Txvestor

I think like Berkshire, for a long time Fairfax taught their shareholders to consider book value when evaluating the share price. I think the gap between intrinsic value and book value has diverged significantly overtime. In both of their cases and probably more so in the case of Fairfax. Considering Mr Market was assigning values as low as 0.6 BV in the past. 1.25 may appear like more reasonable. But in an environment where the insurance segment is much improved, interest rates are likely to stay materially higher for longer, and where excess fair value over carrying value is 4B+, and with where recent ROE numbers have been ie high teens compared to mid teens previously, I believe that is not much of a rerating. My view is at the recent average of 18% ROE, even accounting for the volatility and inherent risks of an insurance company, an adequately capitalized, well managed company that's been around nearly 50yrs should merit 1.8x BV in this very expensive stock market. I'm happy for them to keep buying at these levels. ,

I think the key metric in assessing intrinsic value—while admittedly imperfect and particularly volatile in Fairfax’s case—is net earnings. Ultimately, a business’s intrinsic value is determined by its ability to generate earnings over time. With that in mind, it may be informative to look at the trend in annual net earnings alongside earnings per share (EPS). Since Fairfax has also been aggressively repurchasing shares, the EPS trend provides additional insight into the value accruing to each remaining shareholder. I also thought it would be useful to include return on equity (ROE). Although ROE is also subject to significant year-to-year volatility and accounting noise at Fairfax, it remains a helpful measure of how effectively the company has been compounding shareholders’ capital over time. Year Total Revenue (US$B) Net Earnings (US$B) Diluted EPS (US$) ROE 2017 16.2 1.74 64.98 15.0% 2018 15.6 0.38 14.08 3.2% 2019 19.1 1.65 62.45 13.3% 2020 20.0 2.06 80.76 15.6% 2021 27.0 3.18 123.61 20.2% 2022 29.0 3.38 129.23 18.6% 2023 31.8 4.38 173.24 20.2% 2024 35.2 3.87 160.56 16.0% 2025 38.3 4.77 213.78 18.1%

I asked chatGPT to construct this going back to 2017 since when's they've taken out almost 30% of their outstanding shares via buybacks. I would argue this divergence goes back to ever since the year the buyback started happening in earnest about 9yrs ago, once their equity hedges came off. This is evidenced by the fact that their earnings whether measured by total net earnings or EPS has grown despite all the capital ~$6B cumulatively allocated towards these buybacks. Year Shares Repurchased (millions) Total Cost (US$ millions) Avg. Purchase Price Year-end Book Value/Share Avg. Purchase Price as % of BV 2017 ~0.35 ~150 ~$430 ~$450 96% 2018 ~0.55 ~250 ~$455 ~$455 100% 2019 ~0.38 ~170 ~$447 ~$484 92% 2020 ~0.56 ~215 ~$385 ~$525 73% 2021 ~2.31 ~1,240 ~$537 ~$674 80% 2022 ~0.61 ~398 ~$652 ~$752 87% 2023 ~0.31 ~276 ~$890 ~$940 95% 2024 1.347 1,588 $1,179 $1,060 111% 2025 1.007 1,625 $1,614 $1,260 128% Â

But based on the last TRS experience. Would there be a counterparty this time?

This is one of the unfortunate things for Fairfax in the recent past. Certainly since 2008. They have very rarely if at all traded at valuations one would consider expensive. Even though it reduces the opportunity to buy back their own shares. If the shares are trading materially above intrinsic value, that gives Management an opportunity to make acquisitions by issuing shares. That is a luxury afforded to few. That was also part of the Singleton playbook.

I think this is a good way to think about it. The TRS position is basically leverage on their own shares. Fortunately, they are in a strong enough cash and leverage position that the volatility can be handled without too much problems. They also bought so low that the likelihood of needing to pay on them for further drops was remote. At least we can say that in retrospect. Does anyone know the run rate cost on keeping this position going? I guess the only other thing to consider is that if the share price does fall, they have to pay up cash to Settle, at the same time that it would be opportune to buy back their shares as well. I'm sure they have a good strategy around this investment, and we will realize what it was in due course.

Not really, unlike what you are implying, what I was saying is if they cash out the gains on the TRS and simultaneously buy back the shares when they are priced lower, you'd actually be gaining from the increase in share price. The only thing you would be locking in is the lower taxes. That's a subtle difference.

