Please give me your thoughts on the interview in the comments section or feel free to e-mail me. I’m always looking for new investors to interview.

You can find more about the Tilson Dividend Fund here or learn more about the fund’s performance via Morningstar.

My questions are in bold.

Can you give us a brief bio of yourself and how you came to run Centaur Capital?

I started my career in the financial software business as a consultant deploying complex treasury and risk management systems for large banks and conglomerates, mostly in Europe. At the time, I thought that my natural career progression might be to become a risk manager for a large bank or insurance company.

Somewhere along the way I developed an interest in the stock market and discovered Warren Buffett’s Berkshire Hathaway letters and was immediately hooked. I also was a big fan of the Motley Fool website, and when I decided that I wanted to change careers to investing, I was fortunate enough to land a job there. I moved back to the States and started working for TMF as an investment writer in early 2000 – just in time for the bear market. I spent two years writing articles and research on investing for TMF, which enabled me to learn and refine my own investing approach.

In 2002, I decided that I was ready to start investing professionally, and moved to the Dallas area and started Centaur Capital Partners. I set up a private limited partnership and opened for business with less than $1 million under management, and it took several years to get to the point where Centaur Capital was a viable business. In 2005, we launched a mutual fund called the Tilson Dividend Fund (TILDX) in partnership with our good friends Whitney Tilson and Glenn Tongue at T2 Partners, and that has done well. We’ve now been in business for eight years, and while it’s not been without its challenges, overall I feel very fortunate to be where I am today.

A while back in 2007 at the Value Investors Congress, you gave a presentation (PDF) about how you think about asset allocation at Centaur. Is it largely the same today? Or has the financial crisis influenced your take on capital allocation?

That VIC presentation was primarily a discussion about portfolio construction, and it was really in reaction to what I thought was a growing pressure amongst value investors to run excessively concentrated portfolios. Keep in mind that this was 2007, and the market had produced a long stretch of good returns from 2003 to early 2007. The book “Fortune’s Formula” had become quite popular, and there were many discussions amongst investors about the potential for employing the Kelly Formula as some sort of secret sauce that would allow investors to increase returns by increasing concentration.

My own view is that most investors are better off running portfolios of 15-25 stocks because such a portfolio would ultimately be a truer reflection over time of an investor’s skill. In other words, a 15-25 stock portfolio has enough concentration to allow a skilled investor to really stand apart from the market, but is not so concentrated that bad luck, bad timing, or one or two mistakes can sink an otherwise competent investor. One of the points of emphasis in that presentation was that concentration shouldn’t be a constant, but rather should be idea and environment dependent. It has always seemed to me that each idea in the portfolio should be sized based on a careful assessment of the body of evidence available for that idea, with particular emphasis on risk factors. This would include factors such as how deeply the security appears to be under-valued, how predictable and reliable the business is, how it is capitalized, the quality and track record of the management team, and even how familiar the investor is with the idea. Also, it should be influenced by the presence of clearly correlated ideas in the portfolio.

I believed then and I believe now that using the flexible 20-stock model portfolio position sizing exercise that I described in the presentation is a very solid framework to start with. In looking back over that presentation today, I wouldn’t change a thing regarding the content of that discussion. But I’d sure like to have the stock picks back – I presented four ideas at that conference and three of the four performed very poorly in the bear market that followed.

How long do you study a potential investment before you decide to buy? After initiating the position, do you continue your research process on the name?

We generally produce a research document that covers all the important components of the investment, both qualitatively and quantitatively, prior to investing. For a simple idea, the document may well be five pages long. For a very complex idea, the report will be longer. But regardless of the complexity of the idea, writing a research document using a fairly standard template serves as both a form of checklist for us and ensures that we both understand the idea and can articulate why the idea meets our criteria for both value and safety. It also allows for a “quality check” in that it can be reviewed by a second analyst internally and even potentially by contacts outside of our shop that may be able to review our work and provide some insight back to us.

You have mentioned in the past that you are increasingly looking at macro data when making an investment. What kinds of macro indicators do you look at? Has there ever been a situation where a stock looked cheap but you did not invest because of the macro?

