Berkowitz: “Great Environment” for Stock-Pickers

Top fund manager Bruce Berkowitz, whose Fairholme Fund has earned about 12% per annum over its 10-year history while the S&P 500 has lost about 3% annualized, says that this is a “great environment for an investor, for a value-based stock picker, security picker”, and that he’s continuing to see a number of bargains in the market even after its recent rise.

Berkowitz, who is something of a contrarian, tells Steve Forbes that his fund remains high on healthcare stocks, despite — or perhaps because of — all the talk of sweeping healthcare reform. “They’re in the high to mid-single digit [price/earnings ratios] with rock solid balance sheets and you really can’t ask for much more,” he says of Fairholme’s healthcare holdings, which include Pfizer, Forest Drugs, Forest Labs, Humana, and WellPoint. “And my question is: Well, if these companies aren’t going to do it … in healthcare, who is going to do it for us?” Berkowitz says it’s a similar story with some defense stocks.

Berkowitz also delves in to the ins and outs of his portfolio management style. One of his key tenets: Keep a focused portfolio. “Once you get much more than 25 securities, you’re going be lucky to, you know, you’ll be approaching the averages,” he said.

Another of his principles: Keep a good amount of cash on hand. On average over the past 10 years, Fairholme’s percentage of cash has been in the mid-teens, he says — something he learned from Warren Buffett.

Cash is also critical to Berkowitz’s analysis of individual companies. “The one key characteristic is cash. We basically count the cash that a company generates because, after all, what else can you spend? … That’s what we’re looking for, free cash flow. I think Benjamin Graham called that ‘owner earnings.’ … I know that’s a concept a lot of people aren’t using these days, especially management. But yes, we’re looking to see what the shareholders will receive over time.”

“We stick to cash because it’s hard, so a dollar is a dollar,” Berkowitz continues. “It’s hard to disguise a dollar in the bank as opposed to a dollar of GAAP earnings where it could be a dollar, maybe it’s nothing. I mean, we’ve seen it with the airline industries, capital intensive industries where all these earnings over time have disappeared. And we’ve seen it many of our big conglomerates over the past few years where great earnings were all wiped out.”

Because of the intense research needed to assess a company, Berkowitz says individual investors are better off putting their money with a fund manager. But he offers four rules to live by if you do so:

1. Choose a manager with a good paper trail track record.
2. Choose someone with a proven level of honesty and integrity.
3. Have a basic comprehension of the strategy the manager is using, so you won’t panic when things get tough.
4. Make sure it’s a level playing field — that is, make sure you’re investing with someone who has most of his or her net worth in the fund or vehicle.

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