But equally it's better for continuing shareholders and best when done sooner than later. Berkshire has been sitting on $150B plus for over four years now. They've just let the cash pile up, keeping it in treasuries, etc. While I realize that gives them optionality; the share price has gone from roughly 300 to 500 during this time. There's no way they generated anything close to that return in cash. And what's worse they would still have had $180 billion if they just bought back their own shares at that time and we know raising capital would never have been an issue for them with their AAA rating. So, I don't think it's good or bad. I think it all just depends on the share price compared to the intrinsic value. And like you said when the share price is low, the alternatives perhaps look less appealing. Fairfax is what they know better than any other external investment they will make, I believe it should serve as the benchmark hurdle on which all other investments they make should be judged. As we saw with the Brit acquisition, Allied world acquisition, and many others over the last decade when the right opportunity comes they're willing to buy, even at the expense of temporarily diluting their share count, or partially monetizing their subs, presumably because even though their shares themselves maybe undervalued, they felt certain that what they were buying was even more undervalued and strategically important. That's exactly the type of capital allocation thinking that you would want as a long-term shareholder.

Pardon me if this is a basic question, but I’m trying to understand the mechanics of converting Fairfax’s TRS position into share buybacks. My understanding is that the TRS has appreciated substantially since it was established—perhaps on the order of 4X and thus 75–80% of its value is capital gains. If that’s correct, then when the position is eventually settled, Fairfax would likely realize a significant taxable capital gain. If that’s the case, am I correct in thinking that they can’t simply “cancel” the shares represented by the TRS? Instead, wouldn’t they first have to settle the TRS, pay any applicable corporate tax on the realized gain, and then repurchase shares in the market (or through a negotiated block purchase) in order to actually reduce shares outstanding? If my understanding is correct, it seems there could be an advantage to unwinding the TRS when Fairfax’s share price is lower rather than higher. A lower share price would mean: A smaller gain realized on the TRS, resulting in less tax being paid. The same amount of after-tax capital could then retire more shares through buybacks. The tax paid is real cash leaving the company, whereas the benefit of any future appreciation in the repurchased shares accrues to continuing shareholders without an immediate corporate tax cost. For example, all else being equal, it would seem more attractive to unwind the TRS and buy back shares at around $1,600 per share than at $1,900. Am I thinking about this correctly, or am I missing an important aspect of how the TRS settlement and buyback process actually works?

Also juices up the EPS reported.

Fairfax is all about keeping a 360 optionality in their capital allocation toolkit. I'm convinced it's part of their investment strategy. I've not seen anyone use that as intentionally as them. Fortunately for us, all other things being equal, that looks likely to be a $4-5B annual stream they will be allocating. This one(share buybacks) however is not one where they give optionality to themselves, but rather it's decided by Mr Market. So as many have said if you're a long term holder this is good news for you. The other options ie private equity deals, funding subsidiary growth, public stocks, bonds, sub. buybacks, leverage ratios, dividend payouts, acquisitions are more in their control. I hope and would think they measure each decision in terms of overall portfolio risk and investment return hurdle. IMHO stock buyback being available at the current prices is a good anchor for looking at every capital allocation decision they make with this stream of $$. They quite literally won't understand any external investment better. Over the very long term, let's say 10yrs or so, for a compounder in the double digit range. A one off multiple expansion measures in BV( let's say a 1.25BV ---->1.75BV or 40%) for example will not mean a whole lot. In the short term <5yrs it absolutely does.

