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How to Pick Stocks by Ignoring the Herd


Fund manager Bruce Berkowitz gives us his top picks.

Morningstar recently selected its top mutual fund managers for the past decade, with Bruce Berkowitz of Fairholme (FAIRX) clinching the domestic equity title.

Morningstar analysts say the new award aims to highlight those fund managers who have achieved superior risk-adjusted results over the past 10 years and have a proven record of serving shareholders well.

The 51-year-old Berkowitz, who also won Morningstar's domestic-stock fund manager of 2009, has racked up an impressive long-term record: FAIRX generated a 13.2% 10-year annualized total return through December 31, leading the S&P 500 by 14 percentage points and beating 99% of its rivals.

The five-star fund, with $11.2 billion in assets, has an expense ratio of 1.01%, and requires a minimum investment of $10,000.

Recently, we checked in with Berkowitz at his office in Miami. We chatted about the market, his top picks right now, and his new found talent for the electric guitar.

Minyanville: Walk us through the fund's investment philosophy and process.

Berkowitz: We assume our shareholders have worked hard for their money and, in the future, they will need more of it. We try and follow the Golden Rule in everything we do, which is to treat our shareholders as we would want to be treated.

Minyanville: How do you do that?

The only way to really do it is to make sure I am a big shareholder. I put as much of my family's money in the fund as I can. That way, I am both consciously and subconsciously thinking about shareholders. I am trying to have the same joys and pains as my shareholders. I want to create as level a playing field as possible.

Minyanville: How do you find your stock picks?

We run in the direction people are running away from, meaning we head towards stressed sectors. We compare the stressed market prices of securities to what we believe will be the cash generation of those securities over the lifetime of the investment. If we believe that we will get much more over time than what we are giving, well, it might be an interesting investment. So, paying cheap is half the battle.

What's the other half?

Berkowitz: The other half is figuring out what those cash flows are. We turn the question around and ask: what would stop the cash flows from happening? If we don't think they will be killed then we might be onto a good investment.

Minyanville: Let's do some stock picking. Why is real estate company St. Joe (JOE) a buy?

We are a large holder in St. Joe. We bought beachfront property at swamp prices. There is a new international airport opening up this May in the middle of their land. So, for the first time, the Panhandle, with its beautiful beaches, will be in easy reach of a good chunk of the United States.

Minyanville: And it was looking cheap?

Right, awfully cheap. And the company is net debt free. They have enough land for generations upon generations to develop. Just their airport project alone is greater than the island of Manhattan.

Minyanville: How about Hertz (HTZ)?

Berkowitz: Hertz is doing great. The management team did what it had to during the recession. Now they are starting to grow again. It's a great franchise and a great brand. As the economy picks up steam, they will do quite well.

Minyanville: Talk to us about AmeriCredit (ACF), the auto finance company.

Berkowitz: We went on the board there, which helped to do a great deal for our shareholders and for AmeriCredit. It's a good company and it is one of the few that survived. I believe they have a solid couple of years of growth ahead of them.

Minyanville: Analysts note that there are many forces for this company outside its control, like a lousy labor market and demand for used cars. Is that a fair worry?

Berkowitz: Yes, it's a fair worry but there are counterbalancing forces. There is much less competition so terms and conditions for loans are better. There is still significant demand but not enough supply for those loans. Also, we are starting to see an improvement in used-car prices.
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No positions in stocks mentioned.
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