Circle of Competence

Here are the numbers:

Since the inception of the Fairholme Fund (FAIRX), right at the end of 1999, the fund has returned a cumulative 240%, through June 30, 2008.  On an annualized basis,  those are returns of 15.5% per year.  That would turn a $10,000 investment into $34,000 in the span of 7 and a half years.   Compare this to the return of the S&P 500, 0.11% per year, more commonly known as zero.

While those are extraordinarily impressive numbers considering the growth in assets under management from what I believe was under $100mm to begin, to now over $9B (and rising, the Fund is still open), that’s not the whole story.

Fairholme has yet to experience a significant down year.  In fact, their worse year was a loss of 1.77% in 2002, a year when the market declined by 22%.    With remarkable consistency, the fund has continued to crank out returns between 10% and 25% year after year.  Not only are their returns high on a relative basis, if you take into account the fact that Fairholme has held an average of 20% of the fund in cash over its life, the numbers shine even brighter.    That points to ~20% annual returns on the equity portion of its portfolio, with the S&P completely flat.

The principal manager of the Fairholme Fund is Bruce Berkowitz.  He and he team run Fairholme Capital Management, managing private accounts in addition to the mutual fund.  Alongside Mr. Berkowitz sit Keith Trauner and Larry Pitkowsky, the lieutenants.  While I am unsure about the separation of responsibility, it is no doubt Mr. Berkowitz’s show to run.

From time to time, the Fairholme team pops up in news, interviews, and articles.  Wealthtrack has hosted Berkowitz and Trauner in the past, which you can view on their website.    The reason that I tend to fawn over Berkowitz and his team, besides their amazing performance, is the simplicity of their approach.  Basically, they look to “count the cash,” a mantra that Berkowitz tirelessly repeats in interviews.   Berkowitz likes to talk about how Fairholme tries to turn every business into the “corner grocery store.”  I find it a simple, and useful, mental exercise to go through when analyzing the free cash flow of my companies.

In my recent article on the failure of common heuristic measures, I mentioned the advantage of using cash flow as a proper valuation measure, rather than earnings.    No doubt, Berkowitz has influenced my thinking on this matter.  My highly unqualified opinion is that Fairholme is run similarly to the early Berkshire Hathaway, at least in their approach to marketable securities.  Berkowitz buys two things:

1. Stable, cash generating businesses with terrific balance sheets and legendary managers at depressed prices (they look for a 10% free cash flow yield or better)

2. “Special Situations” - Cigar butt type investments that, while not wonderful businesses, are trading for extremely cheap prices.

Unlike the modern Berkshire, Fairholme can and will sell stocks that are fully valued.  Over time, this will tend to augment their returns, an approach Berkshire cannot follow due to size and various other business constraints.

* * * * * *

The reason I bring all of this up, besides a chance to show my admiration, is that Berkowitz has done a blitz of media over the past couple of weeks.  In June alone, Berkowitz showed up on Wealthtrack, Morningstar, CNBC, and Fox Business.  I don’t think he’s done that much media in 7 years!  Needless to say, this has been an exciting time for me.  Truly pathetic, but, pathetically…true.

So, take a half hour out of your busy day, and watch the videos.  Berkowitz has a grasp on intelligent investing that is rare in the world of insitutional investing, and we mortals can learn a tremendous amount.

You may be asking why the surge of public appearances. The answer is…I have no clue. With success comes attention, and Fairholme is getting the attention it deserves. My job isn’t to figure out his motivation, only to enjoy the results!

Besides that, he owns Sears!  What’s not to like?

Morningstar Video (click on “What Fairholme’s Been Buying)

CNBC Video

Wealthtrack Video

Fox Business Video

Full Disclosure: Rabid Fairholme Fan