I think some investors who are much more concentrated than I am focus more on the latter aspect of this type of thinking. Bruce Berkowitz is an example of a focused investor. Eddie Lampert, Mohnish Pabrai and Allan Mecham are other investors who focus. They each own just a few stocks, and their top idea represents a major part of their portfolio. Perhaps this is part of the reason for their huge returns over time. I run portfolios that are more diversified, but these investors often provide me with great ideas to research.
13-Fs Are Idea Generators
As Pabrai recommends, I look at 13-F filings each quarter to find out what the greatest investors are buying. I think of 13-F filings as idea generators. They are starting points… not ending points for investment ideas. I think of these 13-Fs as a way to leverage these larger firms’ vast resources, talent and experience to source investment ideas. They are analysts, and I don’t have to pay them!
I think there is research out there that has concluded that following the best investors’ best ideas leads to significant outperformance. But I don’t think of these 13-Fs as an automatic investment system. I don’t run out and buy a stock because one of the investors I track just bought it. If I see an idea that looks interesting, I’ll look at it more closely and determine if it makes sense to me. More often than not, it doesn’t.
I go through my usual pre-inspection checklist:
- Do I understand it? (Very basically, how do they make money?)
- Is it cheap? (Big picture simple valuation metrics)
- What are insiders doing?
- What are the risks?
- What’s the upside?
Bruce Berkowitz Discusses His Best IdeasLast week, I caught this Bruce Berkowitz video where he discusses his new position in Fannie Mae and Freddie Mac preferred shares. The positions represent about 5% of his portfolio, but have the potential to become much larger since they trade at 20% of their par value.
These Fannie and Freddie preferreds are trading at about 20% of their liquidation value, and thus have significant upside. I took a look at these a few weeks ago, and after a quick look, decided that their fortunes were too tied to Congress. I don’t see an alternative to these GSEs, and the residential housing market is too tied to these entities to simply remove them from the equation, but at the same time, I’m having a hard time determining how the government decides to play this out. And we know they play by their own rules. For example, they implemented a “sweep” amendment which simply allows them to take all of the profits from Fannie and Freddie (and these profits are huge [size=11pt; line-height: 115%; font-family: Calibri, sans-serif]— [/size]the GSEs just had one of the most profitable quarters in their history ).
I don’t quite see how this is possible, legal or constitutional, but they did it, and now shareholders have to file suit just to try to protect their rights as owners.
Obviously this uncertainty is the reason that the preferreds trade at 20% of their par value, leaving a 5x possible return if this gets sorted out in Berkowitz’ favor. I decided to pass (it failed my first question: Do I understand it?) and will watch with interest to see how the situation resolves itself.
Berkowitz also discussed his ideas on AIG, BAC and SHLD, his top 3 positions which represent a large majority of his overall assets. These ideas are much easier to follow — they’re cheap, selling well below book value (or in Sears’ case, below Berkowitz’s estimated value of their real estate assets).
It’s interesting to note that he’s very bullish on all three, even after huge runs by AIG and BAC.
Here is the video with Berkowitz discussing his ideas: