returnonmycapital

ubuy2wron, Now that ELF is close to voting control over UNC, what do you think the odds are of disolving the fund and issuing its holdings to shareholders? Munger used to do stuff like that back in the day. It would mean a balance sheet revaluation from $46/sh to $66/sh or so. On 6 million shares, that's a boost of $120 million to balance sheet assets, or $36 per ELF share. I imagine it's low, but that won't stop me from talking to them about the idea soon. There is so much that can be done at ELF to unlock accounting value and improve disclosure. I can't help but get excited. The only reason I can think of that would deter its revaluation is whether management (majority shareholders) are only thinking of themselves. I even explained to the CFO that I thought it was important for new and old shareholders alike to enjoy changes in intrinsic value over time, much like what Bufett/Watsa urge. I sort of intimated that they were cheating shareholders by not expalining how it all comes together on an NAV/IV basis. frog03, My holdings are really concentrated in insurance and banking at the moment. I still have all my prefs from March as well, 100% margined on their cost.

The real book value of ELF as at Sept. 30/09 is $722/share. Price to book value is less than 2/3 for a growing, profitable company with conservative management. I have recalculated the company's equity method investments to their net asset value. The difference between carrying value and net asset value, less 14.5% income tax on the gain (as per management's advice), comes to $50 per ELF share. I have asked management why they do not highlight or explain the following in their reporting: 1) net shares outstanding (3.3 million) versus total shares outstanding (4 million) 2) book value per share 3) the net asset value of equity method investments, which are predominantly closed end funds The answer was that they think no one cares. After some nudging, they are talking about improving their reporting. 30% of the company is held by outsiders. That's 1 million shares. They have a story to tell. The only insurance company I follow that has grown investments per share faster (+10%/yr) in the last 10 years was ORH (+15%). FFH (+3%), BRK (+6%) and Co-operators (+5%) are way behind. Book value has grown 11%/yr since 1998. ORH (+18%), FFH (+11%), BRK (+7%), Co-operators (+8%). Is no one looking at this? What are others' thoughts on the merits of this sleeper?

Book value per share at $672 (up 10.3% year to date). Float per share at $1,485 (up 11% year to date). Investments per share at $2,276 (up 11% year to date). Current stock price at $475. Operating problems this year mean float has come at a high cost; 9% (including life insurance). The average has been 3% per year. The main culprit is P&C which is showing a CR of 117% year to date. Management says premium pricing has improved and 2010 is projected to continue to harden. Management also suggests that something is being done about claims severity and frequency. CR has not been this high in the last 11.75 years I have data for (going back to and including 1998). On the investment side, the company now has 116% of book value in common and preferred equity (including equity method investments, which are mainly comprised of 2 closed-end funds trading at about 0.7X NAV each). Continued writedowns in these closed-end funds mean little as they are reflecting a wider market price discount to NAV. Therefore, ELF continues to invest $0.70 of cash into $1 of equities through these funds. In an even stranger twist, the largest investment inside Economic Investment Trust (the second largest closed-end fund investment) is ELF itself. So, effectively, the company is purchasing and retiring its own shares (7,031 shares year to date) at .7 X .7 = .49X book value per share.

Shalab, I think so too. Looked at another way, much the same result appears. Assume investments per share grow at 10% per annum (some from increasing float and other from after-tax investment results). Between $9 and $10 billion in investments is produced. Take Shalab's $10 billion in pre-tax operating earnings, close to $7 billion after-tax. These two figures add to book value as no new capital is required to earn them. With these layup assumptions, book value grows by almost $16 billion in a normal year, or $10,300 per share. That equates to a 13% average growth rate, using Q3 book value. The figure of 13% can also be called Comprehensive ROE. Assuming BRK trades at the long-term average 7% earnings yield of the S&P 500, the price to book value (based on comprehensive ROE) should come in around 1.8X. IV comes close to $146,000 per share.

It could be argued that he meant more value in acquiring entire businesses vs. buying portions via the stock market. It would be nice to think the operating businesses had a higher value but that might mean normalized pre-tax operating profits of $13,000+ per share. I am pretty sure they are nowhere near that mark, even in the rosiest of outlooks.

I'll take a stab at it. From the 2008 annual report, WEB mentions that pre-tax operating earnings (ex-investment income & gains) of around $4,000 per share in both 2007 & 2008. Assuming that is normalized, and applying what WEB would suggest is a reasonable multiple of 10 times, I get a value of $40,000 per share from operating subsidiaries (probably low-ball considering the economic climate and the prospective addition of BNI). As at Q3 2009, investments per share were around $92,000. These investments have come at no cost over time. In fact, cost of float has been slightly negative, on average, over the last 11+ years (going back to and including 1998). These two figures added together suggest an IV of $132,000 per share.