I wouldn’t say necessarily that we look at macro “data” when making an investment. It is more the recognition that an otherwise compelling idea can get overwhelmed if the larger forces surrounding that idea are negative enough. Going forward, we will probably be a little more cognizant of looking for the larger risks that could really hurt us as investors. As for an example, we basically decided in mid-2008 that we weren’t going to invest in any bank or other leveraged financial business given our concerns about the credit environment, and we sold the one stock he held at that time that qualified, which was American Express (NYSE:AXP). Granted, this was an extreme case, but it did help protect us from the worst of the permanent capital losses that many of our value investing peers suffered in banks and other leveraged financial stocks.

I suspect that our approach going forward when assessing ideas where we have identified a major industry or macro risk would be to use smaller position sizes, demand more compelling prices, or actively look for a way to hedge out any obvious macro risk that we identify if it can be done in a cost-effective way.

When you use valuation methods like DCFs, what kinds of factors do you look at when forecasting? Is it mostly things in the current-year, the past, or your own predictions? How far out do you model?

We use DCFs more as a sanity-check and to reverse engineer current market expectations than to try to produce any kind of precise valuation. When basing our views as far as what the future might look like, we try to look at a longer view of the company’s operating history (normally five to ten years) to see how the business has done over time. As an example, one of our larger current positions is Lab Corporation of America (NYSE:LH). Qualitatively, this is an outstanding business with tremendous barriers to entry. There is something of a Coke / Pepsi dynamic in the laboratory services industry, with competitor Quest Diagnostics (NYSE:DGX) the slightly larger company in the industry and LH being a strong number two in terms of revenues. LH has been a consistent but moderate grower over many years, with revenue growth in the high single digits and free cash flow growth at around 10% for the last five years. In looking at the recent stock price of around $72, when we plug the numbers into a DCF spreadsheet, we find that the market basically assumes that LH will never be able to grow its free cash flow at more than 2% annually going forward forever. Our view of the company’s growth prospects is significantly more optimistic than that.

So that’s our first sign that LH is a potential opportunity for us.

If I drop in even 5% average FCF growth for LH going out for ten years before dropping down to a terminal growth rate of 2% after that, my spreadsheet tells me the stock is worth $96. Because I’ve owned LH in the past and am extremely familiar with the business, I am very comfortable taking the view that the company will be able to grow its FCF much faster than the current market price is discounting. I don’t have to be super precise. When the stock gets to $85-90, it will be a closer call and I will probably respond by reducing our position size somewhat. So we try to use the full body of evidence we have available about a company, but in general we just don’t buy stocks that require heroic growth assumptions to justify the current price.

You operate largely as a generalist. Sometimes that entails investing in unfamiliar industries. Can you give an example of a case where this happened? What were some of the things you specifically did to learn the ins and outs of the business?

Yes, being a generalist means that one needs to have a framework for getting up to speed quickly when looking at a company or industry that is new for us. So we have learned to quickly identify the business model, which gives us a huge head start in terms of how to approach the research. There really probably aren’t more than a dozen or so basic business models in existence and most companies employ a variation of one of them. Then we start our study of the targeted business and some competitors, and we start reading annual reports, industry publications, and whatever we think we need until we feel we have a good handle on the business. One of the good things about this business is that knowledge is cumulative and the longer I’ve been investing, the more businesses and industries I’ve become familiar with and the faster I am able to get up to speed.

What is one company that you think you would be comfortable with buying and holding for 15 years? Why?

That’s an interesting question, and I’m going to have to answer it by changing your question a bit. We’ve come to believe that if your goal as an investor is to compound at high rates (our goal is 15-20%), that a “buy and hold” philosophy for 15 years simply isn’t likely to work except perhaps in very rare cases. To get that kind of return, you have to buy stocks when they are undervalued and sell them when they are fully valued. Therefore, to give you a stock that I’d be comfortable buying and holding for 15 years simply doesn’t reflect our philosophy, since over a 15-year period we’d expect to have the opportunity to buy a stock at discounted prices and sell it back at full prices multiple times. Of course we are prepared to wait a long time if necessary to get fair value for our holdings, and there are other cases where the performance of the company results in ever-increasing estimates of fair value such that we can hold on to the position for a long time. But we are usually hoping that we will be able to get full value for our stocks within 2-3 years of purchasing them.

