Fairholme Sticks to Quality Names

We have entered 13-F filing season for the 2009 third quarter, and with a market rally of more than 60% since March, it's instructive to pay close attention to what the most successful risk-averse value investors are doing. One of my regular checkups each quarter is of the Fairholme family of funds, run by Bruce Berkowitz.

One of the reasons I pay close attention to Fairholme is the firm's principal focus on the cash generation of the any business it invests in. As Berkowitz often says, Fairholme likes to count the cash. Notice it doesn't talk about profits, which can be massaged, but focuses on the cash flow statement. This focus coincides with Fairholme's other philosophy of teaming up with top-notch management.

A Wonderful Recipe

Going forward, I think companies with exceptional managements will have an edge in this economy. What you want are unconventional thinkers -- managers who are thinking about risks when everyone else is trying to grow the business at any cost.

The first item of significance regarding Fairholme's third-quarter activity is that the firm was a net seller of equities. The firm held 26 positions, compared with 33 positions in the second quarter. As disciplined value investors, the surge in equity prices has clearly led many to reduce exposure to equities. While the market appears to be headed higher into next year, guys like Berkowitz and Seth Klarman base all buy and sell decisions on value gained for the price paid.

Stockpickr Tools Fairholme Capital's Portfolio

Fairholme completely sold out of American Express (AXP - commentary - Trade Now), General Dynamics (GD - commentary - Trade Now) and Boeing (BA - commentary - Trade Now). Amex has been a tear this year, up more than 100% year to date and up 300% from its March lows.

Fairholme's biggest position continues to be Pfizer (PFE - commentary - Trade Now), and it's easy to see why. Pfizer is a cash gusher and has now become the eighth-largest generic drug company in the world. A Monday New York Times article talked about how drug companies are raising prices ahead of the health care legislation. According to the article, drug companies have usually been successful at raising prices ahead of any major legislation, as was the case when Congress added drug benefits to Medicare earlier this decade. Whatever the final form of the health care bill, it's anticipated to add coverage to 30 million more people -- a big boost for drug companies.

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At the time of publication, Gad had no positions in stocks mentioned, although positions may change at any time.

Sham Gad is the managing partner of Gad Capital Management, a value-focused investment firm based in Athens, Ga. Gad has written extensively for The Motley Fool and was a securities analyst for UAS Asset Management, a small value investment fund in New York City, in 2007. From 2002-2005, Gad managed assets for the Gad Investment Group.

Additionally, Gad has just released a new book, The Business of Value Investing: Six Essential Elements to Buying Companies Like Warren Buffett. He earned his BBA and MBA at the University of Georgia. Gad appreciates your feedback; click here to send him an email.