Thursday, July 31, 2008

Fairholme: Semi-Annual Report

Over the eight and a half years since the Fund’s inception, we have lived by the belief that you should be fearful where others are greedy and to be greedy where others are fearful. We continue to ignore the crowd.

For instance, as energy stocks surged this year, we took profits in Canadian Natural
Resources, reducing our position to about 7% of net assets as of May 31, down from 15% on Nov. 30, 2007. Oil and gas prices have multiplied since our initial purchases and are now high enough to increase supply and slow demand. Alternative sources such as solar and wind are booming while sales of SUVs and other gas hogs have plunged.

We also halved our position in Berkshire Hathaway in the November-May period. While we have the greatest respect for Chairman Warren Buffett, we made this move because we cannot see how the company can replicate its past stellar performance given its current size and the age of its key personnel. Berkshire should still make good money for shareholders, but not enough to justify so large an investment at prices sold.

With the proceeds of sales, new inflows, and cash held for stressful times, we are buying healthcare stocks, ranging from manufacturers of ethical and generic drugs to health maintenance organizations, at what we consider reasonable or even dirtcheap valuations. Many of these stocks’ prices fell off the proverbial cliff prior to our purchases and have declined further since we took our initial positions. On May 31, global pharmaceutical giant Pfizer was about 10% of net assets, making it the Fund’s second largest holding. Also in the top ten is WellPoint, a provider of health maintenance organizations and other forms of medical insurance. These fundamentally sound businesses have become fallen angels, as slowing growth, rising costs, and election-year politics stoke investor fear. Still, these are companies with essential products and services and large free cash flows relative to purchase prices. We expect them to rise again.