So let me give you a list of companies that we admire and that we very much like to own when the stocks are cheap: Fairfax Financial (TSE:FFH), because we admire Prem Watsa. Berkshire Hathaway (NYSE:BRK.A / BRK.B) of course. In our current portfolio, I like Lab Corp (NYSE:LH), Dreamworks (NASDAQ:DWA), and a small Canadian company called Ag Growth International (TSE:AFN). In all of these, I either have a great deal of comfort and admiration for the management team, or else the business is extremely unique and enjoys a strong competitive advantage.

One of the things that value investors often talk about with shorting is how it gives you potentially unlimited losses. How do you manage risk with shorts?

Shorting is a very tough business, and we continue to learn new lessons every year. I have come to the belief from talking to several guys who are more experienced than myself on the short side that the best way to manage risk is to keep position sizes small and have a slightly more diversified short book. We also limit the size of our overall short exposure. Unlike the long side, where we have no individual position loss limits, we have historically used a position loss limit on short positions, though over time it has probably hurt us as much as it has helped us.

Can you give an example of a past investment mistake? What do you think happened? What did you learn?

Sure. Rather than give you a specific mistake, I’ll give you a category mistake that we’ve made more than once and that I therefore think is one that investors are extremely vulnerable to. The mistake is one of commitment bias, where for example we will decide that a given idea is very compelling but due to its potential risk is justifiable only as a small position. For example, every once in a while we find ideas where there is a very wide range of possible outcomes, but where either the potential magnitude of the return in the good case scenario is very high or we think the probabilities are favorably skewed in our favor. On balance, we’ve done OK with this kind of idea. The problems have come when we’ve initiated the position at an appropriate position size (say, 1% of the fund, or 2% or whatever) but then the stock declines either because of some new development or for another reason. We’ve often added to the stock and built them to inappropriately large position sizes simply due to the lower price, rather than sticking to our initial game plan of limiting our bet. Because of this, we’ve occasionally made what would have been a small loser into a bigger loser.

Another and similar mistake is reacting immediately to a sharp decline in an existing holding on negative news without taking adequate time to fully review the new information to ensure that making the additional deployment is justified by the new development. We try now to be rigorous in ensuring that each incremental add to an existing position is truly justified by the existence of a widening discount to our expected range of fair value and not due to some embedded commitment to the name.

What are some of your favorite books? Investing or non-investing related.

I kind of like to follow good writers around. For financial-related books, I always like to read anything by Roger Lowenstein, with particular nods to his biography of Warren Buffett as well as his book Origins of the Crash that described the causes of the tech and large cap bull market of the late 1990’s. I think Michael Lewis does fantastic work – his latest of course is The Big Short, but I also loved Liar’s Poker as well as his non-financial books The Blind Side and Moneyball.

How do you look at the market cap of a company? Are you less willing to invest in large caps? Do you see more opportunities in one than the other?

No, we don’t care what the market cap is. We are looking to get the best combination of value and safety out of our investment dollars as we possibly can. I do think that large cap, high quality stocks are as cheap now relative to the rest of the market as I’ve ever seen them, and that being the case our portfolio is more heavily weighted to large company stocks than it has been for most of our history.

Can you give us a company that you think is undervalued/attractive right now? What is your thesis there?

Sure. Lab Corp is our biggest position, and I’ve already explained our thinking there. Let me give you an esoteric one. This one is a small position for us, because the stock trades on the pink sheets and isn’t very liquid. Therefore, I’m not making a recommendation, only naming a stock that I personally think is undervalued and attractive. The company is Mass Financial Corp (PINK:MFCAF), and it trades in the U.S. on the pink sheets under the ticker MFCAF. MFC is a merchant bank specializing in a combination of traditional financing services and proprietary investing, primarily involving commodities and natural resources. The business is run by Michael Smith, who is also the chairman of the company formerly known as KHD Humboldt Wedag and is now called Terra Nova Royalty Corporation (NYSE:TTT).

MFC was spun out of KHD in January 2006, and had negligible book value at the time of its spin-off. The stock trades for $9 and change, and has a market cap of approximately $200 million. In the last four years, MFC has averaged over $40 million in net income and over $50 million in free cash flow. Here’s the book value per-share at the year-end each of the last four years, starting basically from zero at January 2006 (note that the book value per share figures are adjusted for a 9% stock dividend issued in late December 2009):

December 31, 2006 $2.43
December 31, 2007 $4.39
December 31, 2008 $5.71
December 31, 2009 $9.72

Going back further, prior to folding MFC into KHD, Michael Smith ran the company (then called MFC Bancorp) from 1984 to 1995, and during that stretch he grew book value from $1.49 per share to $17.09 per share, which is a pretty impressive performance. Overall, we think that MFC is a very intriguing investment at a discount to book value given the impressive track record.

