Value Investors sometimes confuse the search for value with bottom fishing companies that are prone to fall further. One way to avoid the value trap is to look more closely at the balance sheet, compared to the income statement. Bruce Berkowitz, who is the founder of Fairholme Capital Management, shares his view at the University of Miami.
The video is worthwhile:
(hat tip to valuewalk)
To summarize, Berkowitz makes a case for Bank of America (BAC), American International Group (AIG), and Sears Holdings (SHLD). AIG is his largest position and was purchased at less than the cash value held by the company. Sears is viewed upon as a real estate investment. The bullish thesis for Sears is based on liquidation value, and these companies are valued at that level alone. Both the brand name and the real estate value are not accounted for in the share value of the company.
Berkowitz thinks the U.S. economy is on the recovery phase. He likes companies that are most hated.
AIG is deeply undervalued and is an investment favorite for many big hedge funds, but it is still possible for insurance companies like AIG to allocate an insufficient amount in reserve losses on its balance sheet. Following the height of the financial crisis, reserve losses rose. In 2011, AIG booked $4.1 billion in net charges to clean up its balance sheet. In 2009, Chartis, the property and casualty insurance unit, took a $2.3 billion charge.
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Bank of America reserved $8.5 billion to cover claims against Countrywide Financial. If the amount is too small, it could hurt the bank’s balance sheet more than originally thought.
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Bank of America reported first quarter earnings that improved, helped by cost-cutting activities. The bank earned $0.20 per share on revenue of $23.7 billion. Non-interest expenses were $18.15 billion, declining by $1 billion from last year. Tier 1 capital rose to 10.58% from 10.38% over the previous quarter. The tangible book value per share for the bank is $13.46, compared to $12.87 last year.
The CEO of Sears Holding will stay onboard for another year, and will earn a mere $1 a year in salary. The bulk of compensation will be through stocks and incentive payouts. The company is enhancing shareholder value by paring down assets and improving its balance sheet.
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Written by Chris Lau, Kapitall Contributor