SumZero Takes on Bruce Berkowitz (Fairholme Capital)

Bruce Berkowitz has become one of the best-known mutual fund managers in the world. Despite struggling in 2011, his investment firm Fairholme Capital Management has been able to consistently outperform the market. Since its inception in 1999, Fairholme has produced an overall return of roughly 460% compared to a 65% return on the S&P 500 over the same period of time. These numbers would translate to annualized returns of 12.9% and 3.6%, respectively. Today, Berkowitz’s firm is comprised of three funds, including the Fairholme Fund (FAIRX), the Allocation Fund (FAAFX), and the Focused Income Fund (FOCIX). This week, we will take a look at some of Berkowitz’s recent moves and see how SumZero sentiment relates to those moves.

We will focus our analysis on the Fairholme Fund since it makes up more than 80% of Fairholme’s total $10.5B of assets under management. It should be noted, however, that there are major similarities between all three funds. For example, Sears Holdings Corporation (SHLD:US), the specialty retailer that operates in the United States and Canada, is the third largest position in the Fairholme Fund and the largest position in the Allocation Fund. Also, the largest holding in the Focused Income Fund is Sears’ debt.

Roughly 83% of the Fairholme Fund is held in equities. Below is a listing of the Fund’s largest positions:

1. American International Group (AIG:US) 47.0%
2. Bank of America Corporation (BAC:US)14.7%
3. Sears Holdings Corporation (SHLD:US)10.3%
4. Cash and Equivalents - 7.1%
5. Fannie Mae- 6.7%
6. Freddie Mac- 5.1%
7. St. Joe Corporation (JOE:US) 4.6%
8. Leucadia National Corporation (LUK:US) 4%

Berkotwitz’s Fairholme Fund appears to be much more concentrated than most funds. This is particularly evident in the fact that American International Group (AIG:US), the provider of insurance products, makes up nearly 50% of the Fund’s total holdings. SumZero analysts are roundly bullish on AIG as well.

Over the past year all 10 SumZero analysts who have valued AIG have recommended holding a long position. AIG’s stock is up more than 45% year-to-date and currently trades at $52 a share. Recent price targets given by SumZero analysts have ranged from $50 to $65 over the next 1-2 years. While, in general, SumZero sentiment reflects that there is still upside in AIG, Berkowitz seems to be even more bullish on the stock.

The second largest position in the Fairholme Fund is Bank of America (BAC:US). Similar to AIG, all 3 SumZero analysts who have recently given price targets on Bank of America have recommended a long position. BAC’s recent earnings report, which was released on Wednesday of this week (1/15), indicates that both Berkowitz and SumZero analysts have made correct bets. Following the earnings report, BAC’s stock jumped nearly 3%. It should also be noted that Bank of America has outperformed all of the major US banks as its stock has risen roughly 42% year-to-date.

Given that AIG and BAC make up more than 60% of the Fairholme Fund, it is clear that Berkowitz is very bullish on financial stocks. This is confirmed when looking at the breakdown of Berkowitz’s Allocation Fund. Below you can see the Fund’s top-ten holdings, five of which are stocks within the financial sector:

1. Sears Holdings Corporation (SHLD:US) 12.89%
2. American International Group (AIG:US)11.88%
3. Bank of America Corporation (BAC:US) 10.93%
4. Wells Fargo & Company (WFC:US) 6.13%
5. Information Services Group, Inc (III:US) 6.09%
6. Fed Natl Mort Assc Pfd -5.06%
7. FHLMC Pfd -4.98%
8. Leucadia National Corporation (LUM:US) 4.39%
9. J.P. Morgan Chase (JPM:US) 3.82%
10. Hartford Financial Services Group (HIG:US) -3.60%

One stock outside the financial sector that Berkowitz has become increasingly bullish on is the Information Services Group (III:US), which now constitutes roughly 6% of the Allocation Fund. Despite the fact that III has a relatively small market cap of $182 million, the stock has captured the attention of many investors. III currently trades at $4.93 a share. Despite the fact that III is up over 300% year-to-date, a SumZero analyst recently placed an $8.33 price target on the stock over the next 1-2 years. This would translate to an expected return of 71%.

One company that Berkowitz and SumZero are less in agreement on is J.C. Penney & Co (JCP:US). Despite the decline in JCP’s stock over the past year, Berkowitz has become increasingly bullish on J.C. Penney’s debt, now the second largest position in Fairholme’s Focused Income Fund. Although the S&P 500 rallied nearly 30% in 2013, JCP’s stock is down more than 60% from its 52 week high. This week, the stock has continued to decline as JCP announced it would close 33 underperforming stores and eliminate 2000 employees. As news from J.C. Penney continues to worsen, yields on JCP’s debt have risen.

While the larger investing community has becoming increasingly bearish on JCP, SumZero analysts are in disagreement over the future profitability of the company. Over the past year, roughly half of the analysts have recommended a long position while the other half have recommended a short position. What makes JCP particularly interesting, however, is the range of the price recommendations that analysts have placed on JCP. While JCP currently trades at $6.53 a share, a number of analysts who have recommended a short position believe the stock will become valueless over the next 1-2 years. On the opposite end of the spectrum, one analyst has given a price target of $100.

Other than J.C. Penney, Berkowitz and members in the SumZero community seem to have very similar opinions on several stocks. We did not see as much agreement when we compared SumZero sentiment with the recent investing activity of Seth Klarman’s hedge fund the Baupost Group (Click Here to Read More). Either way, we at SumZero have profound respect for both men and their investment strategies.