The downside to an investment in MFC is that there is never really any way to know what Michael Smith is up to. Smith’s policy is to report financial results every six months, and only issues press releases when a material development occurs. In addition, the company’s disclosures are not as highly detailed as one might like regarding its merchant banking and direct investment activities. Nevertheless, the performance of the company speaks for itself, and MFC has an extremely strong and liquid balance sheet and uses very little leverage in its activities, making the historical performance that much more impressive. A couple months ago, MFC took over a majority interest in a micro-cap Canadian listed company called Canoro Resources (CVE:CNS), which has some very interesting oil and gas assets in India. As I mentioned, MFC is a small position for us, but I like having it in the portfolio.

Zeke, thank you for taking the time to interview with Street Capitalist

A friend recently attended an talk with Prem Watsa of Fairfax Financial (PINK:FRFHF / TSE:FFH). I know there are a lot of Fairfax followers on here, it is a company I’ve been bullish on for a while. Here are some of their notes. Keep in mind, these are just notes, they could be totally wrong:

The Soft P&C Market:
If you look at the insurance sector, a number of businesses are trading at low multiples because of the current pressures of the soft market. Some, like the management over at W.R. Berkely believe that the market is poised to turn around.

-Fairfax has wide reach. Active in over 100 countries, 25% premiums outside of N. America
-Fairfax faces declining volumes because of soft market but Fairfax has power to write more business if they see things improved.
-Globally, P&C markets remain soft. Signs of improvement in certain regions: Northbridge managed to raise rates in Canada.
-Fairfax could easily double underwriting volumes in the face of hard market, boosting earnings and investment float

The Investment Environment:
As some of you may know, Watsa’s Hamblin-Watsa Investment Counsel takes Fairfax’s float and uses it to make investments in all sorts of securities. They have an excellent track record of beating the market over the years.

-Watsa sees the possibility that growth will be flat as we may encounter deflationary pressures on the economy.
-Fairfax has structured their investment portfolio so that it can withstand a 50% drop in equity markets in addition to major CAT losses.
-Fairfax continues to be conservative about the markets and has 30% of the equity portfolio hedged with index swaps.
-2/3 of their muni bonds are insured by Berkshire Hathaway. Most were purchased near bottom prices. This boosts their yield on the portfolio which has an extra kicker of being tax exempt securities with a 5.75% average yield
-Some opportunities for value investors but they are becoming fewer.
-Target holding at least $1B in cash at holdco level in case of negative events.

Zenith Acquisition:
Fairfax recently acquired Zenith National Insurance Group. The company specialized in workers comp insurance and ran a conservatively managed investment portfolio.

-Fairfax has known Zenith management for over 20 years. Zenith has an excellent underwriting record and the company scaled back volumes because of soft market
-Zenith has a vanilla investment portfolio, Fairfax intends to have Hamblin-Watsa take over and try to boost performance
-Crum & Forster may be able to sell products through Zenith’s network of brokers and agents.

So, I’m pretty happy to see this acquisition of Zenith National Insurance (NYSE:ZNT). Zenith is in the workers’ compensation insurance business, which means that policies are generally long tail, meaning that payouts happen over longer periods of time. To contrast, short-tail insurance usually has payouts over shorter periods of time and more frequently. This is typical when you look at the likelihood that a person will get into an accident in their car versus an injury at the workplace.

So why is acquiring long-tail insurance operations so beneficial to a company like Fairfax? For one, Zenith is well operated. Moreover, the long-tail policies enable Fairfax to increase the size of its float — which is the amount of Zenith receives in premiums that it does not have to be paid out immediately or held in reserves. That capital is often invested in securities, in Zenith’s case mostly bonds, which could potentially be redeployed into more attractive securities by smart capital allocators like the people at Fairfax. Fairfax is not the only smart investor to have acquired workers’ compensation insurance companies, Warren Buffett’s Berkshire Hathaway owns National Indemnity which has workers’ compensation operations in California.

The one stickler for the Zenith deal is the fact that Fairfax will have to issue a little equity to complete the deal but will still have about $1 billion in cash on hand after the acquisition.

