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High-flying Fairfax is poised for more positive momentum

Norman Rothery is the value investor for Globe Investor's Strategy Lab. Follow his contributions here and view his model portfolio here.

The holiday season is fast approaching and with it comes the traditional roast beef dinner. I'm already salivating at the thought of chowing down on a slab of beef smothered with eye-wateringly hot horseradish.

Combining flavours can be a real treat. But only a few brave souls do the same when it comes to investing. That's a shame because mixing different investment styles can provide a nice performance boost.

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Melding value investing with momentum investing tends to be particularly powerful. In this case, think of value investing as the meat and potatoes of portfolio construction. The idea is to stick to good companies at reasonable prices. Momentum investing represents the horseradish because it favours hot stocks that are expected to move even higher.

I spend most of my time scouring the market for value stocks. But I was reminded about the power of momentum by a paper from professors Thomas George and Chuan-Yang Hwang entitled The 52-Week High and Momentum Investing. They studied the performance of stocks trading near their 52-week highs and lows. Those near their highs gained an average of 6.2 percentage points a year more than those near their lows from July, 1963, through to December, 2001.

The results inspired me to look for Canadian stocks trading near their 52-week highs. But, ever the thrifty bargain hunter, I focused in on the high fliers with low price-to-earnings ratios (P/E).

Fairfax Financial Holdings Ltd. (FFH) is currently the largest stock on the TSX that fits the bill, according to S&P Capital IQ. It also happens to be an old favourite and a large personal holding.

I chuckle to think of Fairfax as a high flier because I doubt Prem Watsa, its CEO, would appreciate his firm being described as a go-go momentum stock. After all, he's an outstanding value investor who loves buying cheap stocks. But he'll have to suffer the slings and arrows – and increasing net worth – that positive momentum brings.

Fairfax is a Toronto-based conglomerate with large property and casualty insurance and reinsurance operations in the United States and Canada. It also has extensive overseas operations, which are starting to make a real impact. They include a highly lucrative Asian insurance business, run by Ramaswamy Athappan, and substantial ties to India via its Thomas Cook India Group and an interest in ICICI Lombard.

Fairfax's investment portfolio contains down – but hopefully not out – stocks like BlackBerry along with a few picks inspired by Warren Buffett. The firm is also keen on several Greek names.

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Fairfax's stock hit a new 52-week high last week and it is getting close to eclipsing its record high. But even after the big move, the firm still trades at only seven times earnings and 1.3 times book value.

However, the stock isn't super cheap on a price to book value basis because it traded below book value on several occasions during the past decade. More positively, it changed hands for 1.6 times book value in 2007 and north of four times book value in the late 1990s when it was a much smaller company.

Fairfax's recent performance isn't the result of taking on a huge amount of market risk. Quite the opposite, the firm's portfolio is protected against a stock market collapse, and deflation, by a large hedging program. It also holds a significant amount of cash.

Despite its conservative stance and value investing roots, Fairfax sports a nice bit of positive momentum. If the trend continues, investors will be able to dine out on the stock for some time to come.

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