Hamburg Investor

Totally agree with your conclusion about what 0-2% interest rates mean for insurance. Just some remarks: - Haven‘t you forgotten premium growth as an important part for how to reach 15% roe? (I don‘t mean acquisitions but internal growth). Another point: The equity returns are not taxed every year; so the overall tax is lower than 26%. And you forget the earnings through a profitable insurance business (cr of e. g. 95) - You claim 4% roe Bonds / 16% roe stocks. Shouldn’t the bond portfolio yield way higher? Treasuries are higher (and logged in for nearly 4 years) and the corporate bonds even yield higher (like 10%). - That logic (which I don‘t share) - needing 16% returns on the inherent stock/business part for getting an overall 15% return for the holding company - seems structurally absurd to me. The whole idea of FFH (and the other insurers investing part of their equity in businesses/stocks) is it to get overall higher returns than the inherent businesses (stocks, wholly owned businesses) returns. So you have two parts (insurance + businesses), both yielding less than the whole. Possible through the magic of float leverage. If one part alone would yield better than the whole - why than not sell the lower yielding one, as that would only be a drag to returns? In other words: If Prem in his own plan would need 16% in the equity part for getting 15% for the holding: Why shouldn‘t he sell the insurance part than and invest the outcome into stocks/wholly owned businesses alone? After doing that he would have a holding with a roe of 16%, before he would have one with a roe of 15%.

That's a terrific discussion between both of you, @Viking and @petec, that really resonates to me. I think both of you really hit it. Fairfax was under pressure on several levels during the low-interest phase: - Low interest rates are not good for the insurance business. BRK, MKL and FFH (also Geico) were not only stronger compounders in earlier years because they were smaller; interest rates were also higher. This discussion has been held many times and you can disagree. - Low interest rates = low, eroding moats. I'll take Blackberry as an (absurd?) example. Blackberry was a bad idea (no discussion about it!). But in times of 10% interest rates, competitors would probably have invested less quickly and heavily in tech; Blackberry's moat and brand would have eroded more slowly; maybe it wouldn't have turned out so badly. Eurobank and other investments haven't exactly benefited economically from low interest rates either. - Stock market valuations: = Growth beats value. Strong sales growth led to high stock market valuations in times of low interest rates, regardless of how profits developed. Was that exactly Prem's investment style? Probably not. So were FFH's stock market investments valued rather low on average during the low-interest phase? I think so. And at the same time, this should not be overestimated: Prem made many mistakes. Hedges are one of them (he has sworn off them - I call that improvement) If you look at how Fairfax's CRs have developed compared to Markel or the PC market as a whole, you will see that Fairfax was a below-average profitable insurer until 2011. Since 2011, Fairfax has been catching up relative to Markel and the market; massively so. That is a difference in quality between then and now. India is new. TRS is new and smart etc. I think FFH has gotten a really good bit better in recent years; there's good evidence of that. But they were also never as incredibly bad as they looked; they were just always "speculating" that interest rates would become "normal" (whatever that means; 0% doesn't mean it) and that growth wouldn't outperform value for all eternity. But for me this also means: FFH was always better than it looked for many years after 2009; the visible compounding in these years always suffered from an unusually deep and long headwind; and not only from this, but - yes, of course - also from the mistakes of the management. But that's just it: Not only. Now it is more "normal": interest rates are more normal than they were at 0% to 2% for so long. The hard market is still a tailwind - but in contrast, "growth beats value" is still active, i.e. a headwind. One normal, the other a tailwind, the other a headwind - this is certainly not an extreme scenario but a balanced one altogether. However - and that's what I want to add - I think that many still underestimate or have forgotten how well insurers like FFH (and BRK and MKL) can, indeed have compounded in normal times due to the "decade of headwinds". The combination of cost-free, growing float, a value investor at the top, diversification of corporate assets was a good idea and remains a good idea. But float was almost worthless and value was dead. But now interest rates are becoming normal. And there is the fact that the rest of the market is historically highly valued with a P/E ratio of 27 or so and we have higher interest rates; but insurers are historically rather lowly valued; so the spread is enormous. And Fairfax has gotten better. Yes, it's more about compounding now, but I can't find anything that should be 15+% (my best guess is more like 18%) compounding and buyable at a P/E below 7.

