Date updated:12-29-2007
IT'S BEEN A DREADFUL YEAR FOR NOTED VALUE MANAGER Rich Pzena, whose funds lost money in 2007, while shares of his newly public management company (ticker: PZN) sank to 12 from more than 22. Blame it in part on the manager's fondness for financial stocks, which had an even more dismal year -- and which account for 40% of Pzena Investment Management's assets. Then there's a shareholder lawsuit, charging Pzena failed to disclose outflows from the John Hancock Classic Value Fund (PZFVX), which he also manages, when the firm went public. Pzena says the suit has no merit.
If the present is trying, the manager's long-term record still stands tall. The firm's assets under management grew tenfold, to nearly $29 billion as of the end of the third quarter, from $3 billion in 2002. The $7 billion John Hancock fund is down 13% this year and has seen outflows of $1.6 billion since Sept. 30, but it sports an average annual return of 11% over five years. Bloodied but unbowed, Pzena explains what went wrong in 2007 and why there's good value now in beaten-up financials and big-caps generally.

-
FRE
Freddie Mac - $0.78
- 0.00%
- $0.771
Q: What is the upside for their shares? A: Fannie and Freddie are selling for 25% or 35% of what they are worth. The upside is three- or four-fold once the mortgage crisis unfolds. These stocks in the $20s don't make any sense, even in a bear case where they have to raise lots of capital. Even if Freddie has to issue $5 billion in equity at $20 a share, massively diluting the existing shareholder base, you still come up with earnings power of almost $4 a share. In a best-case situation, assuming nobody else gets back into this market and they are the only game in town, you can get $9-$10 of earnings power for a stock that is in the $20s. You don't ever see that kind of risk/reward trade-off. Hence, big positions for us in both Fannie and Freddie.

-
FNM
Fannie Mae - $0.70
- 0.00%
- $0.721
Q: What is the upside for their shares? A: Fannie and Freddie are selling for 25% or 35% of what they are worth. The upside is three- or four-fold once the mortgage crisis unfolds. These stocks in the $20s don't make any sense, even in a bear case where they have to raise lots of capital. Even if Freddie has to issue $5 billion in equity at $20 a share, massively diluting the existing shareholder base, you still come up with earnings power of almost $4 a share. In a best-case situation, assuming nobody else gets back into this market and they are the only game in town, you can get $9-$10 of earnings power for a stock that is in the $20s. You don't ever see that kind of risk/reward trade-off. Hence, big positions for us in both Fannie and Freddie.

-
COF
Capital One Finan - $24.45
- 0.00%
- $24.64
Q: Is that one you are buying now? A: Yes. We use normal earnings power as the indicator, which is not what they are going to make next year. But it is what they would make if conditions were neither boom nor bust. To buy financials at four to six times their normal earnings power is as good as it gets, and that's what I see. We're looking for earnings before special items of $7.05 a share for this year, and $4.75 after the items, and against a recessionary backdrop, we're looking for $4.85 a share in 2008.

-
C
Citigroup Inc - $3.51
- 0.00%
- $3.61
Q: What is your downside risk? A: 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.

-
BAC
Bank Of America C - $11.41
- 0.00%
- $11.19
Q: Do you feel the same about other banks? A: 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.

-
LEH
Leh - $0.00
- N/A
- $N/A
Q: Which other financials have been unfairly tarred? A: It is pretty much across the board. Lehman Brothers [LEH] and Morgan Stanley [MS] are interesting.

-
MS
Morgan Stanley - $30.09
- 0.00%
- $28.27
Q: Which other financials have been unfairly tarred? A: It is pretty much across the board. Lehman Brothers [LEH] and Morgan Stanley [MS] are interesting.

-
ALU
Alcatel-lucent - $2.62
- 0.00%
- $2.62
Q: Beyond finance, you're a fan of Alcatel-Lucent. A: In the end the price war will abate and Alcatel-Lucent will be successful in reducing costs as per the merger plan. There is a lot of earnings power here -- between $1.25 and $1.50 a share of earnings on a stock that is now $7 a share. It is pretty outstanding, given the quality of the franchise. In '08 we'll see improvement. We won't hit $1.25 to $1.50 of earnings power next year, but we'll be moving in the right direction. When it happens, the stock won't stay at $7.
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A. fascinating story. I had read last week
of goldman pullig out of some reporting
making it more secretive. I guess we
are learning why
A. The only one I own : SLX,
too hard pick a winner out all of them
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