You Can't Win 'Em All, Part 1

The year in review: a little self-reflection on my less successful column ideas.
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Before we move on to my bombastic predictions for the future, I want to half-finish a promised recap of this year in The Buysider.

I'll save the back-patting for next week: There's already plenty of it in the financial media, and let's face it -- it does precious little for the thickness of the subscriber wallet to read what he or she should have done months ago. So, the topic today is three dogs, discussed at length in this space, plus a recap of:

What could I have possibly been thinking?

What happened that wasn't part of the plan?

What can we learn from it and what now?

I'll take

Fairfax Financial Holdings (FFH:Toronto) and

Ace Limited

(ACL)

together because, being in the same industry, they have fallen prey to a number of the same factors.

Realize that I try not to plug every stock I own in this space (even though I personally think that my columns are better and more valuable to

TSC

subscribers when I am writing about things that I am 125% involved in), and I attempt to be distinctly clear between when I write about something I own -- and when I am just thinking out loud.

Although both columns were clearly of the "now, isn't this interesting" variety (with a clear call that anyone should do more work before adopting them), they still give me pain, given the dismal clobbering both stocks received post-publication. In the interest of full disclosure, I have always had a bent toward insurance companies and think that both the property-casualty and life insurance businesses are in similar states to the banking industry 15 years ago: too much capital, too many players, too little management.

That's why I expect a major pickup of merger-and-acquisition activity in the area in 2000, and my portfolio is loaded with both potential buyers and sellers. In the meantime, the industry in general -- and property-casualty insurance in particular -- is suffering under dismal conditions, and Ace and Fairfax are deeply affected by these trends. That (and the severe disgorgement by Wall Street in general of anything

not

over $50 billion in market cap and associated with technology or the Internet) has been the cause of most of the declines. While I mentioned these two companies, I would have been equally mortified if I had brought up any number of other insurers.

The twist on Ace was that Brian Duperreault ran

American International Group's

(AIG) - Get Report

biggest division for years and was building what conceptually looked like AIG Two. The big leap for Ace was the purchase of

Cigna's

(CI) - Get Report

international insurance arm, which, as Duperreault gushed, was a one-of-a-kind franchise that would take 30 years to build from scratch. Under enlightened and entrepreneurial management, this would be a genius move.

But as often is the case, genius has a price, and that was roughly 3 times book value, which is

high

relative to nearly any deal either closed or contemplated in insurance or reinsurance. So, besides being in a miserable environment, Ace is under an enormous show-me cloud, and that has also kept me on the sidelines. But this clearly remains a company to watch.

I now own Fairfax and I am embarrassed to say I picked it off at C$210 ($142) a month ago, and have been meaning to write about it for weeks. The stock has popped a bit on absolutely no news. My take? Once the selling by panicked Canadians stopped, it appeared that not a single share was for sale, thus producing a pop.

I'll take lucky vs. smart when I can get it, and I still think it's a buy at current levels. Anyone contemplating this should go straight to

www.fairfax.ca and read Chairman V. Prem Watsa's unusual third-quarter letter to shareholders. It's unusual in that Watsa communicates very little all year -- and then tells it all in the annual,

a la

Warren Buffett

in the

Berkshire Hathaway

(BRK.A) - Get Report

annual. Selling at book value after a sickening 60%-plus plunge from its all-time high, it seems Watsa felt that maybe a little hand-holding was in order. Read that and the past few annual reports available online, and the odds are that you will either buy the stock immediately -- or you never will.

Fairfax is clearly in a giant show-me phase as well. It remains to be seen if Watsa and his team can run an acquisition-swelled organization 10-fold bigger than the one that produced a stunning 14-year track record. Like Ace, it has been tough to show progress in a miserable environment, and Fairfax hasn't gotten close. Nevertheless, this company is a very levered play on any modest improvement in PC and reinsurance fundamentals. Thanks to the mathematics of compounding, each C$240 is backed by C$1300 or so of investable assets, which as noted in my original piece, creates compelling economics, if the insurers don't underwrite the assets away. Think of it as Berkshire or a

Markel

(MKL) - Get Report

on speed.

It is also a play on a return (sometime in our lifetime, no doubt) of value investing, as Watsa is 85% in cash and bonds and is a deep-discount value investor. And of course, and most importantly, this is a play on management. If Watsa is a shrewd and conservative investor that has had a rotten couple of years -- a 14-year brilliant track record that was no fluke -- then Fairfax is a buy.

Editor's note: Be sure to check back later and read You Can't Win 'Em All, Part 2, in which Jeff analyzes the technology play that didn't.

Jeffrey Bronchick is chief investment officer at Reed Conner & Birdwell, a Los Angeles-based money management firm with $1.2 billion of assets under management for institutions and taxable individuals. Bronchick also manages the RCB Small Cap Value Fund. At time of publication, RCB was long Comdisco, Corning, Fairfax Holdings, Hughes Electronics, Motorola and United Global Communications, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Bronchick appreciates your feedback at

jbronchick@rcbinvest.com.