Six 5-Star Stock Ideas from Master Investors

Investment companies can themselves make great investments. These businesses often benefit from significant managerial ownership and much longer investment horizons than mutual funds subject to quarterly evaluation by "consultants" dare pursue. Two of the more prominent investment companies we follow,  Berkshire Hathaway (BRK.A) (BRK.B) and  Markel (MKL), also benefit from the low-cost "float"--funds they can temporarily invest due to the lag between receipt of insurance premiums and claim payments--that their primary insurance businesses generate, which helps leverage their investments.

While we've previously profiled both Berkshire and Markel's investments, we think many investors will also benefit from an introduction to  Alleghany  and Leucadia National (LUK). Note that at the time of writing, we were in the final stages of adding research coverage on Leucadia, and we expect that our Analyst Report will be available within a few weeks. In the interim, we highly recommend Leucadia's shareholder letters; and note that much useful information on Alleghany is available on its Web site.

Unlike Berkshire and Markel, neither Leucadia nor Alleghany is an insurance company--although both have previously invested in the field, and Alleghany's recent acquisitions of several insurers suggest it may eventually more closely resemble Berkshire and Markel. Both firms, however, boast hallmarks of great investment firms. Managerial ownership is high, which aligns interests with the true interests of outside shareholders--maximizing long-term net returns from investments. Alleghany's managers own about 24% of its shares, while Leucadia's team owns about 25% of their firm. Both also aspire to make long-term investments at prices far below fair value, a historically successful strategy of which we heartily approve. There are important differences between the strategies of the two firms, which we'll explore momentarily. We'll follow with a selection of six 5-star stocks culled from the firms' publicly disclosed portfolios, then list their largest holdings. Given the exceptional long-term records of each firm, we contend that these stocks are excellent candidates for further research--as are, naturally, Alleghany and Leucadia.

Alleghany: Deep Value Financials and 'Hard Assets'
Since 1980, Alleghany's shares have climbed more than 2,600%--a 14% compound annual return we largely attribute to the company's impressive investment strategy. The firm aims to invest at a 50% discount to fair value, although it will pay up to 66% of fair value for a high-quality company, then sell when the shares become fairly valued. Alleghany's managers primarily invest in businesses they understand well enough to remain comfortable owning for long periods. Historically, the firm has had most success investing in financial services firms and "asset-intensive" operations like railroads, miners, and heavy industrials. We don't always agree with Alleghany's investments--for example, the firm disclosed a new $5 million investment in 1-star stock  General Motors (GM) during the second quarter--but we think its proven strategy will earn attractive returns well into the future.

Leucadia National: Buy Cheap, Then Extract Value
Over the past 25 years, the team at Leucadia has assembled one of the best records in business. Leucadia shares have appreciated about 28% annually, far outpacing the 16% annual return of the S&P 500. Note that we include the value of Leucadia's dividends in that estimate. Leucadia's team seeks to invest in out-of-favor industries that provide products and services with low obsolescence risk. Such opportunities are frequently available at attractive discounts. The firm then seeks to improve the profitability of those firms or utilize their tax losses to shelter investment profits earned elsewhere. While many of Leucadia's investments are in private firms, it also frequently invests in listed equities. We'll have more on Leucadia in our forthcoming analysis.

Six 5-Star Investment Ideas
Here are six investment ideas we've culled from both firms. We note that all six originate from Alleghany, as Leucadia's current investments are mostly in smaller-cap stocks that Morningstar doesn't cover. However, given Leucadia's history, these may be trading at equally attractive discounts--and, therefore, likely warrant further research. (Star rating as of Aug. 16, 2005.)

 Berkshire Hathaway (BRK.A) (BRK.B) 
 Estee Lauder (EL) 
 Johnson and Johnson (JNJ) 
 Coca-Cola (KO) 
 3M Company (MMM) 
 Wal-Mart Stores (WMT) 

Top 18 Investments
Finally, here are the 19 largest stock investments of the two firms--12 from Alleghany and seven from Leucadia. In the latter's case, this represents their entire stock portfolio, while their private investments--which are at least 4 times larger in total--are excluded. We hope these prove a fruitful source of investment ideas.

The Alleghany Portfolio--Top 12 Stocks
Stock	Weight
Burlington Northern	55.8%
Apache (APA)	6.2%
Anadarko	6.1%
Devon Energy (DVN)	5.6%
Merck (MRK)	4.6%
Kerr-McGee	1.7%
Bank of America (BAC)	1.4%
Harley-Davidson	1.1%
Magna International (MGA)	1.0%
Whirlpool (WHR)	1.0%
Johnson & Johnson (JNJ)	1.0%
Countrywide Financial	0.9%
Data through Aug. 12, 2005

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The Leucadia Portfolio--Top 7 Stocks
Stock	Weight
White Mountains Ins. (WTM)	93.4%
International Assets Holding	3.2%
Parkervision (PRKR)	2.7%
FEI Co.	0.2%
Symyx Technologies	0.2%
Veeco Instruments (VECO)	0.2%
Accelrys	0.1%
Data through Aug. 12, 2005

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