Billionaire John Paulson Loves Bank of America Corp (BAC). Why?

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Insider Monkey tracks quarterly 13f filings from hundreds of hedge funds, including billionaire John Paulson’s Paulson & Co, and the firm’s love of Bank of America Corp (NYSE:BAC). We’ve found in our work researching investment strategies that the most popular small cap stocks among hedge funds earn an average excess return of 18 percentage points per year (learn more about our small cap strategy) and it can be useful to track hedge fund activity over time as well. For example, we can review a fund’s long term stock picks and treat these as initial ideas which investors may want to research further. Read on for our quick take on three stocks which Paulson owned at least $150 million of in his most recent 13F and at the end of March 2011 (or see the full list of Paulson’s stock picks over time).

PAULSON & COThe fund reported a position of over 37 million shares in MGM Resorts International (NYSE:MGM) at the end of the first quarter of 2013. The resort and casino company has rallied 68% over the last year, bringing it roughly back to its levels of two years ago. In its most recent quarter revenue ex promotional allowances rose 3% compared to the first quarter of 2012, and combined with cost cutting this was sufficient for MGM to report earnings of 1 cent per share.

This was good news for a company which had seen net losses in the previous three quarters, though certainly there’s a long way for MGM to go in order to justify its valuation: Wall Street analysts expect EPs of 13 cents next year, making for a forward earnings multiple of more than 100. Investors should be aware, if they are not already, that markets are generally assigning premium valuations to casino companies. In addition, many companies in the industry have a good deal of general market exposure as well as vulnerability to conditions in China. In MGM’s case, the beta is 2.4 and about a third of total segment EBITDA comes from operations in Macau.

Paulson has also been a long term owner of Mylan Inc. (NASDAQ:MYL), a $13 billion market cap developer of generic drugs and manufacturer of branded drugs. Mylan’s revenue has been up, according to recent reports, though higher research and development expenses have resulted in lower earnings on a GAAP basis (some analysts argue that in many cases investors should think of R&D as an investment rather than an expense). The sell-side is somewhat bullish, and so Mylan trades at only 10 times forward earnings estimates; however, many market players are more negative on the company and as a result 105 of the float is held short.

Bank of America Corp (NYSE:BAC) rounds out our list of Paulson’s long term stock picks with the most recent filing disclosing ownership of more than 27 million shares. Bank of America Corp (NYSE:BAC) had been one of the most popular stocks among hedge funds during Q1 (find more of hedge funds’ favorite stocks). Earnings have somewhat recovered from what had been low levels on a trailing basis; net income rose over 60% last quarter compared to the second quarter of 2012. Even with the stock price nearly doubling in the last year, it is still valued at a considerable discount to book with a P/B ratio of 0.7.

Analysts believe that Bank of America Corp (NYSE:BAC)’s earnings will continue to do well going forward, and so the P/E based on expected earnings for next year is 11. While somewhat low in absolute terms, this means that Bank of America Corp (NYSE:BAC) is actually priced at a premium in forward earnings terms to some other large banks including JPMorgan Chase and Citigroup. Despite its discount relative to book value, it might be best to compare the stock to its peers keeping in mind that megabanks in general may be vulnerable to less accommodative monetary policy from the Federal Reserve in the event the central bank does pursue tightening.

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