Berkowitz’s largest financial positions (AIG, Bank of America and MBIA) together comprise approximately 65% of his portfolio. His largest holding, AIG (NYSE:AIG), he began purchasing in the first quarter of 2010, when the price dropped to $24 per share on average. That year, AIG’s book value per share was $94.94. He then more than doubled the stake in 2011, at an average price of $31 per share. The book value in 2011 was $53.46.
Bank of America, his second largest holding, was mainly purchased in 2010 at average prices ranging from $12 to $16. The book value that year was $23.31.
MBIA (NYSE:MBI), his sixth largest position, was mostly added in 2010 at prices ranging from $8 to $11 per share on average, when it had a book value of $13.99.
Berkowitz said that even if these prices approached tangible book value he would be unlikely to sell. “Why sell at tangible book? You buy something at half its liquidation value. Problems are fixed. A more normal environment develops. The equity values rebound. Price eventually surpasses equity values and you have an above average performance return for a number of years,” he said.
The market price of each of his top three financial holdings have made significant gains, contributing to his returns last year, but still have a distance to meet their tangible book value. AIG is trading for $37.63 on Monday afternoon, still under its fourth quarter tangible book value per share of $66.45, after gaining 33% over the past 12 months. Bank of America has a market price of $12.37, still trailing its fourth quarter book value of $14.33 after gaining 25.5% over the past 12 months. Finally, MBIA trades for $10.77, trailing its fourth quarter book value of $16.35, after gaining 13.5% over the past 12 months.
He also mentioned that he believes these companies can achieve 10% return on equity again, as they have in the past. In AIG’s case, the last time its return on equity reached double digits was in 2006, when it was 13.8%, and the three preceding years. Its most recent annual return on equity was 3.5% in 2012.
AIG listed enhancing return on equity as a key goal in its core business strategy in its 2012 10-K, specifically, “Build on simplified legal entity structure to enhance financial strength and durability, capital efficiency and ease of doing business. Improve operational efficiencies, expense control and service through investments in technology and more productive use of existing resources and lower-cost operations centers.”
AIG data by GuruFocus.com
Bank of America returned 10.2% on equity last in 2007, and broached double digits the preceding four years. Since then, it has struggled to reach historical levels, returning 1.8% on equity in 2012. In the fourth quarter, however, it reported a 10.48% return on average allocated equity in its consumer and business banking segment, an increase from 9.47% the previous quarter.
BAC data by GuruFocus.com
MBIA exceeded 10% from 2003 to 2006, then again in 2009, and again in 2012, with a 38.9% return on equity.
MBI data by GuruFocus.com
Berkowitz also expects his theses to play out similar to Wells Fargo (NYSE:WFC) and other financial institutions in the 1990s in the wake of a commercial real estate collapse. Warren Buffett, a major Wells Fargo shareholder, commented on the event, analogous to the 2008 financial crisis, in his Berkshire Hathaway (NYSE:BRK.A)(NYSE:BRK.B) shareholder letter from the time, as a buying opportunity:
“Our purchases of Wells Fargo in 1990 were helped by a chaotic market in bank stocks. The disarray was appropriate: Month by month the foolish loan decisions of once well-regarded banks were put on public display. As one huge loss after another was unveiled - often on the heels of managerial assurances that all was well - investors understandably concluded that no bank's numbers were to be trusted. Aided by their flight from bank stocks, we purchased our 10% interest in Wells Fargo for $290 million, less than five times after-tax earnings, and less than three times pre-tax earnings.”
Wells’ stock price fell from $84.75 to $42.75 from peak to trough in 1990, while the company had a book value of $57.44. Five years later, the market price had increased 209%.
Though Berkowitz’s calculations are far more complex, history and the metrics he mentioned in February indicate that his highest-conviction financial stocks have significant upside remaining at this point one to two years into his five-to-seven-year time horizon.
“I still consider the holdings within our portfolio to be cheaper than anything else I can find and understand,” he said in February. “I can’t kill them. Overall, I’m very optimistic about their futures.”
See Bruce Berkowitz’s Fairholme portfolio here. Also check out the Undervalued Stocks, Top Growth Companies and High Yield stocks of Bruce Berkowitz.