Thank you, @Viking, again a great perspective. „I have nothing more to add“, but I have one question. With a roe of 15% for the next two years (and probably some more… and maybe for the very longterm, if Prem finishes his outspoken goal) and using the pb ratios from 1.1 to 1.4 you use in your analysis - what pe ratios would that be? PE Ratios of 7 to 9 (1.1 divided through 0.15…) Are those typical pe ratios people pin on the wall, when analysing other companies with a 15% roe in the last years? PE Ratios of 7, 8, 9? I don‘t think so. Why is that? When looking at Berkshire, it has been valued above a pb ratio of 2.0 since 1985 only in very rare cases; and that time, when that hallend (until mid 1990ies) were times, when BRKs roe was well above 15%. The picture would be similar for Markel I think and for Fairfax (there were higher valuations at some points; but since over 2 decades valuations above 2.0 were really rare). How can this be? The average S&P500 company has been valued at pe ratios of around 15 to 30 most of the time since the 1990ies (https://www.multpl.com/s-p-500-pe-ratio). And the strong insurance growers, outgrowing over 90% (99%?) of stocks since the 1980ies with roes between 15% and 19% since the mid 1980ies (or longer) have nearly never been valued as the average S&P500 company. How can that be? Why is that? A PB Ratio of 1.3 feels normal for an insurance company. But it shouldn‘t. Are we all biased due to a „pb ratio anchor effect“. So something like „PB Ratios between 1.0 and 1.5 is normal for an insurance company“ Even though that‘s like saying „insurance companies should be valued at a pe ratio of 8; that’s less than a third of the average S&P500 company, which is valued at a PE Ratio of 27 these days. Insurance companies are not worth more, even though insurers have higher roes. Somehow this doesn‘t make any sense to me, but that’s how insurers are seen over decades. I can live with that, as I jever feel any pressure selling an insurance stock for its rich valuation and it helps the company to buy back stocks on the cheap site. Still it doesn‘t feel consistent that insurers often don’t get compared to other investements on an apples to apples basis.

Regarding TRS you are actually calculating share price being nearly flat (or up 25 dollars, so 2.5%) until end of 2024 for the next 3 quarters and two weeks, or do I misunderstand how the TRS works? Of course the share price could be higher or lower within such a short timeframe, but of course you have to assume something. But what’s the rational behind $250 for 2024? Wouldn‘t it be rational to e. g. assume a share price end of 2027 (whatever that would be) and than draw a straight (or compounding) line to that point? Than it would maybe be rational to readjust that line each time you recalculate your forecast? Otherwise you maybe would come to the point, where you would have to assume a negative return to the end of the year, if you assume a fixed return per calendar year and the share price gets above that?! I am just asking Why are net gains in investments lower in 2025 than in 2024? Intuitively I‘d think one would assume Fairfax to get 7% again but on 107% of 2024 equity, so it should be higher. Same with the TRS: If shareprice goes up algorithmic, than it should be higher 2025 than 2024; or is this a function of the good start of Fairfax share price in 2024, so you adjusted 2024, but not 2025? In general I totally understand, that you have to be conservative with your assumptions the longer you look into the future (that’s what all good investors do - margin of safety) at the same time looking at the numbers I ask myself: If Fairfax just manages a roe around 15% in 2024 and 2025 like in your foecast (so for times with a hard market, good hand with equity investments and bonds, very good crs…) and Prem at the same time gives out the goal of a roe of 15% on average (he said stock return or book value compounding should be 15%; but roughly that’s the same as having a roe of 15% as a goal. Or am I wrong?), than the question occurs: Is that goal doable if he just manages 15% as a roe in such good times, where not only management performs near perfection, but the circumstances (hard market etc.) give an extra tailwind? If Prem doesn’t manage 18%, or 20% or more on average in such good times, he won‘t make 15% over time. My best guess is, that this difference to 18% or 20% or even more is just a function of you being conservative with your estimates (which is very fine!). What do you think?

