Hamburg Investor

Thank you very much, I agree on your points. It‘s late here in Germany, but with the resonance here, we should open a discussion separate, I think (happy, that others are interested too in this discussion!) One thing came up in my mind; maybe we should focus more on the term „intrinsic value“; as you write here, at high roe companies, the iv tends to go up in value fast; I tend to agree, but than I think, if nothing really changed to the business, but iv moves up e. g. 30% from year 1 to year 2 (so 30% roe - let‘s say over decades), than iv can‘t be estimated right in year 1… But one gets to absurd levels e. g. of BRK, when you discount its value back from today to the 1970ies. And looked back from that perspective, BRK should have bought back a lot of more own stocks at every price there was, as the discount was just so absurd… But it didn‘t happen, Buffett hasn‘t bought back. But okay, let’s talk about that somewhere else…

Thank you! That makes sense to me. That seems perfectly reasonable and understandable to me, logical. Just one comment: I have always found Munger and Buffett to be very forceful in their assertion that buybacks above intrinsic value are ‘capital-destroying’. But is that really the case? Isn't that oversimplifying? One example: Now let's imagine a company with a sustainable ROE of 40%. Munger would say, ‘No matter at what price you get in here, over a very long time horizon you will get roughly the ROE (assuming everything is reinvested in the company).’ And now let's assume that management buys significantly above intrinsic value, so that the repurchased shares ‘only’ yield 35% (instead of 40% as ROE is 40%) in the long run. I find Munger's judgement that (all) share buybacks above intrinsic value are always ‘capital-destroying’ somehow questionable. By the way, it can't be both ways: Either you get a return over the long term roughly in line with the ROE, regardless of the purchase price for the shares (in other words, regardless of whether you bought above or below intrinsic value), or purchases above intrinsic value are always ‘capital-destroying’. Or would anyone disagree that an average return of 35% per year for most of us doesn't exactly fit the definition of ‘value destruction’? To stay with the image: management would reinvest the surplus with a return of 35%; you have to achieve that yourself first (many of us would also have to pay tax on the dividends first; so we would have to achieve above 35% just to match the management). But that's how I read your formula, @nwoodman: Share buybacks above intrinsic value do not destroy capital; they only lead to lower returns than the company's ROE. In other words, companies with very high ROEs can buy back a large amount of shares above intrinsic value, and yet these are still sensible buybacks (unless you have better reinvestment opportunities). You can also turn it around: If a company with a ROE of 10% buys back shares below intrinsic value, the share buybacks will hardly achieve such a high return for the investor, as in the first example. But how can that be, if Munger is right. For the investor holding both stocks (50/50), it would be better to have the company with a 40% ROE buying back shares (slightly) above intrinsic value than to have the other company with a 10% ROE buying back shares below intrinsic value. In the best case (assuming these are the only two stocks available), the 10% ROE company pays a dividend and the investor uses that to buy more shares of the 40% ROE company, even at a 35% CAGR return. This way, the better company would come to dominate the investor's portfolio more and more. Or am I wrong?

I plan to sell my stocks, when retiring regularly ("4% rule" - so step by step); hopefully in around 7 years. I'd sell/reduce Fairfax before in the following cases: 1. if I feel the need for diversification, which I just did, as FFH was near 50% and the weighting of the insurance within my portfolio pushed above 67%. So I sold MKL and FFH and bought some small caps I like. I think I begin not feeling comfortable, if FFHs at its current valuations is above 50% of my portfolio and if less than a third of my portfolio isn't insurance (while 10% is BRK and I like it for the float, but I don't see BRK as an insurance company with stocks and wholly owned businesses, but more like a fund of different businesses, including insurance). 2. A function of 1 is, if Fairfax outperforms my other investments by a lot and pb ratio grows e. g. into the direction of 2, than a. the concentration of my portfolio in FFH grows and at the same time b. my hunger for such a concentrated bet would go down a bit (maybe to a maximum of 30% or 40% of the portfolio), so I probably would sell step by step and buy other things. 3. if I find something much more compelling as a bargain (e. g. sustainable roe around 30% or above in the small cap world) and Fairfax is much more expensive in comparison. 4. if valuation gets absurd (minimum pb ratio of 3.0, maybe 5.0. 5 if the insurance sector gets structurally into a crisis or disrupted (something like "AI is disturbing the moat of BRK, MKL, FFH, which I don't see).

