John Paulson’s Favorite Financial Stock
Over the past three months, the financial industry has been rocked with scandal, from JP Morgan’s “London Whale” losses to the ongoing investigation into the Barclays Libor manipulation saga. Here’s what Ben Bernanke had to say about the whole mess. During this time, the sector as a whole has lost 7.1 percent, though some investors are still optimistic about certain players in this area. One such stock is held in mega-hedge fund manager John Paulson’s portfolio, which currently has over $15 billion in assets under management.
Paulson is known as the man who shorted subprime mortgages in 2007, but he hasn’t been as successful post-recession. In 2011, Paulson & Co. reported record losses, and the firm is flirting with double-digit declines in the first half of this year. We generally tend to advise our readers to follow the picks of these types of hedge fund managers, but Paulson’s holdings should be taken with a grain of salt. Now, it’s not that investors should consider selling anything he holds, but it is wise to acknowledge that Paulson’s bets have been very wrong recently, which brings into question the validity of his top stock picks. Below is Paulson’s favorite financial stock, which represents the fourth largest holding in his portfolio.
The Hartford Financial Services Group (NYSE: HIG)
Comprising 5.3 percent of Paulson’s overall holdings, and amounting to almost $800 million, The Hartford Financial Services Group has been at least partially responsible for the manager’s recent bout of losses, dropping over one-fifth of its value in July 2011 alone. Last summer, the majority of these declines were a result of massive insurance claims resulting from a worse than expected tornado season. Thus is the conundrum with insurance companies like Hartford – it’s impossible to determine when a freak-event may derail profitability.
Since the start of this year, shares of HIG have been relatively flat, but the company did report a year-over-year net income decline of 80.8 percent in the first quarter. Looking toward next quarter’s results, execs are warning investors that the damages from Rocky Mountain wildfires and flooding in South Florida have harmed their bottom line. Due to the fact that last year’s Q2 results were so dismal, though, Hartford could actually see a YOY jump in EPS. The company reports on August 1st, and the Street is expecting core earnings of $0.55 a share, which would be a near 55-cent increase from one year earlier. This YOY increase would be greater than what’s expected of American International Group (NYSE: AIG) at -$0.10, but lower than its rival Allstate (NYSE: ALL) at +$2.08.
From an earnings standpoint, shares of HIG are trading at a Price-to-Earnings ratio (23.2X) above the industry average (8.3X), and competitors like AIG (2.8X), ALL (16.8X), Travelers (NYSE: TRV) at 18.5X, and Prudential (NYSE: PRU) at 11.1X. This overvaluation seems even more pronounced when considering the company’s own 5-year (4.6X) and 10-year (7.3X) historical averages, which are both way below current levels. In fact, Hartford’s earnings have historically traded at a 56 percent discount to those of the S&P 500 over the past decade. This year, they appear much more expensive, trading at a 59 percent premium.
Now, a more bullish case can be made for Hartford when factoring earnings growth into the equation, as HIG trades at a PEG ratio of 0.4; typically anything below 1.0 signals undervaluation. Other valuation metrics like the Price-to-Book (0.4X) and Price-to-Sales (0.3X) ratios are also trading below their 5-year averages of 0.7X and 0.6X respectively. Interestingly, the company’s cash flows from operations have grown by nearly 30 percent in the past 12 months, but the stock trades at a Price-to-Cash Flow ratio (2.6X) below its own 5-year average (3.4X) and the likes of AIG (11.2X), ALL (8.6X), and TRV (10.9X).
WealthLift’s Sentiment Index seems to share Paulson’s outlook and rates Hartford as a strong buy, with the majority of the community’s users placing an “overperform” rating on the stock. It would be wise, though, to wait and see how the company’s Q2 earnings release shakes before letting the bulls run free on HIG, so to speak. To continue reading about this topic, check out our hedge fund Top 10 list here.
Disclosure: The author has no holdings in the stocks mentioned in this article and has no plans to initiate any positions within the next 72 hours. He does, however, have the intention of rating these stocks on WealthLift.com, a social media website where investment ideas are shared openly and free.