Viking

I love it. This increases the numerator of the EPS calculation. (Buybacks reduce the denominator of the EPS calculation.) Like when they purchased a chunk of Allied World a couple of years ago, I wonder if this will create some minor noise when Fairfax reports Q4 results? I do not understand how a ‘call option’ flows though the financial statements when it is exercised. I am not complaining - more a heads up so we are not surprised. From the announcement today TORONTO, Dec. 13, 2024 – Fairfax Financial Holdings Limited (“Fairfax”) (TSX: FFH and FFH.U) announces that it has increased its ownership interest in Brit Limited to 100% from 86.2% by acquiring the interest of OMERS, the pension plan for Ontario’s municipal employees, for cash consideration of approximately US$383 million. From Fairfax’s 2021AR “Sale of non-controlling interest in Brit On August 27, 2021 Brit issued shares representing a 13.9% equity interest to OMERS for cash consideration of $375.0 which was subsequently paid by Brit as a dividend to Fairfax. The company recorded an aggregate equity gain of $115.4, principally comprised of a dilution gain and the fair value of a call option received, which was presented as other net changes in capitalization in the consolidated statement of changes in equity.The company has the option to purchase OMERS’ interest in Brit at certain dates commencing in October 2023.” “Brit, based in London, England, is a market-leading global Lloyd’s of London specialty insurer and reinsurer. In 2021, Brit’s net premiums written were US$1,998.3 million. At year-end, the company had shareholders’ equity of US$1,912.1 million and there were 854 employees.” From Fairfax’s 2023AR “Brit, based in London, England, is a market-leading global Lloyd’s of London specialty insurer and reinsurer. In 2023, Brit’s net premiums written were US$2,982.7 million.At year-end, the company had shareholders’ equity of US$2,617.2 million and there were 911 employees.”

@mananainvesting , that is a great question. I will admit that ‘multiple’ is the most difficult part of the valuation process for me. Back in 2021 and probably 2022, I probably would have said i would be happy with a P/BV multiple of 1.3 x. But that would have been largely built off of Fairfax version 2010-2020. Much has changed regarding Fairfax over the past 4 years. As a result, my view today is a P/BV multiple of 1.3 x is too low. What is an appropriate valuation/multiple today? My short answer is higher than where we are at today. How high? I’m not sure. My guess is I will know it when we get there (ora least get closer to ‘it’).

@John Hjorth , I look forward to reading your notes. At the end of the day, we are all trying to improve our understanding of the company and make the best decisions we can with the facts as we see them. This is a great board and it is a honor to be able to discuss / debate with other investors like you. Tusind tak.

@Maverick47 , I was knee deep in writing my ‘Davis double play’ post when I read your comment. It put a smile on my face. What you are doing with your investment in Fairfax seems to me to mirror what Davis likely did with his top insurance investments back in his day - redeploy periodically / keep adding to your winners especially when they are trading at a cheap (or even reasonable) valuation. Best of luck. I hope it works out well for you and your family

Beauty is in the eye of the beholder. We are all adults… my assumption is those who do these large deals are also adults - with their eyes wide open. Ben Graham, Warren Buffett’s teacher, says Mr Market is a manic depressive and is there to serve an investor; not to inform them. Graham also said buy low. And sell high. Management teams are supposed to ignore Mr Market?

@Hoodlum , great points. My view is Fairfax is simply planting another seed with the speculated acquisition of French insurer Algingia. What the seed grows into we will see in the coming years. My guess is relationships and having boots on the ground is an important part of doing business in Europe.

Three years ago, in Dec 2021, Fairfax sold 10% of Odyssey at a premium to BV and used the proceeds to purchase 2 million Fairfax shares at US$500/share. Instead of using Fairfax shares, which were in the penalty box, they used Odyssey shares. Brilliant. Yes, a non-traditional way for a P/C insurance company to access a large amount of cash. At Sept 30, 2024, Fairfax’s book value was $1,030/share. Its stock price today is $1,416/share. Guess how much Fairfax would have to pay today if it wanted to buy 2 million shares of Fairfax on the open market (like it did in December 2021)? It would cost them much more than $1,416/share. In three short years, this has become one of Fairfax’s great investments - and a home run for shareholders. The icing on the cake is Fairfax has the ability to buy back the 10% stake in Odyssey when they are ready (when it becomes the best use of their free cash flow). I think the re-purchase price was set at the time the deal was struck (but I will admit I am fuzzy on how the mechanics work). When i say the management team at Fairfax has been best in class over the past 4 years this is one example of why (there are many more). Now it really is an unfair fight (comparing Fairfax to peers). Because the Fairfax team does not have the same constraints placed on them that most of the P/C insurance industry has (when it comes to capital allocation and being able to take advantage of market opportunities).