Make that up 15.2% year to date.

Book value per share up 17% year to date.

I should have added that ORH's float has grown by almost 10%/yr over the last 5 years. My IV calculation goes a little like this: 1. I assume ORH's future underwriting experience and investment results will approximate the past. 2. Zero cost float, with some restrictions, is analogous to equity capital. So, I add it to book value in determining IV. That's one method. 3. Investments per share, net of prefs. and other debt-like obligations that come at some cost is another IV indicator, assuming the growth in investments per share was/is due to defensible investment management and zero cost growth from the underlying business (i.e. zero cost growth in float which produces more investments to defensibly manage). This is the way WEB sized up his purchase of GenRe, as I recall.

Float at the end of Q3 = approx. $81/sh. Cost of float this year = -2%. Cost of float over the last 5 years (including 2005 when CR was close to 120%) = 1%/yr on avg. Book value at the end of Q3 = $60/sh. Increase in book value this year = 31% Increase in book value over the last 5 years = 21%/yr on avg. Investments per share at the end of Q3 (netting out debt) = $143/sh. Increase in investments per share this year so far = 17%. Increase in investments per share over last 5 years = 15%/yr on avg. Intrinsic value at the end of Q3 = around $140 per share. Oh well...

Other than loss provisions being historically lower at USB than at WFC, another big difference between the two is employee compensation. I get average employee comp at USB of just over USD 63,000 per annum. At WFC, it is 50% higher, at around USD 95,000. That is a large difference, affecting their respective efficiency ratios.

Kiltacular, Your thoughts are refreshingly rational. I too have trouble understanding the negative bias toward WFC. WFC appears to me to be in a class by itself. At the risk of countering the crowd, I have even been suspicious of USB's lack of write-offs historically. I often wondered why they did not provision more for a rainy day. Now, as WFC's provisions as a percentage of PTPP decline, USB's have accelerated.

shalab, WFC would have to double its share count to arrive at the same valuation as USB, based on PTPP. In the 3rd quarter, WFC had $16.4 billion in short-term earning assets (average balance for the quarter) earning well less than 1%. They had mortgages held for sale of $5 billion earning less than 3%. So, they appear to have resources available to pay off the preferreds that are presently earning well below the after-tax 5% they owe the govt. On a valuation parity basis, using USB's EPS/PTPP valuation as a benchmark, WFC is worth $46/sh.

I did a little work on future earnings power for both of these banks yesterday using pre-tax, pre-provision profit (PTPP). I went back over the last 10 years and saw that, on average, both of these banks earn (after tax and after provisions) about 50% of PTPP. Ranging from 40% to 60%. Last year, WFC earned 12% of PTPP and this year it will come in somewhere in the 25% range. USB earned 41% of PTPP in 2008 and will come in around 20% this year. WFC is running at a rate of almost $9/sh in PTPP. USB is running at just over $4.50/sh. Assuming an eventual return to normal (i.e. 50% EPS/PTPP ratio), WFC's eps should find its way to $4.50/sh and USB to $2.25/sh. At $29/sh and $25/sh stock prices, respectively, WFC looks seriously undervalued but USB doesn't. None of this includes future growth projections, but to add a little more umph, WFC has grown its PTPP at a 16% per annum rate since 1998, while USB's PTPP has grown at just over 6% per year.

Omagh, ELF has a short-tail P&C business and a life business. They do not have a re-insurance business which is where long-tail underwriting risk typically resides. They are based in Canada, where we suffer less mega-natural disaster situations (wind, tremors) that can mess with underwriting. If you are referring to their life business being long-tail risk, then yes, I am pretty comfortable. You mention inflation but as I understand life contracts, inflation doesn't work against the insurer but for it. Standard life contracts are fixed in payout. Whereas the premiums go to work better as investments in an inflationary environment (i.e. grow faster on a nominal basis against a depreciating payout). Also, medical technological advancements generally require that actuarial assessments of life expectancy need be lengthened every few years (i.e. we keep living longer) which works to the insurer's benefit as well since additional premiums vest for longer. This one seems a lay-up. But, it wouldn't be cheap if everyone agreed with me.

Netnet, Let's suggest that long-term nominal ROE has been 14%/yr for the S&P 500. In a period of inflation/deflation/stability, that nominal rate will typically not change (this statement taken from one of the 1970s BRK annual letters you mentioned). Real ROE declines by whatever the rate of inflation, it eats away at the real value of that return on capital. The higher inflation, the lower real ROE (and this doesn't stop at 0% real ROE, it can go negative). So, as I state, for every increase in the rate of inflation, real value is lost on business as a whole.

