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Fairholme Stays the Course

Fairholme Stays the Course

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Published by: mattpauls on Nov 20, 2011
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Ignore the crowd.

Fairholme Ignore the crowd.

This presentation uses Bank of America as a case study to illustrate Fairholme Capital Management’s investment strategy for the Fairholme Fund. In the pages that follow, we show Fairholme Fund shareholders why we “ignore the crowd” with regard to Bank of America and other financial companies that currently are out of favor with the market. However, nothing in this presentation should be taken as a recommendation to anyone to buy, hold or sell Bank of America securities or any other investment mentioned herein. Our opinion of Bank of America’s prospects should not be considered a guarantee of future events. Investors are reminded that there can be no assurance that past performance will continue, and that a mutual fund’s current and future portfolio holdings always are subject to risk. As with all mutual funds, investing in the Fairholme Fund involves risk including loss of principal. The Fairholme Fund’s holdings and sector weightings are subject to change. As of August 31, 2011, Bank of America securities comprised 6.1% of the Fairholme Fund’s total net assets. The Fairholme Fund’s portfolio holdings are generally disclosed as required by law or regulation on a quarterly basis through reports to shareholders or filings with the SEC within 60 days after quarter end. A complete list of the Fairholme Fund’s top ten holdings is available on our website at www.fairholmefunds.com. The Fairholme Fund is non‐diversified, which means that it invests in a smaller number of securities when compared to more diversified funds. Therefore, the Fund is exposed to greater individual security volatility than diversified funds. The Fairholme Fund can invest in foreign securities which may involve greater volatility and political, economic and currency risks and differences in accounting methods. The Fund may also invest in “special situations” to achieve its objectives. These strategies may involve greater risks than other fund strategies. Investments in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer‐term debt securities. Lower‐rated and non‐rated securities present greater loss to principal than higher‐rated securities. The Fairholme Fund’s investment objectives, risks, charges, and expenses should be considered carefully before investing. The prospectus contains this and other important information about the Fairholme Fund, and may be obtained by calling shareholder services at 866‐202‐2263 or visiting our website at www.fairholmefunds.com. Read it carefully before investing. Additional supplementary information can be found at the end of the presentation.


Ignore the crowd.

The Fairholme Fund (FAIRX):
Average Annual Total Returns as of 9/30/2011: 1 Year  5 Year  Fairholme Fund  ‐22.20%  0.12%  S&P 500  1.14%  ‐1.18%  30‐Day SEC Yield  Expense Ratio  ‐0.52% 1.01% * 10 Year 7.15% 2.82%

*Includes acquired fund fees of .01%. Acquired fund fees and expenses are those expenses incurred indirectly by the Fairholme Fund as a result of  investments in securities issued by one or more investment companies.

Cumulative Returns as of 9/30/2011: 1 Year  Fairholme Fund  ‐22.20%  S&P 500  1.14% 

5 Year  0.61%  ‐5.76% 

10 Year 99.57% 32.00%

Performance information quoted above represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance may be higher or lower than the performance quoted herein. The Fairholme Fund imposes a 2.00% redemption fee on shares held less than 60 days. Performance data does not reflect the redemption fee. If reflected, total returns would be reduced. Fairholme performance numbers assume reinvestment of dividends and capital gains and include all expenses, including acquired fund fees and expenses incurred indirectly by the Fairholme Fund in securities issued by investment companies. While the Fairholme Fund has no front or back loads, or 12b‐1 fees, management fees and other expenses still apply. Current month end performance may be obtained by calling Shareholder Services at 866‐202‐2263.


Ignore the crowd.

Guiding Principles

Shareholders First  Don’t Lose Focus on Value Long‐Term Performance Ignore The Crowd


Ignore the crowd.

 $50,000  $45,000  $40,000  $35,000  $30,000  $25,000  $20,000  $15,000  $10,000  $5,000  $‐

Our performance since  inception has been quite good…

Performance of a $10,000 Investment


S&P 500

* Based on total return. See last page for supplementary information Fairholme Ignore the crowd.

…And, we’ve even kept pace with our heroes.

Performance of a $10,000 Investment










Berkshire Hathaway

S&P 500

* Based on total return. See last page for supplementary information Fairholme Ignore the crowd.