One could see, what you meant; and I agree, that compounding within that 4 years is a factor, that Prem hasn‘t adressed in his letter, but we should be always be aware of. The $125 per share in 2024 will give extra returns in 2025. And the result of that will give extra returns the year after and so on. This is not linear.

You have done a terrific job in the last years and here again laying out management decisions of Fairfax were really bad from 2010 to 2016. I totally (!) agree with that. And I am exactly referring to that in my post, while I have to admit, not having named those again. But the reason why I haven’t is simply, that those bad management decisions have been dicussed here so many times and most people gere (including me) seem to share this critic. So why repeat once again? And there is a lot of use in looking first and foremost at the business itself and on management; in fact this is, what we can understand and make analysis and decide, if we want to invest or not. At the same time there are external factors that - at least in my view - can‘t be predicted, regardless how deep our analysis goes. Nobody knows were interest goes to in the next few years - and yet it has a big influence on businesses and on markets and valuations. It’s hard to predict, where interest rates are heading to. The reason is simple: It makes a big difference, if 9/11 happens or an oil shock, a world war occurs (or just a local war), if a bubble bursts or if a financial crisis occurs. There may be some people that can predict some of those things a few years before they happen, but I clearly can’t and I think I am not alone with that view on my competences. That’s why I see no use in trying to predict interest rates etc. And that’s the reason why I don’t build my investment decisions on such external things. A good stock with a moat, a high roe over the longterm etc. will perform good over time, regardless the swings of interest rates etc. Still there is some use in looking back, especially when people try to interpolate the business and stock results of a decade into the future. People bought the Nifty Fifty in 1972 at pe ratios of 50 and more, thinking that the decade before had shown, that those were good investments. But those strong growers of the 1960ies weren’t performing perfectly good, when the oil price shock came, interest rates exploded in the next decade etc. So all I wanted to say is this: The 2010s clearly weren‘t the decade of the insurance sector (especially for the ones investing in non-growth-stocks like BRK, MKL or Fairfax) in terms of a. business performance and b. of stock returns. Anybody trying to interpolate the returns of the next ten years on the basis of the last ten years in my eyes misses an important point: The years after the financial crisis were the opposite of supportive for the insurance sector as a whole. You won’t find another decade were the three were performing that poor in comparision to the market since the 1980ies; both in business and in stock performance. And yes, all three named were much smaller in the 1990ies and that too helped the three outperforming the market (with the exception of the internet bubble times; Buffett was critized than; but that wasn‘t a whole decade). But there’s another layer and that’s a cocktail of low interest rates (making float nearly worthless), a long soft market, (tech) growth beating value. Fairfax was the worst performer of the three due to bad management decisions; but a second part of the story is, that neither Berkshire nor Markel left the S&P500 in the dust like in the decades before 2007. And the same headwind Berkshire and Markel faced, Fairfax had to face too. And for all three the headwind of after 2007 has changed direction and has changed into a tailwind now. Not only has Fairfax done the right things; on top of that the soft market has changed to a hard market and I wouldn‘t describe Prem being a tech growth investor historically (look at his annual reports of the last years, where he laid out his view on tech stocks and their valuations), so this clearly was a headwind too. And yes, the growth stocks again dominate the media, but e. g. Eurobank is performing good now too and not in the years before with lower interest rates.

