Fairfax Financial's Top Picks

Federico is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The most remarkable item about Fairfax Financial, the investment firm founded by Prem Watsa, comes from its book value track record. The firm increased its book value by almost 25% annually since 1985 according to Insider Monkey. Fairfax Financial also returned close to 100% since 2007 vs. a loss of 20% for the S&P 500 index. Many times in my blog I study what top hedge fund holds in their portfolios. Let’s review Fairfax's current holdings:

Banking picks: go with the best

Prem Watsa seems to agree with Warren Buffett on which banks to invest. Both investors like US Bancorp (NYSE: USB) and Wells Fargo (NYSE: WFC). These banks are considered the highest quality US banks in terms of earnings and balance sheet stability.

USB is Fairfax’s fifth largest holding. U.S. Bancorp is the fifth largest U.S. bank by assets and has some of the best credit quality and best loan growth in the industry. The company said in 2013 it expects the rate of revenue growth to be substantially lower than 2012 and its customers are holding back due to fears about the Fiscal Cliff. While these announcements can create selling pressure in the stock, USB is one of the best managed banks in the large cap space evidenced in the last earnings report. While most banks were showing large sequential quarterly declines in net interest margin (NIM) driven by lower top line yields, USB reported an increase in NIM as it was able to re-price high cost liabilities. In addition, as several large banks scale down their mortgage origination platforms, USB ramps its up to take advantage of record high gain on sale margins.  

Although earnings momentum is positive, I remain on the sidelines and recommend other banks such as Bank of America or Citigroup, which are more levered to an economic improvement. USB is now trading at 2.6x TBV (tangible book value) which is high compared to other large cap banks.

Wells Fargo is more levered to a continued housing recovery considering that 41% of its book is in residential real estate. In fact, Wells mortgage business has been generating record applications in both the second and third quarter. The stock has been under pressure because net interest margin contracted 25 bps to 3.66% in 3Q12 and this came as a material negative surprise as it was significantly different than the guided 17-bp decline the company gave at a conference in early October. As a result, investors did not care about the strong mortgage banking results and the solid loan and deposit growth. I like that Wells Fargo has diverse sources of income considering the existing low interest rate environment.

Technology: hot or not?

Prem Watsa likes what the rest of the market hates in technology land. He goes for what is not hot in technology: hardware and a failing mobile company. Fairfax owns Dell and Research in Motion as its top technology related holdings. I do not like either and advise investors to be cautious when investing in these kind of troubled companies.

Research in Motion (NASDAQ: BBRY) increased 120% from its September lows because the market anticipates the launch of long-awaited high-tier BlackBerry 10 smartphones. While initial sales of BlackBerry 10 smartphones may improve RIM's January and May quarter device sales I think there is a very low probability BlackBerry 10 sales can materially improve RIM's long-term business trends. Consumers are shifting to both iPhone and Android ecosystems and sub-$200 3G Android smartphones in emerging markets (one of the remaining strengths of this RIM) should threaten RIM's global sales and subscriber base. This is an ideal stock for short term traders but not for fundamental, long-term investors. Prem Watsa increased his position 93% last quarter, I think that if the BB10 bet finally fails, Fairfax could experience the biggest loss in its history.

While Dell (NASDAQ: DELL) trades at inexpensive multiples, I stay away from this stock. While the stock went down considerably and appears cheap, I stay away from this troubled business. Dell trades at just 6x forward P/E, 0.3x P/S and 3.5x EV/EBITDA.

Go with the best medical pick

Watsa holds 20% of its portfolio in Johnson & Johnson (NYSE: JNJ). This is the ideal stock for investors looking for safety and stability in these uncertain times. I think that JNJ shares should sustain its 12.6x forward P/E multiple, in line with the S&P 500. Both Barons and Barclays are bullish on JNJ prospects.
Barrons thinks projects that J&J may be set to deliver mid single-digit revenue growth and high single-digit profit growth in the next few years, lead by its pharmaceutical division while Barclays projects that revenue growth is improving in the company’s three main divisions: Pharmaceuticals; Medical Devices & Diagnostics, which makes artificial knees and hips; and Consumer, maker of Tylenol and Band-Aid.

martinzaldua has no positions in the stocks mentioned above. The Motley Fool owns shares of Johnson & Johnson and Wells Fargo & Company. Motley Fool newsletter services recommend Johnson & Johnson and Wells Fargo & Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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