Value investing is a long‐term strategy…even Charlie Munger’s private  partnership (pre‐Berkshire Hathaway) had tough investment periods.
 $180,000  $160,000

Performance of a $10,000 Investment

 $140,000  $120,000  $100,000  $80,000  $60,000  $40,000  $20,000  $‐ ‐ 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975

Munger Partnership
* See last page for supplementary information Fairholme

Dow Jones Industrial Average
Ignore the crowd.

Greedy when others are fearful,  and fearful when others are greedy.
25% 1,350 1,300 20% 1,250 15%




1,100 5%

When investors are fearful prices are low, and we buy.

When prices are high and others are greedy, we raise cash.



FAIRX Cash %

S&P 500


Ignore the crowd.

S&P 500 Index

FAIRX Cash %

Value investors do not equate “volatility” with “risk” over the long‐term.

Vol•a•til•i•ty: [vol‐uh‐til‐i‐tee]
Webster’s Dictionary 
“Tending to fluctuate sharply and regularly.”

Barron’s Dictionary of Finance and Investment Terms
“Characteristic of a security, commodity, or market to rise or fall sharply  in price within a short‐term period.”


Ignore the crowd.

Market price volatility only measures short‐term perception of long‐term risk.
FAIRX Recovery Periods
Recovery Period
8/29/03: $16.52 Span: 16 Months

Recovery Period
4/30/10: $35.20 Span: 30 Months

Recovery Period
12/31/10: $35.38 Span: 8 Months


 $30 FAIRX Net Asset Value (NAV)





Peak To Trough Peak To Trough
4/30/02: $16.40 2/28/03: $13.92 Span: 10 Months 10/31/07: $34.82 2/27/09: $17.32 Span: 16 Months

Peak To Trough
4/30/10: $35.20 6/30/10: $30.30 Span: 2 Months




Ignore the crowd.

Investment Thesis for Financial Stocks

1% Return on 

10% Return on 
Owner’s Equity

20% implied annual
Return on Investment

This would be a  reasonable return to  profitability, and  certainly not a  difficult goal.

This is simply the  math associated with  the leverage of  financial companies.

This is the implied annual return when  you can buy stock at  ½ book value.


Ignore the crowd.

Case Study: Bank of America


Ignore the crowd.


Ignore the crowd.

Investing in our Circle of Competence
 Businesses we understand   Favorable long‐term prospects
$90 $80 $70

 Operated by honest and competent people  Available at attractive prices

Dollars Per Share

$60 $50 $40 $30 $20 $10 $0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Book Value

Market Price


Ignore the crowd.

Bank of America’s Franchise
5,700 Branches, 17,500 ATMs, and 16,500 Financial Advisors in 50 states and over 40 countries.  Touches 80% of the U.S. population, including 57 million consumer and small business relationships. 

Acquisitions and Asset Growth
         North Carolina National Bank Bankers Trust First Republic Bank C&S Sovran  Nations Bank MNC Financial Barnett Bank Boatmen’s Bank Bank America Corp

Dollars (in millions)





     

Fleet Boston MBNA U.S. Trust Lasalle Bank Countrywide Merrill Lynch

1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Total Assets
Fairholme Ignore the crowd.

“You’ve got to admit it’s getting better... A little better all the time.”
$600,000 $500,000 $400,000 $300,000 $200,000 $100,000 $0 $12,000 $10,000 $8,000 $6,000 $4,000

Long‐Term Debt Decline  22% decline since Q1 2010

$2,000 $0

Charge‐Offs  53% decline since Q1 2010   Q‐o‐Q decrease since 2010

Long‐Term Debt $1,060,000 $1,040,000 $1,020,000 $1,000,000 $980,000 $960,000 $940,000 $920,000 18%


Capital  Sufficient Tier 1 Capital

Deposits  7% increase since Q1 2010  Reflects strong customer base

16% 14% 12% 10% 8% 6% 4%


Dollars (in millions)

Tier 1 Common Equity Ratio Tier 1 Risk‐Based Capital Ratio Total Risk‐Based Capital Ratio

* See last page for supplementary information Ignore the crowd.

Legacy Countrywide Loans…

Global Wealth &  Global Banking &  Investment Management Legacy Consumer Real Estate Services Markets


Ignore the crowd.

…Masks Strong Franchises.


Card Services

Global  Commercial  Banking

Global Wealth &  Global Banking &  Consumer Real Estate Services Investment Management Markets
Legacy Asset Servicing

Consumer Real Estate Services


Ignore the crowd.