@Viking Thank you for your answer, which I really appreciate, but I think I haven't made my question clear: 1.There's a roe on the surface, let's call that "face roe". But - as you pointed out and I totally agree - that's understated. 2. So you come up with an adjusted ROE on the basis of FV. That's 19%. 3. Okay, nice. now we have it. As Munger said many times (from memory) "If you have a business with a roe of 20% and you hold it over decades, your return will be roughly 20% - regardless, if you over- or underpay! In other words, if we have the adjusted roe, we know how the intrinsic value grows over time. Perfect, no more questions! But... No... wait?! We forgot the buybacks! Even over 2 decades there's clearly a big difference, between two businesses, where: BUSINESS A never bought back any stock nor sold out any dividends etc. and BUSINESS B, which bought back 99.9% of all stocks outstanding (okay... that never happens, I know ... but I want to illustrate my point... so let's just say for a moment 999 of 1.000 stocks have been bought back). So here you have it, that's my question: How can we take your "adjusted ROE" one step further to get to a number that shows the "growth of intrinsic value per share" (let's call that "givps"). It clearly must be above 19% - but where exactly? My thinking begins with something like: If in a given year we have 19% roe and 5% of stocks are bought back in that year I just divide 19% through 0.95 and get 20%. So the buyback activity would translate a roe 19% into a "givps" of 20% in that specific year. And if you buy back 5% of stocks in the next year and you have a roe of 19% again - is "givps" then 20% or 21% in the second year? I tend to the latter, as now I'd have to divide 19% through 0.9025. But is it just as simple? I don't think so, as e.g. buybacks above book value disturb the "e" in ROE. But how do we adjust the "e"quity back? And the growth in intrinsic value can't be agnostic to the price being paid for the stocks in the process of buybacks, but my simple formula ignores the price. And then we all know, that buybacks at a price below intrinsic value create new value, while above they destroy it ... Maybe it's just not possible to take that step from roe to "givps", not even roughly?! And maybe my idea is just wrong and I am just having knots in the head and I write nonsense here?

Thank you, @Viking, that way of thinking is so good and important! I have one further question, and hopefully you might bring light into the dark: Doesn‘t even this adjusted ROE understate the value creation of Fairfax on a per share basis? Why? Buybacks. There‘s clearly more value creation, when a lot of shares are bought back (way) below intrinsic value. But I don‘t know how to calculate that, not even roughly. There are so many moving parts and variables - price of the shares, when bought, roe of the company in the specific year and in the future, (I’ll bet there’s even a price move, if a lot of shares are bought back over long timeframes, which affects the TRS, but let’s leave that away). Do you have any idea, roughly, or am I totally wrong with that thinking?

+1 order to Germany. to the author: What have you learned or was the biggest news for yourself when doing the analysis?

In Germany government oftentimes steps in, if the economy gets hit badly (covid…). My gut feeling is, that in the US they are more market oriented and let things go without too much intervention; but at some point they would I guess. But I am not an expert, any thoughts from someone else?

If I get you right, than buying on the cheap site isn’t an option for you as for the risk?! So you could get into the situation to buy a security, that is priced reasonable, but if it gets cheaper over time, than you sell, even though the gap to intrinsic value widens…?! I get your point and I‘d agree, that liquidity is all important and you make a good point. Still it leaves you with less opportunities and you would have to sell at points, where I‘d see most value. Think of FFH when it was valued at 0.4 book just 3 years (or so) ago. Have you sold at that point; if not, why? Looking at Prems investment style, doesn’t he invest just totally contrary to you? Thinking about Eurobank and others.

To me, that‘s the key point. Buffett said something like - from memory - crisis is good for a good business, as the crisis wipes out the competitors. A good business WINS through crisis, as it wins market share. Not only, but especially in those times. Gayner wrote about that topic some years ago in his annual report too, saying something like, that it‘s an advantage for its subsidiaries, that Markel will always be there to e. g. buy a new machine, if it gets broke at one of it’s subsidiaries. So management is able to always think for the (very) longterm. So how will the world look like some years after a 600 bn dollar event? BRKs and FFHs market share should have grown AND the premiums within the sector as a whole should have grown too (as prices within the insurance sector would have grown). So both BRK and FFH would get a bigger piece of a growing cake, some years after such a scenario and I wouldn‘t be surprised, if CR would go down a lot. So, yes, there are tail risks, that will ultimately hit BRK and FFH; but in the long run those risks are in fact not risks but chances.