@Hoodlum , thanks for posting. Over the past 10 years, Fairfax’s insurance business has been growing like a fast grower. Fairfax did this by being very flexible and opportunistic - taking what was being offered to them at the time. Today, expectations are that the growth of Fairfax’s insurance business is coming to a hard stop. The hard market is coming to a hard stop so the top line growth at Fairfax has to also stop. Right? This is likely what is built into investor expectations today - and therefore the stock price. My guess is that in the coming years Fairfax will continue to grow its insurance business at a rate better than the industry average. What will they do? It will depend on what is available to them at the time. They will be open minded and flexible. Expectations of investors is very low today - in terms of top line growth of the insurance business. For the management team at Fairfax this will be like jumping over a one foot hurdle. I love it.

@73 Reds , I agree. But I think you need to back it up one step. You need to start with the right industry. How many industries today are as good as a long term investment as they were 75 years ago? Very few. P/C insurance is likely one of a short list. Another key learning is the importance of monitoring an investment. Sometimes companies mess up - AIG is the poster child for this. It delivered exceptional returns for investors for decades - until it blew up in the Great Financial Crisis in 2007/08. So the lessons for me from the book were: 1.) P/C continues to be a great place for a long term investor to focus on (that circle of competence thing). 2.) Buy the best managed operators, ideally at a low (or even fair) price. 3.) Sit tight as long as management continues to execute well. Because exceptional management teams usually deliver exceptional returns. But to do this (sit tight for a decade or longer) requires a huge amount of trust - because you won’t know in advance exactly what management is going to do. You will only know this after the fact. For Davis, management was the key. Today with Fairfax, there is very little discussion of management and how good they are (or not). Even on this board. And i love it. Based on what I have seen over the past 4 years, I think the management team at Fairfax is best in class in the P/C insurance industry. People call me a ‘Fairfax bull’. It cracks me up. I think I am just following the facts. The quality of Fairfax’s management team is not reflected in Fairfax’s valuation today. So I am getting something - the most important thing when investing - for free. It is like getting a free call option on something that is exceptionally valuable - management. What is the right multiple to attach to Fairfax if I am right? My guess is that is something that is not on most investors radar today. Should it be?

