One of our favorite investors here at The Acquirer’s Multiple is Bruce Berkowitz. He is the Founder and Chief Investment Officer of Fairholme Capital Management, and President and a Director of Fairholme Funds. In 2010 Berkowitz was named as the 2009 Domestic-Stock Fund Manager of the Year by Morningstar as well as the Domestic-Stock Fund Manager of the Decade (2000-2009), also by Morningstar. Most recently, he was named 2013’s Money Manager of the Year by Institutional Investor Magazine.
Here’s an excerpt from an interview with Berkowitz in which he succinctly lays out his three step approach to value investing, including the example of Bank of America:
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At Fairholme we’re very focused on price. Price matters most to us. And we think that price determines much of the success you’re gonna have in the future. So rather than predict what’s going to happen with the company we try to price it correctly with a large margin of safety. So pricing with a significant margin of safety is very important in our rule number one of not losing.
Once we determine what a cheap price is, our next step is to look at the investment and the underlying company and stress test it to determine all the ways that business can go wrong, the environment can go wrong, the balance sheet can go wrong. Try to kill the company.
If we can’t kill the company and we’re buying it at a price that reflects near death we may be onto something very good.
The next step in the Fairholme process is to search for catalysts to understand how the environment, the ecosystem is going to change over time. And how that’s going to affect the company getting closer and closer to a more normal return on investment or on capital employed. That’s the third part of the investment process.
We could use for example a current investment, Bank of America. So 2008 the financial world almost comes to an end. Government comes to the rescue. Most investors have lost eighty to ninety percent of their investment in the company. So we’re watching. We see how Bank of America is recapitalized. We see how their earnings power is maintained, in fact the franchise is intact. But because of what just happened the pain and suffering of so many, the diminution value, the company is priced for death.
But it has been restructured. We capitalized and you can see through the business fundamentals and the quarterly earnings that the company’s actually in better shape than probably it’s been in the past fifty to one hundred years.
So here we have a situation, priced for death, looks to have tremendous value, franchise intact, earnings power foggy because of what just happened in the time that’s going to be needed to resolve the sort of legacy issues from the last debacle.
But you know, if you know business and you know banks, the bad burns off, the good increases, you return to a normal, and the price follows it. And this is a good example of what we do and how we can invest a dollar and eventually see that dollar become two and four and six.
You can watch the entire interview here:
Article by Johnny Hopkins, The Acquirer's Multiple