That‘s just a theoretical scenario. I like to think about the downside. Most, if not all, of us are implicit thinking the stock price of FFH should go up in the next years. I wouldn‘t bet against that. Still from time to time things happen and the world changes within a moment. Think Covid, think FFH trading at 0.4 book value. So by this scenario I try to get a rough idea about „What if I am wrong and Mr. Market is go crazy within the next years? After all you‘ll NEVER know, where rhe stock price goes to in the short term (and 3 1/2 years to me is shortterm). So why not think about that „bad“ scenario? Would it be as bad as I think? Often things turn out to be way better even (or: especially!) in a bad case scenario than one thinks in the beginning. E. g. in the other thread about the question if FFH would reach 2.000 dollar until 2027 I just bet „yes“. But I don‘t hope for that outcome. For every longterm holder (net seller or holder) of FFH it would be even better, if the share price would be way below 2.000 dollar. As shares can be bought back way cheaper. So in a nutshell: No, I don‘t think, that the share price will stay where it is. But if anything, than I would hope for such an unlikely scenario, as my share of FFHs earnings would only go up. And I like to lean to the downside. Having shares of a business with a pe ratio of 8 today, and having zero return over 8 1/2 years and than owning a business with a normalized pe ratio of 2 and a normalized roe of 15%- if that‘s the bad case scenario, than that’s a scenario I buy. (Again: ignoring buybacks, which would make the scenario even better). Thank you for the work, which I really appreciate! Gives a lot of colour.

I like the way you think. Mine is a bit similar: The rule of 72 tells us, that at 15% ROE equity doubles in around 5 years, at 18% it doubles in 4 and at 24% it needs 3 years. Of course ROE can be less or more in the upcoming 3 years (and thereafter hard to say), but I wouldn't bet on less than 15% or more than 24% for the next 3 years. My best guess is around 20%. So that's around a double in 3 1/2 years, isn't it? Than I try to find a comparison of FFH to the market. It doesn't make a lot of sense to me to compare the book value of the market (think: S&P500) against book of FFH, as most companies of the index are better understood with pe. So how to come up with a normalized pe for FFH? I just pick a normalized ROE of FFH (my best guess is 15+% over the long run, so I take 15%). If FFH earns 15% on book and I can buy it at less than 1.2 book, than that's a normalized pe ratio of 8, compared to nearly 30 for the S&P500. Wow, that's cheap and I am pretty sure the average S&P500 company won't make 15%, not even 12%. That's my definition of Quality at a cheap price and of GARP. Thinking one step further: Assuming a double of FFHs equity in 3 1/2 years and the price stays where it is, than FFH would be valued below a pe ratio of 4 (!). I would love that, as the buybacks would bring returns even higher. Assuming 15% after the next 3 1/2 years, would bring pe ratio down to 2 after 8 1/2 years.

What companies do you see on a worldwode scale that do mimic Buffetts approach? I see BRK, MKL, FFH and Protektor Forsikring, a small Norwegian company There are other good companies, but as far as I can see they miss one of the points: - e.g. RLI is a very good underwriter; but they fail the value / active / stock / whole company approach. - Some do invest a tiny bit into stocks, but its so less, that it doesn’t move the needle. Anyone with further suggestions?

So just for my understanding: As Fairfax isn't an American business Markel doesn't have to show them in their 13F, right? It wouldn't have been a bad timing to exit Fairfax in 2015, if I remember correctly. What do you think, why they could have voted for not showing Fairfax any more? I mean, 1st they did, than maybe not any more - so, why...?!

Okay - Markel held Fairfax from 2006 and 2015, and it was between 3% and 8% of the portfolio. https://dataroma.com/m/hist/hist.php?f=MKL&s=FRFHF#google_vignette

I am pretty sure that Markel owned Fairfax stock. But that’s mabe more than a decade ago, maybe before the financial crisis. If I remember correctly, then it wasn’t one of the biggest top4 positions of Markel, but at the same time not one of the smallest.