Billionaire Edward Lampert’s Top Stock Picks

Edward Lampert is the best hedge fund manager so far in 2012. His top stock picks had an equal-weighted average return of 44% as of March 2nd. Lampert is also one of the most successful insiders during the first quarter. He purchased around 5 million shares of Sears (SHLD) at less than $30 per share. This investment returned him almost 150% in less than 2 months.

ESL INVESTMENTS

Recently, Lampert’s ESL Investments released its latest 13F holdings. Let’s take a closer look at the large positions in ESL’s portfolio.

AutoNation Inc (AN): AutoNation is the largest position in ESL’s latest 13F portfolio. At the end of last year, ESL reported to own more than $2 billion worth of AutoNation shares. A few other hedge funds were also bullish about AN. At the end of last year, there were 11 hedge funds with AutoNation positions. Murray Stahl’s Horizon Asset Management had nearly $200 million invested in AutoNation. D.E. Shaw, Steven Cohen, and Israel Englander were also bullish about the stock (see billionaire Israel Englander’s top stock picks).

For the fourth quarter of 2011, AutoNation reported net income of $69.40 million, up 3% from $67.30 million for the same period in 2010. Revenue also increased by 13% to $3.7 billion. However, we do not recommend investors to purchase AutoNation at this moment. The stock seems to be overvalued compared to its peers. AN has a P/E ratio of 17.66, versus 15.55 for Group 1 Automotive Inc (GPI) and 12.54 for Penske Automotive Group Inc (PAG). Although AN has a high expected grow rate of 18.2%, GPI and PAG’s expected growth rates are even higher. Analysts estimated GPI to grow at 19.3% per year and PAG to grow at 18.82% annually. Additionally, though AN’s operating cash flow has increased by 20.7% to $65.3 million in the fourth quarter, its P/FCF ratio of 19.8 is still much higher than 9.61 for GPI.

AutoZone Inc (AZO): AZO is also a large position in ESL’s portfolio. As of December 31, 2011, Lampert had $965 million invested in this position. AZO is quite popular among hedge funds. At the end of 2011, there were 30 hedge funds reported owning AZO in their 13F portfolios. For instance, Jim Simons’ Renaissance Technologies invested $128 million in this stock at the end of last year. Louis Navellier’s Navellier & Associcates and Richard Chilton’s Chilton Investment Company both had over $60 million invested in AZO.

We like AZO. The company’s recent performance is compelling. For the 12 weeks ending November 19, 2011, AZO reported revenue of $1.92 billion, up 7.4% from $1.79 billion for the same period a year ago, while the industry’s average revenue growth is about 3.9%. AZO’s EPS also improved by 24% to $4.68. The company also has expanding margins. It has a high gross margin of about 50% and its operating margin of 7% is also above the industry average. Additionally, we are bullish about the long-term trends in the automotive industry and we think AZO will definitely benefit from that. With regard to valuation, AZO’s forward P/E ratio is 14.13 and its EPS is expected to grow at 14.86% per year over the next five years. So its P/E ratio for 2014 is about 10.7, versus 9.8 for Advance Auto Parts Inc (AAP) and 12.6 for O’Reilly Automotive Inc (ORLY). AZO was up more than 43% over the past 52 weeks, beating the S&P 500 index by 37 percentage points. We expect the stock to continue outperforming the market over the next 12 months.

ESL’s other major positions include Sears Holdings Corp (SHLD), Gap Inc (GPS), Capital One Financial Corp (COF), CIT Group Inc (CIT), and Seagate Technology (STX). ESL had at least $100 million invested in these positions. All these five stocks generated double-digit returns since the beginning of this year. Together with AN and AZO, the top 7 positions of ESL returned over 30% since the beginning of this year, versus 9.75% for SPY. We see great potential especially in COF and STX. Their forward P/E ratios are both lower than 10. Moreover, STX is expected to grow at 20% and COF is expected to grow at 10% per year in the next couple of years.

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