Richard Pzena's Picks For 2008

Hat tip to GuruFocus poster Abeck for this Barron's interview with Richard Pzena dated December 31^st, 2007: "Opportunity Amid the Ruins". Excerpt:

Barron's: What is your downside risk [of holding Citigroup]?

Richard Pzena: There is some short-term downside risk. Looking out three years-plus, you have a really spectacular risk/reward trade. The odds that Citigroup sells for less than 30 in three years are very low, and the odds of it selling for substantially above that are very high.

Barron's: Do you feel the same about other banks?

RP: Bank of America [BAC] is the same story. They are going through a downturn, so they're going to have losses and provisions. We're estimating earnings of $3.70 a share for 2007 and $4.10 for '08. Right now, people aren't buying banks because the next quarter might be bad. Whenever investors become hypersensitive to the next piece of information, value opportunities arise.

You have to have a strong stomach to do this. I always joke about it, but the most common question we get from clients in any market environment is "don't you read the paper? How could you possibly do this, given what is going on?" And the response is, these shares don't trade at these valuations unless this kind of stuff is going on. If this proves to be fatal to Citi or Fannie or Freddie, we'll get killed. If it proves not to be fatal, as we suspect, then over the long term we're going to make a lot of money.

The article included this table listing Pzena's six stock picks (Fannie, Freddie, Citi, BofA, Alcatel-Lucent, and Capital One) and their prices as of the end of 2007.

The photo above, of Richard Pzena, is from the Barron's article linked to in this post.

"Freddie Mac is the Cheapest Stock I've Ever Seen"

So said value investor Richard Pzena¹, of Pzena Investment Management, at the 3rd annual Value Investing Congress in New York last November, according to the notes of attendee Amit Chokshi. Chokshi posted the following notes from Pzena's presentation on Seeking Alpha last November 30th (hat tip to commenter "cm1750" on GuruFocus):

* Pzena's talk was entitled 'Evaluating Financials in a State of Panic'
* The only time good businesses sell for cheap prices is during times of distress
* Financial stocks are cheap on a P/B basis against historical multiples
* Freddie Mac (FRE) is the cheapest stock Pzena has 'ever seen':
* Losses are absorbable and GAAP is not useful in evaluating FRE
* Pzena believes the mortgage payment resets that result in higher monthly payments will be handled by borrowers because they will be reluctant to forfeit the equity in their homes
* Fears in the market don’t necessarily impact FRE’s business but are impacting its stock
* FRE Loan to Value = 60% and are mostly in fixed high credit
* Believes FRE will follow similar action to P&C insurance companies

1. Hurricane/natural disaster occurs, P&C insurance companies experience losses, P&C companies raise prices/premiums, P&C stock goes up
2. Housing crisis has occurred, FRE and other industry players will raise fees, tighten credit standards, experience lower losses resulting in strong capital returns and thus improving stock price.

At the time, Freddie Mac (NYSE: FRE) was trading at about $30 per share. Today it closed at 95 cents per share. Off the top of my head, I can't think of a value investor who has made money going long on a financial stock over the last year and a half, but another investor at last November's Value Investing Congress, David Einhorn, has done well shorting Lehman Brothers (NYSE: LEH).



¹Richard Pzena went to Wharton with Joel Greenblatt, author of The Little Book That Beats the Market. In that book, Greenblatt appeared to be alluding to Pzena as "the smartest money manager I know" on p.72.