewIdea/35830

(5) Read PlanMaestro's Charting Banking Series:

http://variantperceptions.wordpress.com/charting-banking

(6) Read Street Capitalist's interview with the Bank Analyst:

http://streetcapitalist.com/2009/10/14/my-interview-with-the-bank-analyst/

Let me know if you have any specific questions after reading any of the above

Hope it helps

Rishi

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