Agreed, @dartmonkey and @Dinar. Just to be clear: the nine times earnings is without the gains on the stock portfolio, without TRS and without (maybe) gains on selling of wholly owned businesses like the pet insurance businesses or IPOs. Assuming normalized earnings of 200 dollar per share (125 dollar in OE isn’t a normalized, but a minimum number) or a little bit less in year 1 gets us to a pe ratio a little bit below 6 and an roe of 21%. If stock markets tank in year 1 it will be way less of course. If Watsa doesn’t reach roe way above 15% in times like these (hard market, value beating growth), than he won’t reach an average of 15% (that 15% isn’t tied to OE, @dartmonkey, so 15% of 29bn or 6bn would be including stock gains etc… That’s your point, isn’t it?!) over the longterm. Regarding that goal of compounding at 15%, I again and again read, that Prem hasn‘t reached it and Buffett hasn‘t reached his (former) goal and that these two and Markel won‘t reach returns like in the years up to 2007/2009 again, as they are e. g. too big. I think what those people miss is, that the years following 2007/2009 until 2019/2021 were really special and giving strong headwinds to all insurers (that’s why the valuations of those three came really down compared to pre the financial crisis). Soft markets, bad returns for value versus growth, low interest rates were a toxic cocktail for those three (and others). It was a very long soft market, growth has never underperformed value by such a margin and for such a long time (am I wrong?) and interest hasn‘t been lower (especially for such a long time). And yes, in case of Fairfax Prem wasn‘t really executing well; but that’s only part of the story. BRK and MKL weren’t either shooting the lights out and even if Prem would have done a perfect job between 2010 and 2016 (which he clearly hasn’t), the returns in those years would have been subpar in relation to historical returns too. And that’s not a coincidence, that all three performed with low CAGRs in those years, it’s structural. It’s the other side of the startup boom, it’s the other side of house prices and oldtimer prices booming, the other side of the tech boom, the other side of businesses not earning a dime getting as much cash as they wanted. What’s the point of float, if you get cash everywhere and as much as you want? What’s the point of float, if you have to pay the bank for holding your cash instead of getting a return? Historical float was a driver of roe at all three businesses, but that special sause literally disappeared in the lost decade. But now hopefully it again all makes sense. Without that decade Fairfax wouldn’t been valued so low. I really feel lucky having found an above average business, reinvesting at 15% (or more) at a pe ratio below 6, while the market is valued 5 times higher.

You’re right, thank you. I misinterpreted the following from the annual report: „We can see sustaining our adjusted operating income for the next four years at $4.0 billion … or about $125 per share after taxes, interest expense, corporate overhead and other costs.“ I didn’t expect the absolute numbers being before taxes and the per share ones after. But I should have known better. Doing the maths with 125 dollar after tax and an assumption of 10% taxes on stocks (what would be realistic?), my back-of-the-envelop maths tells me the return would be around 95% instead of 128%. Still very good and cheap.