I don't disagree. However, here is my lay man perspective as to why Fairfax does deserve a higher multiple of book value than it receives. 1) BV is understated, that's not just an estimation, it's based on publicly verifiable value of associates. And occasionally surfacing valuation of subsidiaries. Even if you exclude the latter there's $150-200 of value which management constantly reports about each quarter. 2) It has a higher insurance float per share compared to many other companies in their cohort. Same when you look at Float/insurance equity, they skew higher. Closer to Berkshire. 3) Their insurance operations have clearly reset to a better quality, we can for sure say they did in the hard market, and await confirmation as the market softens, but it seems to have materially shifted and the market has not acknowledged that fully and certainly isn't awarding it the appropriate multiple. But that realization if accurate will eventually come. Probably gradually. 4) Everytime they do a transaction involving one of their Insurance subs. You get a window into their actual value. You can basically take your pick of the transactions over the last decade ie Pethealth, First Capital, ICICI Lombard. They all happened at valuations significantly above 1.25BV, more like between 2-3x. These valuations were significantly above when they listed shares in Odyssey re and Northbridge in the 2000s at the 1.16 BV region (when the underwriting was arguably more inferior). Quality insurance franchises are worth paying up for and if they do transact, do so at a premium to where they trade. They are great value add engines so are seldom sold. 5) There will always be a holding company discount to their shares, this is something structural for any holding company, including Berkshire. That discount, whatever it is tends to be insignificant over longer periods of time as even if it persists, it doesn't affect the eventual returns. Companies buying back shares and looking at this as a capital allocation vehicle, constantly exploit this to their remaining shareholder benefit. And keep causing the IV and BV to diverge. Fairfax has been one of the more active participants in this area. 6) We are in a pricey stock market and finding even 10% compounders at a reasonable multiple is not that easy. Insurance is one of those industries where if you can take a long enough view of an investment, you tend to have such or better on average returns based on how it all works out with interest rates and investments etc. My guess is it will reset from 1.25 BV or so where it sits currently to closer to 1.75 BV or so over the next 5-10yrs. But it will be a very gradual process and one where management will get the opportunity to keep buying back a meaningful number of shares over time. If you have a 5-10yr time frame it's not a bad outcome.

They probably don't mention and discuss it as much because they don't really take much risk in managing it. I think their focus is on underwriting excellence. And I know in the past they focused on the 10 10 strategy. Where they wanted to get up to $10B of net under written premiums, 90% CR. Despite that they had some steps and have been more transparent recently in discussing the reasons for that. On the investment side, they tend to duration, match and not play the yield duration curve very much. I think their term for float is policyholders funds and they are about 2 times annual underwritten.premiums. On the equity investment side, the returns have been better than Fairfax in recent 15 or so years. And their Markel ventures arm also appears to be doing quite well, although there are clearly some seasonal and cyclical variations in that. So to extent their relatively consistent underwriting and investment performance have made the bond investing part of the returns less significant. I think their bigger problem has been the fact that their insurance operations have grown very anemically over the last hard and soft cycle. If there's one concern for me, it's that they are doing this during a hardening market, that is something we need to keep a very close eye on.

if so why do people talk about 40yr investment track record, or about the long multi decade tenure of senior managers, or seek to increase management voting control. Those are all continuity things. I agree that the insurance has evolved, and is significantly larger. I also observe that interest rates are higher and appear likely to remain higher for longer, this after a protracted period of suppressed rates. They've had some recent wins in the investment side, but I remain curious on whether that's a structural change or a phase. And we won't know how their new investments turn out for years. Yet for me the first 2 items are adequate. I hope they can be average atleast in the equity side. The bar frankly isn't terribly high to generate 15% ROE from the structure they have.

One thing that all Fairfax investors need to keep in mind. Mr. Watsa's holding period for his family shares is forever, and he has stated that publicly and that the continuity after him is his family. They have a dividend to support their lifestyle and time is almost inconsequential to them. And unlike most other investments where you can take a 5 or 10 or even 15 year perspective, I think Fairfax is one of those that could frustrate you even longer and genuinely test your patience. Also given the kind of companies they invest in, cyclicals, turnarounds, leveraged etc, it's not always a sure thing and neither is timeline apparently a major concern. Take resolute forest products., or blackberry, They were failures as far as investments are concerned, but I believe even worse is it took a decade or more to realize that. That can be true even with potential successes, Fairfax India/BIAL (or even Eurobank for instance). In the former's case Shareholders are waiting 11+ yrs with sub par returns whilst they are told shares are cheap and do not reflect intrinsic value. They may very well be, but I haven't seen much done to realize this value. So that's the level of patience that you require. I'm speaking as a shareholder of Fairfax since 2008. I've seen good bad and raging bull market in this time. Even with the run over the last five years, compared to indexing, I am still behind on the portion of shares I bought then. So if you are investing money you need for a college expenses, or retirement or something of the sort with a fixed timeline, you need to take heed, even if it's a decade out.