Bank of America Corp (BAC), Microsoft Corporation (MSFT): Billionarie Pzena is Long on Tech and Financials

Earlier this week, the bank was hit with its latest lawsuit. The U.S. government filed two civil lawsuits against the bank for “investor fraud” related to sales of residential mortgage-backed securities.

In other news, the banking giant managed to beat 2Q EPS expectations. Earnings came in at $0.32, well above the $0.19 for the same quarter last year. The EPS growth was driven by reduced non-interest expenses.

Back in 2011, the bank started Project New BAC to boost earnings and reduce costs. The company saved $900 million in 2012 and expects to save $1.5 billion per quarter by the end of 2013. All in all, the initiative is expected to yield an annualized $8 billion in savings by mid 2015.

In love with tech

Relative to the S&P 500, the tech industry is trading well below historical standards. Since the mid-70’s, the tech industry has only traded this cheap one other time — in the early-90’s.

Microsoft Corporation (NASDAQ:MSFT) has a lot of stock in its server business, which should be able to start gaining traction as companies make the move to cloud computing — with products that include Windows Server and Azure. Its server segment has seen double-digit growth in revenue from 2010 to 2012.

Consider Microsoft. The company currently has 9.5% free cash flow yield despite being the largest software company in the world with a pristine balance sheet, generating $3.27 per share in free cash flow. Though the company faces challenges, investors overlook the company’s undeniable strength in its enterprise software franchise which contributes 70% of earnings, and its responsiveness and determination to protect its consumer franchise. Even assuming low growth, we see the valuation as compellingly cheap.

At the end of last quarter, Microsoft Corporation (NASDAQ:MSFT) had some $77 billion in cash, up $2.5 billion during the quarter. With all of the concerns surrounding the decline in the PC business, Microsoft is turning to enterprise. British Airways is just the latest company to adapt Microsoft’s cloud offering, 360 Office.

Also, other key markets include Microsoft Corporation (NASDAQ:MSFT)’s foray into mobile and the upcoming launch of next-gen gaming console, Xbox One.

Pzena’s top bet, per his fund’s 13F filing, is in the tech space. At the end of 1Q, the fund’s top public stock holding was Hewlett-Packard Company (NYSE:HPQ). The fund had 5.7% of its 13F invested in the turnaround tech story. The company’s product portfolio is wide, with printers, PCs, software and services.

In a 2006 interview for Joel Greenblatt’s investing class at Columbia Business School, Pzena noted that

This was before he became an owner. HP remains an industry leader in the server segment. For me, I think HP has impressive breakup potential, including the sale of its printer business. HP remains one of the largest printer sellers.

The tech company’s latest move includes trying to restructure to save costs. Hewlett-Packard Company (NYSE:HPQ) plans to lay off upwards of 29,000 workers by the end of 2014 in order to save some $3.5 billion. With these cost savings, HP hopes to up its investment in the cloud space.

Specifically, the company has laid out its four areas for growth: (1) increasing sales coverage; (2) digital printing; (3) mobile; (4) and emerging markets. Even still, analysts expect the company to only grow EPS at an annualized 1.6% over the next five years.

Pzena believes that financials and tech are two of the cheapest industries right now. He specifically likes Bank of America Corp (NYSE:BAC) and Microsoft, and I can’t disagree. Bank of America is an under-loved major bank that’s showing strength, while Microsoft Corporation (NASDAQ:MSFT) is looking to turn over a new leaf with forays into new markets and embracing hedge fund ValueACT’s activism — which recently started an activist campaign. Also, HP appears to be in full-blown turnaround mode, but with a number of headwinds still facing the company I’m holding off on investing in HP.