Via Bloomberg:

Fairfax Financial Holdings Ltd., the Canadian insurer run by Prem Watsa, agreed to buy Zenith National Insurance Corp. for about $1.3 billion in cash, adding sales in California.

Fairfax will pay $38 a share, the Toronto-based company said today in a statement. That’s 31 percent more than Woodland Hills, California-based Zenith’s $28.91 closing price on the New York Stock Exchange yesterday. The deal is expected to be completed in the second quarter.

Watsa, 59, is betting on a rebound in a workers’ compensation market pressured by rising medical costs and falling payrolls. Like Warren Buffett at Berkshire Hathaway Inc. and Loews Corp.’s Tisch family, Watsa built his company by investing the assets of insurance operations, often in out-of- favor securities.

“Workers’ compensation is probably the softest of all lines right now,” Bob Hartwig, president of the Insurance Information Institute, said at a conference in November, using industry parlance for a market where rates are falling. “Rate accounts for the vast majority of premium reduction we have seen in workers’ compensation.”

…Zenith, run by Chairman and Chief Executive Officer Stanley Zax since 1978, said in its 2009 annual report that it has “a long-term record of outperforming the industry.” Zenith’s workers’ compensation loss ratio, a measure of how much of each dollar of premium is paid in claims, was lower than the industry average every year from 2002 to 2008, according to Zenith’s annual report.

“There will be no changes in Zenith’s strategic or operating philosophy,” Watsa said in the statement.

Watsa’s Fairfax Agrees to Buy Insurer Zenith for $1.3 Billion

You might think that’s a bit weird, to value from a daily basis. But given Fairfax’s newly acquired equity positions, book value tends to fluctuate as the market fluctuates. So in a sense, the numbers contained below are a bit outdated. The equity portfolio snapshot was completed on July 20, since then the market has probably appreciated around 5%. If you look at the stock portfolio you can calculate what the gains were since then and break that down to a per share basis.

Some other caveats: the $330 estimate probably undervalues units like ICIC Lombard, which are recorded as costs rather than true market value. I think that its tougher to determine the value of units like these, but given the stock market’s movements and the value of those insurance units true book could be closer to $350. Then of course in the longer term you’d see a multiple assigned to that.

July 30 Fairfax Financial Update:

Undervaluation

In October, as equity markets went into free fall, one company saw their stock price actually appreciate in value. Fairfax Financial.

Fairfax Financial is well known amongst the value crowd. Helmed by Prem Watsa, sometimes called the “Warren Buffett of the North” Fairfax has annually grown its book value by 20% for the last 10 years. Few companies can boast such a record of growth.

So why did a company, which such great stewardship and past performance decline in the last 6 months?

1. Fairfax’s past performance was mainly driven by its portfolio of credit default swaps. For a number of small investors, the portfolio of credit default swaps were a great way to profit from the disruption of the credit markets. When Fairfax sold and profited from these positions, many investors exited. Their theme had played out.

2. After selling the credit default swap positions, Fairfax used the profits to acquire equities that they thought were undervalued. From October to March, the markets took another dive, with a number of securities held by Fairfax moving lower. Prime examples of this behavior were Wells Fargo and General Electric. Such a negative movement in the company’s equity portfolio no doubt led investors to fear Fairfax and sell.

3. Poor underwriting profits. Fairfax remains driven by their investment business. Some of the insurers owned by Fairfax, such as Crum & Forester have reported losses on underwriting, as exhibited by their combined ratios.

The value proposition

By now, you must be wondering, why invest in Fairfax Financial?

Fairfax reports earnings July 31st and while results in March appeared bleak, they’re sure to be vindicated with July’s earnings.

1. Equity Portfolio
Equity markets have moved up considerably since March 31. In the March 31 filing, Fairfax posted a loss of $60M primarily a result of negative investment income. By analyzing the company’s equity portfolio below, we can get a clear idea of how Fairfax’s investments have performed over the last quarter.
Fairfax’s equity portfolio broken out:

Overall, with such gains, Fairfax is likely to have at least sold some of their equity positions to lock in profit. However, even if the positions have been kept, when marked to market, the equity portfolio should add roughly $960M to Fairfax’s book value.

