During the 15+ years that he's been running the Fairholme Fund, money manager Bruce Berkowitz has been recognized as an accomplished investor, including Morningstar's stock-fund manager of the decade in 2010. By consistently beating the markets, Berkowitz has established himself as an expert, and gained plenty of followers. Based on my observations of some of the choices Berkowitz has made with his fund, here are five lessons that investors can emulate to help them invest better.
1. Invest in your circle of competence
Now, this is not a new concept. In fact, Warren Buffett has been known to teach the same principle. But focusing on companies in sectors that you are familiar with will better enable you to determine how the business is operating, and decide if there are good reasons to change your investment. Bruce Berkowitz has worked for financial companies since 1983, including Merrill Lynch, Lehman Brothers and, most recently (in the '90s), as a managing director of Smith Barney.
By focusing on the financial sector, including both banks and insurance companies, Berkowitz has been able to utilize his knowledge of the businesses, and take advantage of value plays. The two largest holdings in the Fairholme Fund, Bank of America (NYSE:BAC) and AIG (NYSE:AIG), have come under tough times; but by knowing the fundamentals of their businesses, Berkowitz recognized that the companies had strong foundations and were good value opportunities after the financial crisis.
If you look at the composition of the Fairholme Fund, you'll see that it is dominated by financials and real estate companies. No mention of tech companies or energy stocks here. If you aren't familiar with a company's business, and aren't willing to take the time to become thoroughly knowledgeable about it, don't invest in it.
2. Ignore the crowd
Speaking of the financial crisis, Berkowitz's confidence in both B of A and AIG were contrary to the opinions of most others at the time. The subtitle to this section is actually the motto of the Fairholme Fund, a sure way to get investors thinking of their approach to stocks. By ignoring the crowd, you are able to focus more on the fundamentals of a company's operations, instead of the most recent news blip that could send the masses away in droves (often for illogical reasons).
As Bank of America and AIG suffered their existences as pariahs on Wall Street, Berkowitz recognized that Mr. Market was undervaluing these strong businesses -- a prime opportunity for investing when others won't. In fact, a lot of money managers were eventually noted as saying that, though they thought financials would be good opportunities, they couldn't be seen with the stocks in their funds for fear of losing investors.
If you invest without following the crowd, you are setting yourself up for great opportunities that others might not see or might ignore.
3. Embrace the fear
This lesson also harkens back to another principal shared by Buffett: Be fearful when others are greedy and greedy when others are fearful. The financial crisis was the most recent economic disaster, leaving the nation reeling and investors afraid. But, while others were pulling their money from the market, many smart investors were buying up stocks left and right.
Even after his investment in AIG lost 60% in 2011, Berkowitz was still confident that his choices were right ,and stated in his letters to investors, "The seeds of great performance are usually sown in times of intense fear after a disaster." So far, with 43.2% of the fund's holding in AIG, his statement has proven correct. After gaining 47% in 2012, and dropping the last of the government's ownership, AIG is poised for growth.
Fear can also turn into hatred, which Berkowitz also suggests we should embrace when considering investments. Just as financials have continued to suffer on Wall Street, even though performance does not warrant it, some retailers have also become analyst punching bags. Sears Holdings (NASDAQ:SHLD), which has become a favorite of bears, represents 8.5% of the Fairholme Fund -- its third largest investment.
If others fear or hate a particular investment, take a bit of time to analyze why, and whether it is justified.
Berkowitz is the epitome of a long-term investor. As demonstrated by his lack of changes to the fund for long stretches, Berkowitz takes a great deal of time to consider the future potential of a business, invests in it, and then sticks with it. Berkowitz is already looking ahead five to seven years, and anticipating the changes in store for his investments -- which he thinks will quadruple in that time frame. For its Sears holdings, Berkowitz shows how the long-term approach can give you a different perspective on the future of a business.
While most analysts are looking for improvements in the company's sales information quarter to quarter, Berkowitz isn't hinging his investment on the recovery of Sears as a leading retailer. When applying an eye for the future, Berkowitz recognizes that Sears' properties are valuable and can be used for alternative facilities in the future -- allowing the company to use means outside of retail to provide shareholder value. (This also plays back to lesson No. 1, since Berkowitz is comfortable in the real estate sphere)
Time has proven to be one of the most useful tools for investors, as studies have shown, time and time again, the damage done to portfolios that move with frequency in short-term periods.
5. Price matters...
In context. Saving this lesson for last was intentional, as price should not be the most important factor when judging an investment. While lots of analysts, managers, and investors will obsess over price targets and daily moves, it's important to keep a stock's price in context. One of the biggest reasons for Berkowitz's investments in the three companies mentioned above was an opportunity to exploit a pricing discrepancy for each. More specifically, in the case of Bank of America and AIG, both were trading below tangible book value (or liquidation value). Berkowitz saw this as a chance to get in early and ride the stock as both prices and book values improved.
Instead of looking directly at an individual price and its movement, be sure to measure it against a company's value, cash flows, and other important metrics that can give you a better view of the operation's ability to grow and flourish.
Fool contributor Jessica Alling has no position in any stocks mentioned, but you can contact her here. The Motley Fool recommends American International Group. The Motley Fool owns shares of American International Group and Bank of America and has the following options: Long Jan 2014 $25 Calls on American International Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.