Bruce Berkowitz, head honcho at Fairholme Capital Management, has a reputation as being one of the savviest investors on the street. He’s outgained the S&P 500 is ten of the last eleven years and had negative returns in only the post-bubble years of 2002 and 2008. His 5-year cumulative return of 60.8% matches that of Warren Buffett and his 10-year cumulative return of 196% easily tops Warren’s return of 136%. But Fairlome’s flagship mutual fund is down 26% this year due to an ill-timed bet on troubled financials, including 27% of its total portfolio in American International Group (NYSE:AIG). Add to that a recent Barron’s article detailing Berkowitz’s puzzling choice of an inexperienced lieutenant leading to the departure of his long-loyal analyst team, and it’s no surprise that Fairlome’s assets have been cut in half since last year.
In the most recent quarter's 13F, Berkowitz showed that the financial-induced pain on his returns hasn’t deterred him from all financials as he upped his holdings in many banks and AIG’s weighting still sticks out like a sore thumb. Given the uncertainty that the European debt crises has caused, it is baffling that Berkowitz purchased 510,000 shares of Banco Santander (STD) in Q3.
Although it pays a hefty dividend of 8.7%, with a price-to-book of .6, and a price-to-earnings of 5.7, it's important to remember that European banks have a list of problems longer than a menu at a Greek restaurant. Their exposure to troubled European sovereign debt and a pending, almost certain, forced increase in capital requirements, are sure to sap the bottom line of even the minimally exposed. Santander’s recent fire sale in Chile and Columbia shows that it is trying to boost capital and get out in front of this contagion-driven freight train without reducing dividend payments or selling additional shares at a depressed price. Unfortunately for current shareholders, these steps are inevitable.
In third quarter, Berkowitz dipped his toe back into the defensive telecom sector by picking up shares of some previously held telecom firms. He snapped up 130,000 shares of Verizon Communications Inc. (NYSE:VZ), 160,000 of AT&T (NYSE:T) and 220,000 shares of Telefonica S.A. ADS (NYSE:TEF). This is after a 280,000 share purchase of Vodafone Group Plc (NASDAQ:VOD) in the second quarter. Along with Santander and Winthrop Realty Trust(NYSE:FUR), these telecoms are the highest yielding stocks in Berkowitz’s portfolio.
At its current price of $29, AT&T has a dividend yield of 5.9%, a price-to-book of 1.5 and a price-to-earnings of 12.4. It’s beta of .6 makes it less sensitive to volatile market gyrations. A 5.2% middle of the road price-to-cash flow ratio could come down if the merger with Deutsche Telekom’s (DT) T-Mobile USA unit eventually gets approved. ATT&T operations keep throwing off tons of cash and a big institutional ownership of 55% along with a $171.6 billion market cap make AT%T intriguing.
ATT&T’s biggest competitor is Verizon. Their heated rivalry in cable, mobile and broadband has each clamoring for market share by offering revenue-diluting bundles to rein in customers and gain long-term loyalty. Verizon trades cheaper to book value than AT&T with a price-to-book of 1.1 but more expensive to earnings with a price-to-earnings ratio of 17.6. At its current price of $38.50, Verizon offers a 5.3% dividend yield, with price-to-cash flow of 5. Over the last year, the stock has been kind to investors, increasing 17% and beating 85% of telecom stocks in the Russell 1000 index. In September, the company reported earnings of $0.49 versus $0.23 the previous year. Verizon’s 0.58 beta shows that it won’t be held hostage by volatile market swings . It has a 52% institutional ownership and market capitalization of $107 billion. Like AT&T, Verizon is a good choice going forward.
Telefonica, the Madrid based telecom, serves primarily Spain but also has a presence in the rest of Europe and Latin America. At $17.52, its share price sits about where it was in October of 2008 during the peak of the financial crises. It has a price-to-earnings ratio of 4.7% and a whopping dividend yield of 9.1%. Based on these numbers, you may think that Telefonica is attractively valued . But, a price-to-book ratio of 2.7 and a price-to-cash flow of 8.3 tell a different story. Add to that, a loss of $.13 per share in the last quarter , a projected 28% decline in 2011 full-year earnings along with the ongoing European debt crises, and Telefonica is a stock that I would wait to buy.
Waiting is not what you want to do with Vodafone. The British mobile-network operator has been caught up in the eye of the European financial storm. Its U.S. listed shares currently trade for $27, with price-to-earnings ratio of 10, which is a discount to U.S. rivals Verizon and AT&T. Vodafone and Verizon share ownership of Verizon Wireless, the No. 1 U.S. cell-phone company and each company's best asset. Vodafone owns 45% and Verizon 55%. Investors haven't given Vodafone full credit for that valuable stake, which could be worth $75 billion, or more than half the company's market value. That will change in early 2012 when Verizon Wireless pays $10 billion in dividends to its corporate parents. According to the 12 Barron’s article “It’s Time to Ring up Vodafone”, the decision by Verizon Wireless to pay a dividend in January is a game changer. Vodafone is expected to pass its chunk to shareholders, leading to a total dividend of $2, which is a 7.5% yield. The icing on the cake is that the hefty payout is believed to be an annual and growing event.
Berkowitz’s decision on high-yielding telecoms is a smart move, but his choice to up his financial holdings at this time is quite perplexing. The ongoing deflationary environment along with the recession-inducing European debt crises, leads me to believe there is plenty of time to pluck financials on–the-cheap somewhere down the road.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.