2. Municipal Bond Portfolio
As bond insurers like Ambac came under fire for being poorly capitalized and funding in the municipal bond market came to an almost standstill, Warren Buffett had Ajit Jain rapidly start up Berkshire Hathaway’s bond insurance division. Buffett acted opportunistically, creating a new line of business to seize business at a time when existing players were unable to write new business.

During the same period, Fairfax deployed capital to purchase municipal bonds which were yielding unprecedented rates in comparison to treasuries. Fairfax purchased a $4.36B portfolio of Berkshire backed munis. These were purchased at attractive yields with sound backing from Berkshire Hathaway which adds an extra element of safety.

Since June 30, the S&P National Municipal Bond Index has appreciated 5.5%. With the Fairfax Muni portfolio at $4.36B we can expect that the portfolio’s value contributed $240M to Fairfax’s book value.

3. Other Fixed Income Investments
Along with municipal bonds, Fairfax purchased a number of corporate bonds and treasuries. Collectively, during Q1 these holdings collectively contributed $170M in income, down from $180 from the previous Q. Given the improvement in the corporate bond market since then its likely that this income improved some.

4. Underwriting Performance
Over the last two quarters, Fairfax’s insurance subsidiaries Crum & Forester and Northbridge posted losses for their underwriting business. The company attributes some of this poor performance to Hurricanes Gustav and Ike. When removing these factors, The company’s underwriting performance improves but not enough to make a meaningful contribution to the company’s bottom line.

So far the insurance market has been calm over the quarter but the market has softened. As a result, underwriters have increased the amount of business written at lower rates.Typically this behavior leads to an inflection point, where prices cannot be cut any further and some kind of cat event occurs. This is important for Fairfax primarily because most other underwriters are not only writing bad business but also posted investment losses for 2008. They are clearly weaker, and when the time comes for the market to turn (usually triggered by a cat event ushering in a hard market) Fairfax will be poised to take advantage of its peers distress.
More information on a possible hard market: Marsh “Invisible hard market report”

This means that in the longer-term, we may see an improvement on Fairfax’s insurance end, but primarily for this Q and the near to medium tern, results and performance are going to be driven by the investment side of the business.

Valuation

1. Short Term – Medium Term Valuation
At current prices, Fairfax remains below estimated book value. Book value per share for Q1 was $4558 million or $260 per share.

Estimated investment gains:

$960M Equity Portfolio
$300M Fixed Income Investments (Muni gains + Fixed income investments + Interest/dividend income)
= $1.26B contribution to Book Value or about $70 per share to book value.

Q2 Estimated Book Value Per Share = $330
Current Price $285, a potential 16% gain during a short period as Q2 earnings release will likely serve as the catalyst for rapid price appreciation (note the share price activity over the last 7 days).

2. Long Term Valuation

Over the longer term, Fairfax seems likely to appreciate to a less depressed multiple. Aon Corporation recently released a report on the insurance market. They believe that a number of companies in the industry are trading at depressed multiples due to investment losses (something Fairfax has evaded) but that they believe in the longer term, P&C Insurance companies should return to a traditional multiple of about 1.23X book value. Plugging in a 1.26X multiple with Q2 estimated book value, Fairfax appears to be potentially worth $415 per share or about 45% greater than the current share price.

Read the full Aon research report: Aon Report

Fairfax is short for “fair, friendly acquisitions,” Watsa said, adding the company will never consider a hostile takeover.

Furthermore, Fairfax doesn’t believe in selling its companies for a quick profit. “We say our companies are not for sale,” he said.

That may upset some shareholders, but “the advantage is that you can build a company over the long term,” Watsa said. “You can’t replace people or a culture,” he added.

Fairfax believes in “full disclosure,” to shareholders, taking great pains to stress the potential risks of decisions.

“If they want to buy, they can buy. If they want to sell, they can sell. But they cannot say we didn’t tell them,” Watsa said.

The company follows conservative financial practices. The primary goal is “not losing money,” and long-term returns, Watsa added.

That also applies to the company as a whole, Watsa added. “We will never bet the whole company on any acquisition.”

Fairfax has a decentralized structure, giving its executives a great deal of freedom. “Fairfax itself is a small holding company, not an operating company,” he said.

The result is that Fairfax has “never lost a president who has performed well,” and those presidents operate as if the companies are their own, Watsa added.

Most important is the principle of “honesty and integrity in all relationships,” Watsa said.

The company wants its employees and executives to be hard working, “but not at the expense of families,” he added.

