The folks over at Dealbook have Paulson’s 3Q investor letter up. The letter is peppered with his insights from stocks to defaulted bonds.
What I wanted to do though, was highlight a few parts of the letter where I thought we could take a look at his methodology for looking at stocks. The idea here isn’t to find potential buys, but to see how he looks at companies.
Bank of America (NYSE:BAC)
-Paulson believes that by 2011, banks will have passed the write down cycle and return to growth in 2012.
-They are using a 10x normalized earnings multiple for large banks and the team estimates BAC to be worth $29.81 per share in 2011. Current shares trade at $16.35, so you are looked at almost 40% annualized.
-They expect provision for credit losses to come down quite a bit from 2008 levels, to 1.75%. That figure, $16,357 is about 61% of 2008′s numbers.
Then, there is Paulson’s gold position. If you looked at the latest 13F-HR filings, there are a lot of ways that investors have been playing gold. Some are going after miners, others are gaining exposure via ETFs, and then there are some that are trying to get their hands on the physical asset.
Paulson mentions two gold miners in his portfolio. This is how he looks at them:
-Five gold mining stocks comprise 14% of their portfolio.
-All five stocks would have upside in a flat environment, but an even higher upside in a rising price environment.
-AngloGold Ashanti (NYSE:AU) is the third largest gold producer in the world but trades at a lower Price/NAV than peers. So this is a value play based on comps.
-The company has a number of figures, which could contribute to its peer undervaluation:
1. Exposure to South Africa
2. Declining production profile
3. Large hedge book
4. Poor safety record.
-Paulson & Co. believe that the new CEO, Mark Cutifani would be a catalyst for change in the company and indeed: the company diversified out of South Africa, reduced their hedge book, increased their production profile, and improved their safety record.
So what we can take away here is that Paulson and his team were looking for a gold miner undervalued, relative to peers and viewed Cutifani, a great mining operator, as a catalyst.
Then, there is Gabriel Resources (TSE:GBU)
-Gabriel is another miner with an event catalyst
-The company is the largest potential goldmine in Europe and Paulson & Co. own 19.9% of it.
-NGOs have stymied the process for the mine to get their permit due to environmental concerns
-Newmont Mining and Electrum Strategic are other large owners of the company with 16% and 19% stakes
-Though the company trades at only $2 per share, the upside can go to $6-8 and $8-12 if they receive their permit and start production.
Gabriel appears to be a low risk high uncertainty situation with a binary outcome. Without their permit, the company is likely to trade flat while having a number of potential catalysts in place to unlock value.
Be sure to read the rest of the letter at the NYTimes Dealbook.