The Davis Double Play - Learning from one of the GOAT’s “History never repeats itself, but it does often rhyme.” Mark Twain Is it possible to learn from history to become a better investor? Yes. One of the reasons is because human nature/investor psychology does not change. But there are other reasons too. By studying the great investors of the past we can learn what they did to be successful. In turn, this can help us to better understand what is going on in financial markets today. And this can sometimes provide an important edge for an inquisitive and open minded investor. —————- Shelley Cullom Davis (1909 - 1994) Shelby Cullom Davis was one of the most successful investors of his generation. John Rothchild captured his accomplishments (and those of his son, Shelby M. C. Davis and grandsons, Chris and Andrew Davis) in “The Davis Dynasty: Fifty Years of Sucessful Investing on Wall Street”. In this post we are only going to profile the father, and we will refer to him as Shelby Davis. Of interest, his grandson - Chris Davis - sits on the board of Berkshire Hathaway today. The book is a great read for investors who like financial history and are also interested in the P/C insurance industry. What did Shelby Davis accomplish? Starting out in 1947 (at age 38), Davis turned $50,000 into $900 million by 1994 (when he died, at age 85). Over 47 years he achieved a CAGR of 23% per year. The annual rate of return is exceptional. The timeframe he achieved that rate of return is otherworldly. Yes, that performance makes Shelby Davis one of the GOAT’s. Adjusted for inflation, $900 million in 1994 is equal to $1.9 billion today. Ok, he got really rich. So what? Three things really stand out with how Davis built his fortune: Investing in stocks - Davis is one of the rare individuals who built great wealth solely from investing in stocks. Throughout his lifetime, he invested primarily in one sector - insurance stocks (P/C and life). Leverage - Davis was a heavy user of leverage. Often 100%. Interesting that it never blew him up (especially in the 1969-1973 bear market). This guy got filthy rich investing in insurance stocks? Ok. This guy is starting to sound interesting. Investing framework Before we start exploring the insurance angle it should be noted that Davis was a disciple of Ben Graham: “In 1947 Davis was elected president of Graham’s stock analysts’ organization.” TDD - Page 81. Circle of competence Prior to becoming a full time investor, Davis was deputy superintendent of the New York state insurance department. Even though it was a relatively small industry, when he became a full time investor in 1947, Davis decided to focus on insurance. Over the years he became an expert in both life and P/C insurance companies. “Davis was already famous in the life and casualty circles. Insiders began calling him ‘the dean of American insurance,’ though he’d never worked for an insurer.” TDD - Page 99 Over the years, Davis built up an incredible edge over other investors with his deep understanding of the insurance industry. Expanding the circle of competence Along with John Templeton and a few others, in the 1960’s Davis was a pioneer in investing in Japan and other international markets. Unsurprisingly, his focus when investing internationally was insurance companies (life and P/C). Davis expanded his circle of competence not by looking to invest in other industries. Instead he expanded his circle of competence by looking to invest internationally, primarily in Japan. This is what led him to many outstanding investments, including AIG. What did Davis like so much about P/C insurance stocks? In his book, Rothchild explained why Davis was so attracted to insurance stocks as investments: “Insurance companies enjoyed some terrific advantages as compared to manufacturers. Insurers offered a product that never went out of style. They profited from investing their customers’ money. They didn’t require expensive factories or research labs. They didn’t pollute. They were recession-resistant. During hard times consumers delayed expensive purchases (houses, cars, appliances, and so on), but they couldn’t afford to let their home, auto and life insurance policies lapse. Because interest rates tend to fall in hard times insurance companies bond portfolios became more valuable.” “These factors liberated insurance earnings from the normal business cycle, and made them generally recession-proof. Meanwhile, the income from bond-heavy portfolios, continued to rise.” TDD - Page 96 Davis especially liked the float - a liability that was really an asset - that was hidden on the balance sheet of insurance companies. He believed a growing float combined with the power of compounding would eventually make the company a big winner for long term investors. And guess what? Nothing has changed. All the factors that Davis saw and liked about insurance stocks 75 years ago still apply just as much today. How did Davis decide which insurance stocks to own? Davis used three criteria to evaluate insurance companies: Was company profitable/earning money? Was the company a good underwriter? How was the investment portfolio invested? Was the investment portfolio invested in a rational manner? How good was management? The management piece was especially important for Davis. “You can always learn accounting on the side,” he told his son, “but you’ve got to study history. History gives you a broad perspective and teaches that exceptional people can make a difference.” TDD - Page 99 Davis made it a priority to meet with management - something that was unusual at the time. His objective was to separate the ‘bluffers’ from the ‘doers’. Using these three criteria - earnings, fundamentals, management - provided him with a solid understanding of the companies he invested in. Guess what? Nothing has changed. The basic methodology Davis used to evaluate insurance stocks 75 years ago still applies just as much today. Picking the right industry was important. And picking the right company was also important. But Davis did one more thing. And this ‘thing’ is what allowed him to deliver such spectacular returns. Patience Davis never sold his winners. He let them compound undisturbed for decades. As a result, he was rewarded handsomely for his patience - his winners became massive winners. What allowed him to ride out all the volatility? It was what we reviewed earlier - he deeply understood the companies he was invested in. This knowledge allowed him to ride out volatility that naturally came with owning equities. It allowed him to think like and be a long term investor. “The Davis double play” When looking at individual companies, Davis was looking for a particular set-up. Because it could be especially lucrative for an investor. Own the best insurance companies - that should result in modest (or better) growth in the business over time. Buy them when they trade at a low multiple (P/BV, PE). This is a great set-up for an investor, because it usually results in two things happening over time: Growth in earnings. Followed by multiple expansion - when Mr. Market starts to look more favourably on a company. And as any investor knows, this combination can yield spectacular results. Especially if it is allowed to play out undisturbed for decades. “As the company’s earnings advanced, giving the stock an initial boost, investors put a higher price tag on the earnings, giving the stock a second boost.” TDD - Page 95/96 When this played out with an investment, Shelby called it ‘the Davis double play.’ Summary Exploiting this set-up over decades with investments in companies like AIG, Berkshire Hathaway and Japanese insurance stocks, is what enabled Davis to achieve such spectacular returns over his career as an investor. Let’s bring this post from the past and into the present. Is P/C insurance still a good sector to invest in today? Warren Buffett has been selling some of his stock holdings in recent years, like Bank of America and more recently Apple. Has he been buying anything? Yes, Buffett has been buying P/C insurance companies. In 2022, he bought Alleghany. And in 2024, he made Chubb a top 10 equity holding for Berkshire Hathaway. Buffett bought his first P/C insurance stock, National Indemnity, in 1967. Fifty-seven years later he is still buying P/C insurance companies/stocks. Obviously, he continues to like the current set-up - the valuation and long-term prospects of the well managed P/C insurance stocks. Fairfax Financial Fairfax is in the process of delivering ‘the Davis double play’ for its investors. The stock has been on a tear over the past 4 years. However, much of the increase in the stock price so far has been driven by spiking earnings. The multiple part of ‘the Davis double play’ has just started happening for Fairfax. As earnings continues to grow, Mr Market will look at the company even more favourably. As investor expectations/sentiment towards the company continues to improve we should see multiple expansion in the coming years. Today, Fairfax trades at a low valuation. Especially when you consider the quality of its management team (best in class). P/BV = 1.3. Exceptionally low for a company that is delivering a consistent ROE of > 15%. PE = 8.8. Exceptionally low. Fairfax is not over-earning. To quote Peter Lynch, Fairfax is priced for ‘mediocrity’. None of this includes excess of FV over CV for Fairfax’s associate and consolidated equity holdings. This was $1.9 billion at Sept 30, 2023, or $86/share (pre-tax). This means Fairfax is even cheaper than it looks. Exceptional people can make a difference This might be my key learning from reading The Davis Dynasty: invest alongside outstanding people and then be patient - and you can reap amazing rewards, sometimes lasting for decades. “You can always learn accounting on the side,” he (Shelby Davis) told his son, “but you’ve got to study history. History gives you a broad perspective and teaches that exceptional people can make a difference.” TDD - Page 99 The big disconnect today with the broader investment community and their ‘understanding’ of Fairfax is likely perceptions regarding of the quality of the management team - it is much better than most investors think. Fairfax is loaded with high-quality people: Prem Watsa is an exceptional CEO. Lead by Peter Clark and Jen Allen, the senior team at Fairfax is very good. Lead by Andy Barnard, Fairfax has built one of the best P/C insurance platforms/businesses in the world. Lead by Wade Burton, Fairfax has built one of the great investment management platforms/businesses in the P/C insurance industry. Fairfax has been slowly building out a collection of high quality equity holdings that are lead/managed by very good CEO’s/management teams. To name just a few: Fokion Karavias at Eurobank. David Sokol/Bing Chen at Poseidon. Hari Marar at Bangalore International Airport. Kamesh Goyal, founder of Digit Insurance. Fairfax’s current set-up: Growing top line/earnings + Low multiple + Exceptional management/people. The exceptional management/people ‘reason’ is by far the most important of the three listed above. But it gets the least attention from the investment community. With Fairfax today, an investor is able to buy a best-in-class management team at the lowest valuation (compared to peers). This provides a large margin of safety. And solid upside, just from earnings. And significant upside if we see multiple expansion. Even with the spike in the share price over the past 4 years, Fairfax still looks like a compelling opportunity for patient, long term investors. I think Shelby Davis would agree. ————— What did Peter Lynch have to say? Peter Lynch wrote the foreword for The Davis Dynasty. Below is a quote from him that is chocked full of wisdom: Slow-growth industries can produce great growth companies. Exceptional leaders can deliver outstanding results for investors - sometimes lasting for decades. “I differed from the Davises, but in one important area we had something in common. Some of my most rewarding investments came from slow-growth industries where expectations were low and profits lackluster. By looking for the most inspired competitors in uninspiring lines of work, I often found great growth companies (Toys “R” Us, La Quinta Motor Inns, and Taco Bell, for example) priced for mediocrity.” “Similarly, in the insurance arena and later in the banking arena, Davis and his son bought shares in the best and brightest competitors for much less than they’d pay, say, for the best and the brightest in the hottest high-tech industries, which are always highly competitive and subject to sudden reversal of fortune.” “You don’t hear too many college kids say it’s their dream to enter the property-casualty business, but while insurance may be unappealing to most, it has attracted a few outstanding operators like Hank Greenberg, who turned American International Group into an on-going bonanza for shareholders since the 1970s. Davis’ positions in AIG, and a dozen other companies with exceptional leaders, accounted for the bulk of his gains.”

