John Paulson is the founder of Paulson & Co, a hedge fund based in New York. When he founded the company, it only has $2 million assets and one employee. Paulson made $3.5 billion by short selling subprime mortgages in 2007. The bets against subprime mortgages not only made Paulson a billionaire, but also made him become well known in the industry. In 2010, Paulson also made a record in the hedge fund history of making about $5 billion. However, Paulson made a few bad trades in Bank of America (BAC) and Citigroup (C) last year. As a result, one of his top funds Paulson Advantage Plus Fund lost more than 52% in 2011. Despite the poor performance over the past year, Paulson is still one of the wealthiest people on this planet.
Recently Paulson released the latest holdings of his fund in a 13F filing. Let’s take a closer look at his top stock picks and decide whether investors should imitate his bets.
Delphi Automotive Plc (DLPH): DLPH is the third largest position in Paulson’s portfolio. (The top two positions: SPDR Gold Shares (GLD) and AngloGold Ashanti Ltd (AU) are both related to gold.) Paulson reported to own more than $1 billion worth of DLPH shares at the end of last year. Delphi recently reported strong fourth quarter earnings for 2011. It said its fourth quarter profit more than tripled. Its net income for the fourth quarter was $290 million or 88 cents a share, compared with $75 million or 11 cents a year earlier.
DLPH went public on November 16, 2011. It sold 24 million shares for $22 per share, raising about $530 million. As the largest shareholder of DLPH, Paulson has pocketed a large part of the proceeds. DLPH returned 37.74% since its IPO in November, versus 9.13% for SPY in the same period. Although DLPH has already beaten the market by a large margin, we think the stock is going to continue outperforming the market. Currently DLPH is priced at $29.38 per share and we expect it to grow to $35 per share in 12 months. The stock is currently trading at attractive multiples and has strong growth potential. It has a low forward P/E ratio of 6.97 and its EPS is expected to grow at 40.82% on the average per year over the next five years. Therefore, the 2014 P/E ratio for DLPH is only about 3.5, while the 2014 P/E ratio is 7.9 for Magna International Inc (MGA), one of the main competitors of DLPH in the auto parts industry.
Anadarko Petroleum Corp (APC): APC is also a large position in Paulson’s portfolio. His fund had $731 million invested in APC at the end of 2011. APC is quite popular among hedge funds. Besides Paulson, there were another 47 hedge fund managers bullish about APC at the end of the third quarter. For example, Ken Fisher’s Fisher Asset Management had more than $300 million invested in APC at the end of September. Ric Dillon’s Diamond Hill Capital also had $234 million invested in the stock. However, we think APC is a risky stock. The exploration and production industry is cyclical and capital intensive. Additionally, in order to succeed in this highly competitive industry, APC employs aggressive financing strategies. It also seems a bit overvalued compared with its peers. APC has a forward P/E ratio of 18.56 and its EPS is expected to grow at 13.83% annually in the next five years. So its P/E ratio for 2014 is about 14.32, compared with 7.5 for ConocoPhillips (COP) and 8.2 for Exxon Mobil Corporation (XOM). COP and XOM also have lower risks. Their betas are 1.13 and 0.50 respectively, versus 1.50 for APC. Anadarko is expected grow faster but the price premium we have to pay for that marginal growth is excessive. We prefer COP over APC.
Hartford Financial Services Group (HIG): Paulson disclosed owning $609 million worth of HIG shares at the end of last year. On February 14, Paulson & Co filed a 13D and sent letter to the Board of Directors of Hartford. In the letter, Paulson urged “a tax-free spinoff of Hartford's P&C business”. Paulson believes that the spinoff will “produce an increase in value for Hartford shareholders of 40-60%+ above the unaffected share price”. We think HIG is a good stock to invest in. It has attractive valuation levels. Its forward P/E ratio is only 5.30 and its EPS is expected to grow at 7.8% per year over the next five years. This indicates that HIG’s P/E ratio for 2014 is only 4.6, compared with 9 for American International Group Inc (AIG) and 6.1 for MetLife Inc (MET). HIG is also quite popular among hedge funds. At the end of the third quarter, there were 31 hedge funds with HIG positions in their 13F portfolios. Besides Paulson, Andreas Halvorsen’s Viking Global also had $47 million invested in HIG at the end of September. We expect HIG to reach $30 over the next couple of years.
Overall we like Paulson’s top stock picks. We expect DLPH and HIG to outperform the market over the next 12 months. Paulson is also the most bullish hedge fund manager on gold. We have a small position in physical gold which we hold as a hedge against a decline in the value of US dollar. We think gold is going to go up modestly over the next 3 years, but we don’t recommend speculative bets on it.