Get vs. Give

Future Cash  Flows

Market Cap: $70bn

Owners Capital: $200bn Reserves: $50bn

Using Ben Graham’s framework,  recently the market has been a  “voting machine,” but when it  returns to a “weighing machine”  Bank of America’s strong  fundamentals will come into play.


Ignore the crowd.

Déjà vu?
“…Its earnings power has been disguised by the intense provisioning for loan losses. But when the provisioning gets back to a normal level, you’ll start to see that incredible earnings power come down to the bottom line. And it’s as simple as that.”
Bruce R. Berkowitz  Outstanding Investor Digest  November 25, 1992


Ignore the crowd.

Wise investors do not permit “Mr. Market’s” daily fluctuations to  affect their understanding of fundamental value.
1,800% 1,600% 1,400%

Cumulative Return

1,200% 1,000% 800% 600% 400% 200% %

Started to Buy Wells Fargo

Wells Fargo

S&P 500

Banks have been here before.
Fairholme Ignore the crowd.

The S&P 500 Index is a broad based measurement of changes in the stock market, is used for comparative purposes only, and is not meant to be indicative of the Fund’s performance, asset composition or volatility. Given the wide scope of securities held by S&P 500, it should be inherently less volatile. Our results may differ markedly from those of the S&P 500 in either up or down market trends. The performance of the S&P 500 is shown with all dividends reinvested into the index and does not reflect any reduction in performance for the effects of transaction costs or management fees. Investors cannot invest directly in an index. The performance quoted for Berkshire Hathaway (“Berkshire”) and Leucadia National Corporation (“Leucadia”) is based on the closing market price of Berkshire’s Class A Common Stock and Leucadia’s common shares. Berkshire is a conglomerate holding company owning subsidiaries that engage in a number of diverse business activities including property and casualty insurance and reinsurance, freight rail transportation, utilities and energy, finance, manufacturing, services and retailing. Leucadia is a diversified holding company engaged in a variety of businesses, including manufacturing, land based contract oil and gas drilling, gaming entertainment, real estate activities, medical product development and winery operations. Berkshire and Leucadia are not mutual funds. They are subject to different corporate, securities, and tax regulations that affected their return in ways different than a mutual fund. Berkshire has not paid a dividend. Its earnings are retained and taxed at prevailing corporate income tax rates. The quoted returns for Berkshire and Leucadia do not reflect capital gains tax a shareholder would pay upon sale of their stock. As a registered mutual fund, Fairholme Fund's net investment income is exempt from corporate taxation provided it is paid out as dividends. The Fund's quoted returns do not reflect a shareholder's taxes on dividends or upon redemption of shares. Berkshire was the Fund’s fourth largest holding as of August 31, 2011, representing 7.9% of the Fund’s total net assets. Leucadia was not among the Fund’s top ten holdings as of the same date. The “Munger Partnership” was a private investment partnership run by Charles Munger, who is now Vice‐Chairman of Berkshire Hathaway. Tier 1 Capital: a regulatory measure of a bank’s financial strength. It is composed of core capital, which is principally common stock and retained earnings. Tier 1 Common Equity Ratio: the measurement of a bank's core equity capital compared with its total risk‐weighted assets. This is the measure of a bank's financial strength. The Tier 1 common capital ratio excludes any preferred shares or non‐controlling interests when determining the calculation. Tier 1 Risk‐Based Capital Ratio: the ratio of Tier 1 capital to its Risk‐weighted assets. Risk‐weighted asset is a bank's assets or off‐balance sheet exposures, weighted according to risk. The historical return shown for Wells Fargo is based on Closing Price of its Common Stock. The chart refers to the purchase and sale of Wells Fargo stock by Fairholme Fund’s portfolio manager while he was portfolio manager for Shearson Lehman Brothers. Wells Fargo securities were not among the Fairholme Fund’s top ten holdings as of August 31, 2011, and were not held by Fund as of its last shareholder report dated May 31, 2011. Opinions expressed are those of the author and/or Fairholme Capital Management, L.L.C. and should not be considered a forecast of future events, a guarantee of future results, nor investment advice. Shares of the Fairholme Fund are distributed by Fairholme Distributors, Inc.


Ignore the crowd.

Ignore the crowd.


Ignore the crowd.

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