John Paulson is one of the prominent hedge fund managers on the Street. John Paulson’s fund management style is distinctive and extremely complex. As a former investment banker, he uses both merger arbitrage opportunities as well as credit default swap options. In late June, Paulson’s hedge fund took a tough beat from Sino-Forest scandal. Muddy Water’s report on Sino Forest has decimated the stock prices. As Paulson was one of the largest shareholders, his hedge fund took a beat that is claimed to be as high as $720 million. Paulson revealed a memo to to the investors, stating that, based on the initial-cost of shares; the actual loss was around $100 million.
As of the 2011 third quarter, Paulson & Co. had a diversified portfolio of equities. According to Edgar Online, Paulson favors financial stocks, followed by commodity and energy investments. Financial stocks constitute 26.85% of the holdings, followed by SPDR Gold (GLD) (16.45%), basic materials (18.65%), and energy companies (10.18%). Service companies constitute 9.87% of the portfolio. In the most recent quarter, the hedge fund made significant transactions. I have analyzed the 5 big sells and 2 big buys from a fundamental perspective, adding my O-Metrix scores, when applicable. Here is a fundamental analysis of the 5 big sells and 2 big buys by John Paulson’s hedge fund:
Big Sells | |||||
Company Name | Ticker | Shares Held | % Change | % of Portfolio | O-Metrix |
SPDR Gold Trust | GLD | 20.27 million | -35.64 | 16.45 | N/A |
Comcast Corporation | CMCSA | Sold Out | -%100 | 0 | 6.23 |
Wells Fargo | WFC | 23.85 million | -29.02 | 2.80 | 10.23 |
Citigroup | C | 25.11 million | -25.06 | 3.34 | 6.70 |
Hewlett Packard | HPQ | 15.17 million | -35.43 | 1.94 | 5.92 |
Big Buys | |||||
Nalco Holding | NLC | 9.18 million | NEW | 1.66% | 5.64 |
Motorola Mobility | MMI | 9.00 million | NEW | 1.64% | N/A |
Data obtained from Finviz/Morningstar and is current as of November 15. You can download O-Metrix calculator here.
Big Sells
Although Paulson reduced his gold holdings (GLD) by 35.64%, gold is still the largest holding in the portfolio. While gold’s quarterly performance is near 0%, its year-to-date performance of 25% outperformed almost all alternative investment instruments. However, past performance does not necessarily imply future results. Sure, there are a lot of things going on the Europe. Greece is near default. Even Italy’s prime minister, Berlusconi has resigned. However, Italy is not Greece. It has more assets and better outlook than Greece. In the worst case scenario, Italy, the third largest official gold holder, might issue bonds backed by gold reserves. While that might not be the permanent solution, it still offers short-term alternatives for Italy if things get spicy.
In any case, Warren Buffett’s bullishness suggests that the markets are already priced for the near-worst case scenarios. The investment guru does not believe in investing precious metals, and I totally agree with him. Even John Paulson has started getting bearish on gold, slashing gold holdings by more than one-third. After returning near 400% in the last decade, it is too late buy gold. The last quarter of the year has been traditionally the best quarter for equities. Therefore, instead of gold, I would suggest buying gold miners that are trading with low P/E ratios.
Comcast Corporation (CMCSA) is one of the largest communication and entertainment service providers in the U.S. However, the company missed earnings estimates. Q3 EPS of $0.33 was 6 cents lower than the consensus of $0.39. Paulson sold out its holdings in the third quarter.
While Comcast’s debt to equity ratio of 0.88 is a red flag, the company has been an earnings booster. Annualized EPS growth in the last 5 years has been 38.82%. Analysts estimate 15% EPS growth for the next 5 years, which is quite attainable given the company’s past growth record. Based on this estimate, Comcast has an O-Metrix score of 6.23, which is above market average.
Wells Fargo (WFC), a Warren Buffett favorite, has been going to the south for a while. The stock lost near 18% in 2011. Paulson reduced his holdings by 29%, but it still constitutes 2.80% of the portfolio.
There is a lot going on with financials these days, but Wells Fargo is one of the safest banks. It is trading with a low P/E ratio of 9.30, and a lower forward P/E ratio of 7.72. Wells Fargo offers a safe yield of 1.91% with a low payout of only 7.29%. Analysts estimate 15.5% EPS growth for the next 5 years, which might be realized if we observe a strong recovery. Based on this estimate, Wells Fargo has a rare A+ O-Metrix score of 10.23.
Citigroup (C) was among the biggest losers of 2011. The stock lost near 40% in 2011. Paulson slashed his holdings by 25%, but it still constitutes 3.34% of the portfolio.
Since the subprime crises, financials became one of the most hated stocks in the market. They are also among the cheapest ones. Citigroup is no exception. It is trading less than half of its book value. P/E ratio of 7.71 and forward P/E ratio of 6.39 are also pretty low. Analysts estimate 9.30% EPS growth for the next 5 years. Based on this estimate, Citigroup has an O-Metrix score of 6.70.
Hewlett Packard (HPQ) took a big hit over the last few months. The stock is not a financial, but it is treated as such. The massive sell-off in 2011 drive the stock price, all the way down, to a crazy-low P/E ratio of 6.41. Paulson also slashed his HPQ stocks by 35%, but it still constitutes 1.94% of the portfolio.
Analysts estimate 5.5% EPS growth for the next 5 years. Based on this estimate, it has an O-Metrix score of 5.92. Yield of 1.76% is okay, as well as, cash flow. Debt-to equity ratio is 0.66, which crushes the industry average of 6.4. P/B is 1.4, and P/S is 0.5, both of which are well below their industry averages. Morningstar gives a four-star rating to the company. Hewlett-Packard has an enormous upside potential, and I think the sell off is over.
Big Buys
Nalco Holdings (NLC) is one of the largest specialized chemical companies in the world. Established in 1928, it provides solutions to water, paper, and energy industries. John Paulson was pretty bullish on the company, initiating a new position of 9.18 million shares, worth $355 million as of November 15.
In July, Nalco announced its merger agreement with Ecolab (ECL). The merger agreement is defined as follows:
…Nalco’s shareholders may elect to receive either 0.7005 share of Ecolab common stock per share of Nalco common stock or $38.80 in cash, without interest, per share of Nalco common stock.
Soon after the announcement, Nalco jumped to $37, before collapsing back to near $30. I guess Paulson either acquired these share before the announcement or during this sell-off. As of November 15, Nalco was trading at $38.69, whereas Ecolab was trading at $55.52. Multiplying $55.02 with 0.7005 gives $38.5. Thus, there is not much arbitrage opportunity left between the two. However, you will never know, how markets will react to news. Any price below $38.80 is okay.
Motorola Mobility (MMI) has been another merger/acquisition play by Paulson’s hedge fund. Google (GOOG) announced that it will acquire Motorola Mobility for $40 per share in cash. Soon after the announcement, the stock jumped by almost 60% from $24 to $39. It has been trading between $38 - $40 ranges since the acquisition news.
It is quite hard to guess whether Paulson initiated his Motorola position before or after the announcement. However, thumbs up to the hedge fund guru, if he initiated these buy positions before the merger announcements.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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