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Billionaire James Dinan’s High Upside Potential Picks

Wednesday - 1/9/2013, 4:13am  ET

Value investors know that low price-to-earnings multiples are a good place to start looking for good values, but this metric gives no weight to a stock’s growth potential. In order to consider future growth at the cost of less accuracy, we can consider the PEG ratio as well: This metric combines the P/E multiple and analyst expectations of earnings growth rates. As such it’s one way to measure the upside potential, though not necessarily the actual upside, of a stock, with lower values corresponding to lower multiples or higher growth rates. Here are five stocks that billionaire James Dinan’s York Capital Management had at least $70 million invested in at the end of the third quarter of 2012 (some of these picks may no longer be large positions in his portfolio, but we’re looking for suggested stocks to look at rather than to copy Dinan’s portfolio) and which had low PEG ratios.

Dinan’s top pick was American International Group with a position of 8.1 million shares. AIG was one of the most popular stocks among hedge funds in the third quarter (see the full rankings) and the negative sentiment towards the company has helped place it at a very interesting valuation. AIG trades at about half the book value of its equity--we think a more modest discount would be appropriate--and 10 times forward earnings estimates. Analyst estimates imply a PEG of 0.4, and we think that it’s worth considering AIG as a value play.

York reported a position of 13 million shares in Hertz Global Holdings . The $7.3 billion market cap car and equipment rental company is exposed to the broader economy with a beta of 2.7, indicating that its stock price is very responsive to changes in market indices (this is likely more due to the equipment rental business). There’s also considerable short interest in Hertz despite 18% earnings growth in the third quarter of 2012 versus a year earlier and a forward P/E of 10. The PEG ratio is 0.3, though it’s possible that the sell-side is being overly bullish. Jeffrey Tannenbaum’s Fir Tree initiated a position of 5 million shares.

Dun & Bradstreet was a new pick in the fund’s portfolio as Dinan and his team bought 1.3 million shares of the stock. The information and risk management company carries trailing and forward P/E multiples of 13 and 10, respectively, with a PEG ratio of 0.8. It is another popular short target with 13% of the outstanding shares held short as of the most recent data, and while net income was up in its most recent quarterly report from a year ago, revenue was down. John Shapiro’s Chieftain Capital owed 2.2 million shares of Dun & Bradstreet.

The fund cut its stake in Tyco International but the company remained in its top ten holdings as York still owned 1.6 million shares. Tyco’s PEG ratio of .75 also made it a high upside potential pick. Large hedge fund D.E. Shaw, managed by billionaire David Shaw, was buying Tyco in the third quarter. Tyco recently spun out two of its business divisions, one into a public company and one into a merger.

York bought shares of MetroPCS Communications , yet another stock with considerable short interest. MetroPCS’s forward P/E is 12, and expectations for earnings growth over the next several years lead the PEG ratio to be 0.7. Billionaire John Paulson’s Paulson & Co. also bought into MetroPCS, closing September with almost 24 million shares in its portfolio after not having owned any shares of the stock three months earlier (see more stocks Paulson was buying)

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