Looks like we‘re heading for a double in bvps within the next three to five years again: - minimum of 4bn / year adjusted operating income - that’s essentially what Prem writes. That’s 16+bn in 4 years. Let‘s be conservative and say 16bn. - But don‘t forget: There‘s additional compounding happening with the yearly returns within those 4 years. So 4 times 4bn would not end with 16bn additional equity after 4 years; that would compound to 18.6bn at the end of year 4 assuming a cagr of 10% (and 20bn assuming an roe of 15%) and compounding starting after the first of the 4 years. Let‘s be conservative and say 10%. So that’s 18.6 bn after 4 years. - Fairfax has 16.5 bn in stocks (market value). Let’s again assume a roe of 10% (yes, after paying dividends, I don’t have the exact numbers here, do you?). That‘s 9.2bn (13.4bn if invested at a roe of 15%) in additional equity after 4 years. - Okay, so let’s put that together: We have an additional equity of 27.6bn after 4 years for a company with equity of 21.6bn at the end of 2023. That’s 128% or a cagr of 23%. Wow. - Yes, maybe an roe of 10% on stocks excluding dividends is too optimistic. But than there are the greek and indian investments that might give way higher returns. Eurobank has a pe ratio of 6 or so. The digit IPO, Prem might come up with another pet insurance business. And we could be more conservative. Why not round the 128% down to 100%? That‘s a nice margin of safety, isn’t it? The rule of 72 still tells us, that this would be a roe of 18% over that 4 years instead of 23%. Maybe that’s not enough margin of safety? O.K., what if it took one more year for that double, so 100% in 5 years instead of 128% in 4. That’s still 15% roe. At 940 equity, 15% roe would be 141 dollar in normalized earnings. I’d happily pay a PE ratio of 15 for a business with a roe of 15%, while the average S&P500 company has a pe ratio of 27.8. Ups, 15 times earnings… would be 2,115 dollar. Fairfax still has a normalized pe ratio of under 7 assuming not 23% cagr but 15% (141 dollar / 940 dollar). O.K., let’s circle back: I assumed 10% as roe for the reinvested earnings. But if Prem would buy back his stock, and that compounds at a roe of 15% (or way more… ) at a pe ratio of 7, than this easily earns 15% and maybe even 24% or even more with that investments. But if I assume a roe of 15% as a return for the „new“ equity, than the roe for Fairfax as a whole is even better and the buybacks are even cheaper, more attractive. Okay, but Prem will not invest a lot of cash for buybacks, at present. That’s what he said. Not now. But than this only makes sense, if he’s sure finding investments with returns above 10% on equity, even north of 15%. Anyway, my main take away reading the annual report: 2023 was a third fantastic year in a row, and at least four more are coming. That will be a nice 7 year track record looking back in 4 years. Hard to imagine, Fairfax being valued at only 1.2 pb ratio. But it‘s Mr. Market, so we‘ll never know.

45% Fairfax Financial, 1.5% Fairfax India

Thanks, @Cigarbutt, that's really helpful. I know I have to dig deeper into what happend especially at the beginning of the century for getting a deeper understanding. It sounds like you want to name other points - what is it?

How do you get to that estimate? Seems a lot to me, but I have no clues whatsoever.

What else can you say but: Thank you! The picture gets richer every time thanks to the different perspectives you offer and which are necessary for a deeper understanding. What strikes me when watching your last chart: Every single "Non-Berkalike" (I don't like the term, but still...) exploded in valuation, meaning the Price CAGR exceeds the book value CAGR in that 5 year view by miles: Non-Berkalikes: - Intact: 6.8% (17.7% minus 10.9%) - WRB: 11.7% - Chubb: 7.8% - AIG: 11.9% While the Berkalikes (including the original): - BRK: 1.0% (14.3% minus 13.3%) - MKL: (4.0%) - FFH: 1.0% On average the non-Berkalikes Price increase exceeded Book value growth by 9.6%, while the Berkalikes performed (0.6%) in that category. And Apart from AIG, the non-Berkalikes are currently all valued higher (PB ratio). And AIG should certainly be excluded for other reasons. Is this simply coincidence, as its only seven data points? Or is it due to the unorthodox, difficult to understand structure with "owned businesses" and the high level of involvement in publicly traded companies? A different shareholder structure? Mr. Market is going nuts again? Anyhow I would be quite happy if the share price could stay where it currently is and Prem would buy back the company with the profits from the next few years. In less than a decade, the company would belong to the readers of cobf...

Yes - thanks, I changed that.

I could not agree more. I just became aware of that mangement change with Andy Benard here at cobf, so this was like an important mosaic for me for getting a deeper understanding. Regarding returns the question appears: If FFH made with, say, 5.5% worse CR that performance of the 1990ies and they had those headwind with low interest starting from 2011 - what will be the "new normal returns", when they manage to hold the quality in insurance and having much less headwind from interest rate etc. And yes, they are bigger today, so that's worse in comparison to the 1990ies, but still - to me that looks more like a tailwind and not like additional risk. I don't think Buffett would have made that strong returns in the 1970ies and 1980ies, if interest rates and inflation were like in the low interest years of the last decade.