Slow Economy Puts Value Investing to the Test

Croft also likes General Cable, a Kentucky-based producer of copper, aluminum and fiber-optic wire and cable products in the energy and communications market. He said he considers it a good investment because it has had earnings growth and it sells its products not only in the United States but also abroad, where some markets have been faring better.

Bruce Berkowitz's Fairholme Fund, meanwhile, picked up shares of health-care stocks at what it considered reasonable or dirt-cheap prices. Pfizer became the fund's second-largest holding, and WellPoint, provider of health-maintenance organizations and other forms of medical insurance, broke into the top 10. Both have plummeted since May 31. Not to worry, Berkowitz and the other managers wrote in a July 24 letter to shareholders.

"These fundamentally sound businesses have become fallen angels, as slowing growth, rising costs, and election-year politics stoke investor fear," they said. "Still, these are companies with essential products and services and large free cash flows relative to purchase prices. We expect them to rise again."

Even hard-core value investors acknowledge that some of their peers were too quick to jump on the financials bandwagon, which ended up being a sinking ship because of a spike in foreclosures and a tightening of credit.

"I think a lot of the managers didn't expect the housing situation to get as nasty as it has," Lowe said.

Such was Miller's fate. He made his reputation by outperforming the S&P 500 for 15 straight years but chose to invest heavily in Bear Stearns and Fannie Mae, two of the biggest losers in the credit crisis. The fund has dropped more than 30 percent in the past year.

Weitz also got hurt by financials, but he is not giving up completely on the sector. He is sticking with Redwood Trust, a real estate investment trust active in the residential mortgage market.

"They have been preparing for this credit crisis for years and should be able to benefit from distressed sales of mortgage assets by banks and hedge funds," Weitz and Hinton wrote to shareholders.

Weitz's fund also has a stake in American Express, despite investors' concerns with the company's decision a few years ago to depart from its traditional model and provide revolving credit to some customers. While acknowledging that the company is not immune to the credit crisis, Weitz said he believes in its core earnings power, thanks in part to the fact that it earns transaction fees.

Buffett has had some recent bumps, too. His Berkshire Hathaway reported an 8 percent decline in second-quarter profit because it collected fewer insurance premiums and recorded $1 billion in unrealized derivative losses. The company's stock is down 17 percent since the beginning of the year.

Despite some risky picks, Berkowitz's Fairholme Fund is still beating the S&P 500. For the five years ended June 30, the fund has had an annualized return of 15.24 percent, compared with 7.58 percent for the S&P 500. For the year ended June 30, it lost 3.47 percent, while the S&P 500 lost 13.12 percent. And for the first six months of this year, the fund was down 5.9 percent on a total return basis.

"Over the 8 1/2 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," wrote Fairholme Capital Management in a July 24 letter to shareholders and directors.

The managers have also invested heavily in housing-related industries. Among the fund's biggest investments are the Dish Network, Mohawk Industries and Sears Holdings. Those companies, the managers wrote, "continue to generate much cash while awaiting more stable times, and all have rational and opportunistic owner/managers at the helm. Investing is often an exercise in patience, and the drag from the housing bust is giving our patience a good workout."

Staff writer David Cho contributed to this report.