Fairholme Aig Case Study

An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return.”  Graham says “thorough analysis” means “the study of the facts in the light of established standards of safety and value” while “safety of principal” signifies “protection against loss under all normal or reasonably likely conditions or variations” and “adequate” (or “satisfactory”) return refers to “any rate or amount of return, however low, which the investor is willing to accept, provided he acts with reasonable intelligence.” (Security Analysis, 1934, ed., pp. 55-56)

Our Nation Today

The one aim of all such persons is to butter their own parsnips.  They have no concept of the public good that can be differentiated from their concept of their own good.  They get into office by making all sorts of fantastic promises, few of which they ever try to keep, and they maintain themselves there by fooling the people further.  They are supported in their business by the factitious importance which goes with high public position.  The great majority of folk are far too stupid to see through a politician’s tinsel.  Because he is talked of in the newspapers all the time, and applauded when he appears in public, they mistake him for a really eminent man.  But he is seldom anything of the sort.**

** This quotation is on page 67 of the 1991 collection, edited by Marion Elizabeth Rodgers, The Impossible Mencken; specifically, it’s from Mencken’s August 19, 1935 Baltimore Evening Sun essay entitled “The Constitution.”

Investment vs. Speculation

As Graham once put it, investors judge “the market price by established standards of value,” while speculators “base (their) standards of value upon the market price.” For a speculator, the incessant stream of stock quotes is like oxygen; cut it off and he dies.

Below are several case studies by Fairholme:

http://www.fairholmefunds.com/bruce-berkowitz-consuelo-mack-101212-featured-video-page#overlay-context=bruce-berkowitz-consuelo-mack-101212-featured-video-page

Try not to be swayed by stories but by facts.

You may think investing in a bank below book value is cheap and you may be correct on a grouped basis, but I don’t know how one truly can value a complex, huge financial company like Bank of America.

If you are analyzing a good company based on its normalized return on capital, you first have to identify economic capital. Financial groups (Banks, insurance companies, mutual funds) carry “third party capital” such as depositors, policyholders, and investors. This capital does not belong to shareholders, and is not provided by lenders. These are the assets deposited by the clients of these companies; bank deposits, for example.  Due to the complexity of these groups, accurately segregating only the capital financing the company’s own assets is nearly impossible, especially since most of these assets are ‘market to market’, in other words, revalued every day at their market value.

Segregating capital and identifying cash flows for financial groups is difficult because, fundamentally, these businesses do not produce profits in the same way as non-financial groups. The latter simply add some value, via a proprietary process, to a certain amount of operating costs, and sell units (goods and services) of the total cost to its clients. The former capture capital flows, often thanks to a high financial leverage (partly from debt, partly from ‘third party capital’). Transform them and clip a remuneration for this process. Even if it were possible precisely to identify cash flows and economic capital for financial groups, the difference in balance sheet leverage would demand the calculation of an expected return (‘cost of capital’) specific to them.

Investors may find that excluding financial companies from their portfolio would, at worst, not put them at a disadvantage.

It is OK to speculate and invest, just know the difference. 

Ponzi Finance

Carlo   Ponzi, Alias Uncle Sam by Gary North Reality Check(Nov. 2, 2012)Carlo “Charles” Ponzi was a con man who was the Bernie Madoff of his era. For two years, 1918 to 1920, he sold an impossible dream: a scheme to earn investors 50% profit in 45 days. He paid off old investors with money generated from new investors. The scheme has been imitated every since.Every Ponzi scheme involves five elements:1. A promise of statistically impossible high returns
2. An investment story that makes no sense economically
3. Greedy investors who want something for nothing
4. A willing suspension of disbelief by investors
5. Investors’ angry rejection of exposures by investigatorsStrangely, most Ponzi schemes involve a sixth element: the   unwillingness of the con man to quit and flee when he still can. Bernie Madoff is the supreme example. But Ponzi himself established the tradition.

The scheme, once begun, moves toward its statistically inevitable end.   From the day it is conceived, it is doomed. Yet even the con man who   conceived it believes that he can make it work one more year, or month, or day. The scheme’s designer is trapped by his own rhetoric. He becomes addicted to his own lies. He does not take the money and run.

This leads me to a set of conclusions. Because all Ponzi schemes involve   statistically impossible goals, widespread greed, suspension of disbelief,   and resistance to public exposure,

All fractional reserve banking is a Ponzi scheme.
All central banking is a Ponzi scheme.
All government retirement programs are   Ponzi schemes.
All government-funded medicine is a Ponzi scheme.
All empires are Ponzi schemes.
All Keynesian economics is a Ponzi scheme.

But there is a difference between a private Ponzi scheme and a government Ponzi scheme. The private scheme relies on deception and greed alone. A government Ponzi scheme relies on deception, greed, badges, and guns.   Read more:http://www.garynorth.com/public/10280print.cfm

Couch Potato Nation: Hooked on handouts: http://lewrockwell.com/faber/faber144.html

 

This entry was posted in Economics & Politics, Risk Management and tagged aig, BAC, Fairholme, Sears. Bookmark the permalink.

Fairholme Capital's Bruce Berkowitz has released numerous case studies about his investments in the past and one of his latest features his investment thesis on his second largest position: Sears Holdings (SHLD).

In the past, we've also posted up Berkowitz's thesis on AIG (his largest position) as well as Fairholme's thesis on Bank of America.  His latest case study on Sears showcases the key pieces to the investment, including:

- Real Estate: vast property portfolio carried at low cost

- Operations: increasing cash flows through greater efficiencies and cost reductions

- Top Brands: revenue beyond Sears and Kmart

- Leadership: new team with proven success

- Liquidity: ample to meet all liabilities and opportunities

- Catalysts: changing winds


Fairholme's mantra is "ignore the crowd" and this investment certainly fits the bill.  Sears has been one of the more shorted names among hedge funds (who have piled on as the retailer struggles).  They simply wager that a turnaround is farfetched.

Berkowitz takes the other side of the trade and sides with Eddie Lampert, chairman of Sears (and a value hedge fund manager himself: ESL Investors/RBS Partners).  This presentation is intriguing mainly because it provides both a variant view for the short sellers and a long case for value investors.

Embedded below is Bruce Berkowitz's investment thesis on Sears via his case study:

For more from this investor, head to Berkowitz's checklist for investing.


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