How a long term investor values Fairfax today (buy, hold or sell) will depend primarily on their assessment of how good (or not) the management team is. For P/C insurers, the management team is what determines future ROE (beyond the glide path of the next couple of years). Based on what they have done the past 4 years, my view is the management team at Fairfax is best in class among P/C insurance companies. Fairfax’s valuation today is still at the low end (P/BV and PE) when compared to peers (the better managed P/C insurance companies). That suggests to me that the stock continues to be undervalued. ————— Fairfax is a very different animal than Berkshire. Fairfax builds shareholder value in completely different ways than Berkshire. Valuing Fairfax using a Berkshire Hathaway lens makes no sense to me - square peg, round hole. Examples? 1.) Pivot in P/C insurance in India. Monetizing ICICI Lombard and seeding Digit when it was a startup. We know Digit went to Berkshire Hathaway first , and BRK said no. 2.) Taking average duration of fixed income portfolio to 1.2 years in Dec 2021. And then pushing it out to about 3.5 years. 3.) FFH - TRS: this investment has been one of Fairfax’s best ever. 4.) Massive stock buybacks over the past 7 years. 5.) Selling pet insurance for $1 billion after-tax gain. 6.) Investment in Stelco. Steel producer? Home run. Buffett would not have done any of these deal/things. I could list another 10 things that Fairfax has done in the recent past that has built significant shareholder value. None of which Buffett would consider. Comparing Berkshire Hathaway and Fairfax today is like trying to compare great athletes. One is past its prime (Berkshire Hathaway). The other is just entering its prime (Fairfax). Rather than wish/wait for Fairfax to be more like Berkshire Hathaway I am instead just enjoying/appreciating how they play the game. Fairfax is doing things we have never seen before.