Gurjot, you should have it in your inbox now.

I have now had a proper look at ELF and I suggest it has distinct advantages over other insurance businesses, including FFH, at present. A brief synopsis: Assets, float, investments, and shareholders equity at ELF have grown at 9-10% per annum since 1998, without issuing shares. Over the last 5 years, those same line items have grown closer to 12% per year, again without share issuance. P&C insurance combined ratio (what they define as general insurance) has been 102.6% since 1998 and has been 98.1% over the last 5 years. So, recently, float and its growth has been cost-free. ELF also has a life insurance business which distorts the company-wide underwriting ratios (all life insurers seem to operate with some cost to their float). Operating income margins (excluding capital gains) are very high, at close to 9% since 1998 and even higher over the last 5 years. Those are BRK-type operating margins. The valuation is cheap, at 0.67X estimated Sept 30/09 book value of $735, not to mention that it is 0.23X its investments per share (growing at 10%/yr). The one weakness is their past equity investment management. But, with Jarisklowsky, Fraser taking more responsibility and their addressing underperforming managers, they look to be turning the boat around. They recently hired ValueInvest for some of their equities and they have a very good long-term record. If they can get equities right and if we are heading into a brighter overall equity market trend, book value should out-grow assets, investments, and float handsomely. The company is operated by shareholders for shareholders and is growing responsibly faster than I had thought. There is a lot of margin for error in its price. I cannot see why this company's market value is not at least equal to its book value. This looks like an obvious idea to me. If anyone wants a copy of my analysis, let me know.

I would suggest that in periods of high inflation all businesses lose real value. The ones that lose less are those that have pricing power and low capital/re-investment needs. Tobacco springs to mind, so does pharma; as do other high margin, moat-protected, low capital requirement businesses.

Jackman definitely has an owner mentality; not a lot of wastage at ELF, just not run to grow like FFH/BRK/MKL. Jarislowsky ran less than 1/2 of United Corporations when I last checked - they are competent. I am reducing the share count by close to 700,000 due to cross ownership; I get 3.3mln effectively outstanding. Is that wrong?

Yes, I have owned ELF in the past. The Jackman family runs it respectably, but they do control it so it is their way or 'on your bike'. The insurance business is so-so. The underwriting is okay. Their investment returns are okay. They have some closely held investments (United Corporations as an example) which are held in their portfolio securities. My attraction to the company was one of massive discount to book value. Which appears to be the case at present. I get book value of CAD 750.00 per share, yes?

I have calculated the growth rate in retained earnings (including comprehensive income) as well as book value for FFH and ORH since January 1, 1998. For FFH, retained earnings grew just over 8% per annum to June 30, 2009. For book value, it was about 10% per year. Shares outstanding have increased from just over 12 million to 17.44 million as at June 30, 2009. Over the same time period, ORH has grown retained earnings more than 23% per annum on average and book value by just over 16% per year. The share count went from 38 million to 60 million. Based on these metrics, which I argue are very important - especially the growth rate in retained earnings (because it eliminates the beneficial accounting gimmick of issuing stock at premiums to book value) - ORH is worth a great deal more on a price to book basis than is FFH (and probably NB, although I haven't done the math on that one). 65/sh is a great deal for FFH. I am happy as an FFH shareholder but quite unhappy as an ORH shareholder and will vote against it (having 2X as much ORH as FFH).

Just read gaf63's mention of ORH.pr.A's recent price rise. It could just be short-term dividend hunters; the dividend is paid to shareholders of record Sept. 30. But at 8% annualized yield, that is attractive for a pretty safe investment. Also, WFC.pr.L trades at a 9% yield. With USD financing as low as overnight rates plus 0.375% (or much less than 1% in absolute), why aren't more people bidding these issues up?

If over-performing the S&P 500 by more than 10% per annum over the last 10 years with almost exclusively US investments qualifies, then yes, I do know of someone. And he is 43.

Eric, My point is that the float, at no/negative cost, has tremendous value. In the right hands it is equity. Imagine your banker came to you and offered you a perpetual loan at a -2% interest rate. Imagine prevailing interest rates on risk free fixed income were above -2%. You wouldn't think twice about taking the loan. But, imagine that in the past, on a conservative balanced mandate basis, you have actually generated more than 10% annual returns on your investment capital. You would be salavating at the prospect of such a loan? I sure would be. True book value (i.e. intrinsic value) for ORH is nothing short of accounting book value + float. The trouble is we all talk rationally about value until a takeover is announced and then we all change from a long-term perspective to a short-term take the money and run point of view.