After growing Fairfax into a multibillion-dollar company, Watsa cited one his favourite quotes, from the Bible’s Matthew 16:26: “For what is a man profited, if he shall gain the whole world, and lose his own soul?”

Investor advocates honesty, fairness (The Record)

Elsewhere, I saw it reported that Watsa recommended My Years with General Motors by Alfred Sloan which certainly seems interesting when you consider the current troubles at GM. The book seems to primarily be about Sloan’s time at GM and how the company changed its management structure in favor of decentralizing certain decision making roles. When you consider what Watsa says above, it’s likely that the book had an influence on the way Fairfax is run today.

(click the image below)

The largest mistake that Fairfax Financial Holdings Ltd. made in the past year was underestimating the effect of the recession on the newspaper industry, chief executive officer Prem Watsa suggested.

Mr. Watsa was responding to a shareholder, at the company’s annual meeting in Toronto on Wednesday, who asked what the biggest mistake of the past year had been.

Fairfax took a 90-per-cent hit on its stake in AbitibiBowater Inc., and also lost money on its investment in CanWest Global Communications Corp. , Mr. Watsa noted.

And on removing the portfolio’s equity hedges:

Mr. Watsa also suggested that, in retrospect, he might have waited a few extra months before removing the hedges that Fairfax had in place on its stock exposure.

The company’s stock portfolio was fully hedged last year, but it recently chose to remove the hedges given how far markets had tumbled. “The fact that we hedged covered up a lot of our sins,” Mr. Watsa said.

He added that roughly three-quarters of Fairfax’s equity investments are in big companies such as Johnson & Johnson and Kraft Foods, and he believes that this is a “time of opportunity” for investors who will be in the market for the long term. Markets will not turn on a dime, but the next five to 10 years will be good to value-oriented investors, he suggested.

Fairfax regrets Abitibi, CanWest deals (Globe Investor)

Its funny, a few months back I looked at the newspaper sector myself (specifically the Sun Times Media Group) but couldn’t figure out what kind of cash flow to normalize my valuation estimates with. I never invested as a result. I guess I got a bit lucky on that end. Then there was also a post I wrote a while back on the NYTimes, I saw what appeared to be declining YoY cash flow numbers combined with difficult industry headwinds and issues with the Class A and B share listing. Since then, the company has fallen considerably.

On the bright side, Prem mentioned that the investment portfolio had two big positions in JNJ and Kraft. Interestingly enough, Kraft looks like they’re trading near a 52-week low. Given the company’s moats I’m going to start digging into them. The predictability there is much better than in the rest of the financial sector.

This USG deal is quite interesting though. In most cases, Berkshire Hathaway (NYSE:BRK.A) does deals like this by itself. In the past, I know that they’ve partnered with Leucadia National Corp. (NYSE:LUK) but it’s really quite rare. At the very least we can probably agree that Buffett thinks positively about Fairfax, since he’s allowing them to invest alongside Berkshire.

From the Globe and Mail:

Toronto-based insurer Fairfax Financial Holdings Ltd. has teamed up with Berkshire Hathaway Inc. to invest in a U.S. building products company, creating a partnership between the chief executive officer of Fairfax and his investing hero.

“It is our first co-investment with Berkshire,” Fairfax spokesman Paul Rivett said. “We are extremely pleased to be investing in a leading industrial firm with one of the world’s great investors.”

Fairfax CEO Prem Watsa is a devotee of Berkshire CEO Warren Buffett, and is often referred to as the Canadian version of the legendary investor, someone he has openly sought to imitate…

As for their joint investment, USG Corp. will sell $300-million of convertible senior notes to Berkshire, and a further $100-million to Fairfax.

Watsa teams up with his investing hero (Globe and Mail)

As you can see, things haven’t been so good for USG’s stock price. They’ve been hit hard by the downturn in the housing market, but once things turn, USG will be poised for strong performance. The company has sort of a monopolistic position with their sheetrock products which gives the company a pretty sustainable moat. In addition, after their bankruptcy in 2001, the company was able to shed a lot of terrible liabilities which helps bolster their long term prospects.

This, combined with the fact that Fairfax has recently removed their equity hedges makes me think that Watsa is gradually finding some good opportunities for investing our capital. That’s going to be good news for any other shareholders in Fairfax, especially when they factor in the gains that we’ve made from the financial crisis.