Tilson split from partner Glenn Tongue in mid-2012 and now manages money on his own. As part of the split, Tilson vowed to raise his hedge fund’s cash level to 70% in an effort to reallocate the funds on a long/short basis, looking to move toward a 100% long and 40% short blend.
Per his letter, Tilson has vowed to concentrate his funds in only his “very best, carefully researched investment ideas.” Tilson’s ideal number of stocks owned includes fifteen positions on the long side and a similar number on the short side.
With that in mind, let’s see what Tilson’s top five (check out six thru ten) ‘carefully researched’ investment ideas are on the long side, his top pick is Berkshire Hathaway Inc. (NYSE:BRK.B). The holding company owns subsidiaries engaged in a number of industries. Berkshire also owns and operates a number of other businesses engaged in a variety of activities. Its insurance segment accounts for around 25% of revenues, which includes GEICO and General Re. The other major segment is the regulated utility business (around 20% of revenues) and includes MidAmerican and Burlington Northern Santa Fe Corp.
The insurance segment is the real growth driver, where it managed to increase its float, which is the money held between the time policyholders make their payments to when the money is paid out in claims, to $65 billion from $28 billion over the last ten years. Meanwhile, its utility business, driven by Burlington Northern, should see an uptrend in revenues with GDP growth in the next few years.
In his letter, Tilson noted that Berkshire is indeed firing on all cylinders. Per his letter, Tilson outlines that he believes Berkshire’s “intrinsic value is likely to grow at roughly 10% annually.”
American International Group, Inc. (NYSE:AIG) continues to trade at half its book value and is Tilson’s second largest pick. AIG is a vastly different company than it was when the government intervened a few years ago. After a string of losses from 2008 to 2010, AIG posted an operating profit of $1.3 billion in the second quarter of 2011. Operating results were also strong for first nine months of 2012, posting operating income of $7.64 billion, versus a loss of $2.6 billion for the same period a year ago.
The U.S. Treasury ended its ownership of AIG in mid-December after selling its remaining 34 million shares and the company has also been streamlining its operations to work itself back as a primary property and casualty operator, having sold off a majority of its airline leasing operations and its remaining stake in an Asian life insurer.
Tilson believes the stock is “worth at least 1x book value, so I expect it will double in the next 2-3 years.” During the fourth quarter, AIG over took Apple as the most owned stock by hedge funds (sell the top five).
Howard Hughes Corp (NYSE:HHC) is Tilson’s third largest long position. Billionaire Bill Ackman is also a big fan of Howard Hughes (see all of Ackman’s stocks). These two hedge fund managers have a number of investments in common, including Tilson’s seventh largest holding, Canadian Pacific.
Tilson touted Howard Hughes at this year’s Value Investing Congress, noting that Howard Hughes is a good inflation hedge. However, that’s not the only reason to invest; the company owns a number of key master planned communities and development opportunities that are producing little to no cash, which makes the properties inherently difficult to value. As a result, Tilson believes the real estate is being undervalued. Tilson states that the intrinsic value could be upwards of $125 per share, versus its current trading price just below $80.
The fourth largest pick of Tilson’s is Citigroup Inc. (NYSE:C). Citi posted a disappointing 2012 fourth quarter, but the stock has held up relatively well, and is up 10% year to date. Earnings came in at $0.69 per share, well below consensus of $0.87, but earnings were still up 68% from the same quarter last year. For the quarter, there was also notable improvement in the bank’s capital ratios; its Basel III Tier 1 Common Ratio was 8.7%, up from 8.6% in the prior quarter, and its Tier 1 Capital Ratio was 14.1%, up from 13.9% in the prior quarter.
Despite its improving capital structure, the bank still trades in the mid-range of its 5-year price to book of 0.6x. The major bank also trades below major peers on a price to cash flow basis, trading at 8.4x, compared to Well Fargo’s 9.4x, Bank of America’s 30.2x and U.S. Bancorp’s 10.8x. Tilson notes that Citi is still below its tangible book value of $51.19, which is the low end of his range of intrinsic value. I have previously covered Citi and cited it as a solid investment (read more here).
Goldman Sachs Group, Inc. (NYSE:GS) is Tilson’s fifth largest pick. Goldman has been working on establishing a strong capital position, but Tilson acknowledges that Goldman has seen much the same pressures as Citi and AIG due to the financial crisis. The investment bank did, however, recently report earnings results with revenues up over 50% and earnings per share more than tripling from the same period last year.
The bank is also showing positive strides in returning capital to shareholder, by announcing dividend hikes of 31% and 8.7%, respectively in April and October of 2012. Tilson believes that the bank should be able to “consistently earn at least mid-teens ROE, in which case it’s worth a substantial 30% to 50% premium to tangible book value.”
Don’t be fooled. Tilson remained heavily invested in financials, with four of his top five picks being exposed to the insurance, banking and investment industries. I am a fan of Berkshire given its inherent diversity; AIG given its turnaround strategy and relative cheapness; Citi, which is one of the top ‘big’ banks and is still cheap; Howard Hughes given its tough to value properties that still might be undervalued by the market; and Goldman, thanks to its international presence and leading market share.
The article Top Five Picks Of Whitney Tilson’s Investor Letter originally appeared on Fool.com and is written by Marshall Hargrave.
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