@Hamburg Investor , you ask some really good questions. In terms of what investors have been doing, I only have two strong opinions: 2020 was the year we got capitulation and many long term shareholders sold their shares. The share price was exceptionally weak from March to October. Even though the overall market rebounded by mid year. What you did - held your shares through much of the lost decade and then added in 2020 - is very uncommon. Well done! I do like to do lots of speculating when i write - it is simply my reading of the ‘animal entrails’ at a point in time. Sometimes I am probably talking to myself. Usually my comments aren’t directed at board members. At the end of day, I hope people on this board have made an absolute killing with their Fairfax investment.

Well said everyone. My interest in the S&P/TSX 60 add is primarily as an item of interest. I do think it will be a modest tailwind to shares when it happens. As CIBC said in their research report, the add is coming, we just don’t know the timing.

My guess is the pain for those who like P/C insurance but have missed out on Fairfax (didn’t buy or sold too early) is only going to get worse. Like missing out on Berkshire Hathaway when Buffett was in his prime. That was me. When it happened we all said… ‘I learned a valuable lesson.’ And ‘won’t let that happen again…’ And then, of course, the same thing usually happens again. Not buying a stock because it has gone up in price - that is likely one of the greatest mistakes that is constantly being made by most investors. It a psychological failing. I think Druckenmiller has discussed this in the past (as one of his failings/watchouts). It is exceptionally difficult to be rational and honest with oneself.

@RockNation, great post / summary. Peter Lynch had 6 ‘buckets’ that he used to value stocks. He said some stocks move from one bucket to another… his point was you need to use the right tool to get the job done properly (to value a stock properly). The key question to value Fairfax today is: how good is their senior management team (corporate / insurance / investments). I think we are learning they are very good. Best in class when it comes to capital allocation. Is that how the stock is valued today? No, i don’t think so. The challenge for investors is Fairfax has a business model today that is unique in the history of P/C insurance. How they do capital allocation is unique. Seeding an insurance start-up in India (Digit)? Selling pet insurance and realizing a $1 billion gain? Buying back 20% of shares outstanding over the past 7 years? And of course, putting on the FFH-TRS position? Crazy town. Selling RFP at the top of the lumber cycle? Selling Stelco at a nosebleed price right before Trump gets elected (tarrifs coming to Canada)? The above list is just a few of the things this management team has done in recent years. There are many more examples. All the while their P/C insurance business has been growing like a weed. Back to my original question… How good is the management team at Fairfax? Better than Mr Market thinks. Probably by a lot. So guess what is likely built into the current price? Average to below average management team. What is the most important input to use when valuing a P/C insurance company? Especially one like Fairfax (with its leverage to investments)? You need to get this answer right: How good is management?