Buying cheap stocks is the basis for successful investments, says Bruce Berkowitz, founder of the Fairholme Capital Management fund. How does an investor who has become the “manager of the decade” according to Morningstar choose assets?

Having worked in several banks at the beginning of his career, Bruce Berkowitz founded his own fund Fairholme Capital Management in 1997, earned a large fortune and many professional awards, including the title of “manager of the decade” from Morningstar.

Despite significant achievements, Berkowitz’s investment approach is very simple. He adheres to the strategy of value investing, preferring to buy undervalued stocks. “With my approach to value investing, your actions can look very strange until in the end you are right,” says the fund manager.

Berkowitz became the first person in his family to enter a higher education institution — in 1980 he received a bachelor’s degree in economics from the University of Massachusetts at Amherst. He then worked at Merrill Lynch, Lehman Brothers Holdings and Smith Barney.

Bruce Berkowitz is not afraid to go against the crowd and bets only on a few selected stocks. Berkowitz firmly believes that investing goes far beyond understanding just numbers.

“You should have a liberal arts education and knowledge of history and biology,” says the investor.

Berkowitz argues that humans are programmed for movement and momentum. According to him, in prehistoric times, when thousands of people ran in one direction, so as not to become the dinner of some predator, it was important to run with them. However, now investors need to recognize that these instincts are a hindrance to long-term success in the markets.

Following the crowd almost always guarantees defeat, he is sure.

Here are the top tips for investors from Bruce Berkowitz.

1. Look for companies that can survive hard times

Berkowitz believes that investors need to look for companies that can cope well with difficulties. “It is important to understand how people will behave under stress. And if you know that a company has assets and management that will allow it to succeed in difficult times, then you will not need to bother predicting the future of this business. This is the case when you can get very high results,” he says.

2. Be greedy when everyone is fleeing the market

According to Berkowitz, at some point in the economic cycle, investors should become greedy. He believes that in order to recognize the period when luck is on your side, and then be able to take advantage of this chance, you need a special skill.

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“The time to be greedy comes when investors flee the market without looking back. That’s when you need to strengthen this feeling in every possible way,” he is sure.

3. Always have enough cash

Berkowitz advises investors to have enough cash with them, as they will help to restrain themselves during a panic.

“Money is the equivalent of financial valium [a sedative]. They help to keep cool, calm and collected,” he believes.

He believes that cash can be considered as a strategic asset because it allows investors to use the opportunities that appear on the market from time to time.

4. Focus on a limited number of companies

Berkowitz is confident that investors should focus on a very small number of companies that can withstand any economic conditions.

“Concentration in investments [on several companies] implies less risk of losses, since you are well aware of the companies you own. The risk arises from not understanding what you are doing,” he says. He believes that investors only need a few good ideas that can make them very rich.

Bruce Berkowitz says that investors need to be prepared for the fact that markets are unpredictable and at any moment something can go wrong, so they need to be ready to handle the situation.

“We [in the fund] focus on a very small number of companies. We try to buy only those businesses that, in our opinion, are designed to work in any conditions. Because you only need a few good ideas for a lifetime to become incredibly rich. We are always trying to figure out what could go wrong, and we are very focused on a possible fall,” he admits.

Berkowitz says investors should avoid over-diversifying their portfolio. “Excessive diversification will lead to average returns. You will have to pay for an above-average income with short-term volatility,” the investor says.

5. Never lose your vigilance

Berkowitz is sure that investors should always be on the alert, even if they have already earned a lot of money. This is important because any next investment idea can lead to a catastrophe, because of which in a few minutes you can lose everything that you have accumulated for a long time.

“As you get richer, you invest more and more money. And your next idea, which may turn out to be bad, can lead to serious losses. In the end, you can lose more than you have earned in decades,” he notes.

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6. If there is a profitable opportunity, do not hesitate for a long time.

As Berkowitz says, there are two approaches to investing: one is to try to predict the future, and the second is to react to an emerging situation.

In his opinion, investors should focus on the facts of today and not think too much about the future, as such reflections increase stress. The best strategy is to react to any situation, not be afraid of stress and buy if there is a very profitable opportunity. Berkowitz warns that it is important for investors to carefully study macro variables, as they can have a serious impact on their investment success.

“When it comes to macro events, you can either try to predict what will happen next, or just react. I find time and time again that my “crystal ball” works very poorly, so I focused on reacting to extremes in individual securities, selling when they are high and buying when they are very cheap,” he says.

7. Avoid taking too much risk

According to Berkowitz, the main goal of an investor should be to achieve long-term capital growth without much risk.

8. Go against the crowd

Berkowitz believes that investors should avoid popular stocks and pay attention to not so bright securities in order to benefit from their current low prices.

In his opinion, the brain of investors is tuned to overreaction, impulse and following the crowd, therefore, as the expert is sure, in order to achieve success in the market, investors must go their own way and ignore the actions of the majority of participants.

9. Learn from Great Investors

Bruce Berkowitz advises you to be open to new ideas and use interesting developments of other investors that match your investment philosophy.

“We use a lot of ideas based on word of mouth, asking people what they have already bought that could be interesting for us. Why don’t you use what other great investors have already found?” —What is it?” he asks.

10. Invest in what you are competent at

Bruce Berkowitz warns that if you are not familiar with the company’s business and you do not have time to study it well, you should not invest in this project.

11. Be patient

Berkowitz reminds that time is one of the most useful tools for investors. Scientific research confirms that short-term portfolios are more prone to losses than long-term ones.

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12. Avoid short positions

Bruce Berkowitz notes that a short position is a potentially dangerous investment strategy and few investors dare to use it.

“When I open a short position on a stock, which doesn’t happen very often, I buy options because all I can lose in this case is the value of the option. I admit, I’m not cut out to be short. If you have a long position and you make a mistake, you go to zero. If you have a short position and you make a mistake, then this is the end,” Berkowitz warns.

Checklist for asset valuation by Bruce Berkowitz

How unkillable is this company? Cyclicity and jumps in growth can be mistaken for the quality of an asset. Berkowitz is in favor of revealing what can kill this business. This will allow you to see the true competitive advantage of the company: for example, McDonalds will not close because someone else will make a better burger. Location, advertising and brand are what make a company strong and unsinkable. But a titan like Google is vulnerable in terms of the best search algorithm that competitors can come up with.

How significant is this company? No matter how profitable a business is now, if its success depends on subsidies, loopholes in legislation or the tax regime, it is very vulnerable.

What is the company capable of? Berkowitz is always trying to assess the potential of the business. It can be difficult: Who would have expected Apple’s iPad to become so popular? This item will allow you to get rid of false hopes and unlock the new potential of the asset.

How decent is the company’s management? Good management does not always guarantee good investments, but bad management is always a disaster for business. This item is more of a test of the management for honesty than for quality. The main thing is to exclude dishonest managers.

What are the catalysts of this business? Cheapness can be justified for various reasons. Berkowitz tries to understand why the market devalued the stock, and then tries to imagine how to solve this problem. What will happen next: asset sales, cyclical reversal or breakup? It is important not to avoid problems here — these are important details of the analysis.

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