Viking

Is Fairfax a Growth Company? Talk to other investors about Fairfax and guess what they usually want to talk about? Investments. Not Fairfax’s insurance businesses. Which is nuts. Because Fairfax is a P/C insurance company. In this post, we will explore Fairfax’s little followed and therefore likely misunderstood and under-appreciated insurance business. Is Fairfax a growth company? I realize that sounds like a dumb question to ask. I mean this is Fairfax after all. But hey, just for fun, what do the numbers tell us? Despite its sizeable investment management business, Fairfax is - at its core - still a P/C insurance company (sorry to disagree with you Morningstar). And the best measure of top line performance at a P/C insurance company is to look at the trend in net premiums written. How has Fairfax performed over the past decade with this very important metric? The 10-Year performance of NPW (2014-2024) Fairfax has grown net premiums written (NPW) from $6.1 billion in 2014 to an estimated $25.4 billion in 2024. This performance is on track to deliver a total increase in NPW of $19.3 billion or 315%, which is a compound annual growth rate (CAGR) of 15.3%. To state the obvious, that is an amazingly high level of growth in NWP over a decade. Importantly, this high level of growth was delivered through both soft and hard P/C insurance markets. And bull and bear financial markets. The external environment did not impede Fairfax’s ability to grow. That is pretty impressive. And really, really instructive. Truth be told, the external environment was one of the key factors that allowed Fairfax to deliver such outstanding growth year after year. Volatility creates opportunity. And one of Fairfax’s core strengths is being opportunistic and capitalizing on volatility. Per Share Buffett teaches us that total growth numbers are not the metrics investors/shareholders should be primarily focussed on. What really matters is what is going on with the per share metrics. Per share, Fairfax has grown NPW from $289/share in 2014 to an estimated $1,160/share in 2024. This performance is on track to deliver a total increase in NPW of $871/share or 302%, which is a compound annual growth rate (CAGR) of 14.9%. Bottom line, the phenomenal growth has not been driven by diluting Fairfax's existing shareholders. Much more on this in the next post. But Fairfax’s performance over the past decade has actually been much better than this. And that is because the numbers above do not include Fairfax’s P/C insurance company in India - called Digit Insurance. In February 2017, Fairfax made their initial investment in a P/C insurance start-up called Digit. Over the past 8 years, Digit has been one of the fastest growing P/C insurance companies in India. Earlier this year, Digit completed its IPO. The company currently has a market cap of about $3.8 billion, with Fairfax’s position worth around $2 billion. Fairfax is the largest (and controlling) shareholder of Digit. Importantly, India is expected to have the best performing economy in the world over the next decade. With its investment in Digit, Fairfax is perfectly positioned to benefit from this rapid growth in the coming years. Including Digit, the growth of Fairfax’s P/C insurance business over the past 10 years has been best in class among P/C insurance companies. How did Fairfax do it? Fairfax’s management team has been putting on a clinic for the past decade in how to do/utilize capital allocation to rapidly grow a P/C insurance business. But investors/analysts have been so focussed (infatuated?) with Fairfax’s investment business they have completely missed out on what has been happening with its P/C insurance business. And what it means for the company moving forward. Capital allocation Yes, we keep coming back to capital allocation. Why is this? Because it is really important. Especially for a P/C insurance company like Fairfax. As we have discussed in the past, capital allocation is the most important job of a management team. But the funny thing is, when people think about capital allocation and Fairfax they tend to only think (and talk) about the investment side of the business. (Yes, I am including much of my writing/analysis when I say this). That’s the ‘sexy’ part. And yes, Fairfax has done some pretty spectacular things with investments, especially in recent years. But the insurance business? It gets very little thought. Even less discussion. But guess what? On the capital allocation front, Fairfax has done some pretty spectacular things with its P/C insurance business as well. Of course this matters a great deal. Because the two businesses - insurance and investments - are joined at the hip for Fairfax. Grow insurance and you grow that wonderful thing called float - that liability that is really an asset (for well run insurance companies, like Fairfax). The steady, long term growth of the P/C insurance business was the primary engine that allowed Warren Buffett to deliver decades of outstanding growth for Berkshire Hathaway and its shareholders. Understanding what Buffett was doing with his insurance business over the years was a critical input to properly understanding and valuing Berkshire Hathaway. So let me say it again. Fairfax has grown its insurance business by 15.3% per year for the past decade. Not including Digit. Guess what this kind of steady, long term growth does to the intrinsic value of a company? Yes, it sends it to the moon. Are we paying attention yet? What happens with insurance matters. A lot. Because the growth of the insurance business is what feeds the investment business. The fact that such little attention is paid to Fairfax’s insurance business (its quality and its growth) puts a smile on my face. It tells me it is likely not yet reflected in the share price. As a result, investors continue to underestimate Fairfax’s future earnings and ROE. Over the past 10 years, Fairfax has made a number of extraordinary moves to rapidly grow their insurance business. Under everyone noses, they have quietly built a power house P/C insurance business - in terms of quality and growth. This post is focussed on the growth aspect. A future post will tackle the quality aspect. The quiet giant Guess how many large cap Canadian companies have grown their top line by 15.3% for a decade straight? Not many. Apparently not many P/C insurance companies either. Like a goat going up a mountain, Fairfax has been nimbly and quickly climbing the rankings of the largest global P/C insurers. In 2023 they were ranked in the #21 position (same as 2022). Source: From Fairfax’s Slide Presentation at April 2024 AGM – Excluding Lloyd’s So, let’s ask the question again that we began our post with… Is Fairfax a growth company? Yup. WOW! A Canadian company that is competing against the best the world has to offer… and not just playing the game (that participation award thing we love so much here in Canada) but actually winning? That is crazy. Canada must be so proud! Let’s invite Prem to Ottawa, hold a parade and celebrate! Except… ummm… few people in Canada seem to know that Fairfax exists let alone that it has been growing like a weed. It looks like most investors are also in the same boat because how does Mr. Market reward a fast-grower’s share price? My current estimate is Fairfax will earn $160/share in 2024. This would put year-end book value at about $1,085 and would represent an ROE of about 16%. From a valuation perspective, this would put Fairfax’s: P/BV at 1.29 x PE at 8.7 x These are very low valuations for a company that: Has a CAGR for NPW of 15.3% over the past decade. Is also projected to deliver an ROE of 16% in 2024 (and mid teens moving forward). Why is Fairfax’s valuation so low? One reason is likely because with the hard market slowing, investors/analysts expect top line growth (in net premiums written) to markedly slow at Fairfax in the coming years. That might make sense from an industry perspective. But does that make sense for Fairfax? Looking at Fairfax's past, I don’t think it does. Because Fairfax has a proven ability to grow its insurance business over the long term at above market rates. Accounting value versus economic value Importantly, Fairfax’s book value of $1,085/share does not include the ‘excess of fair value over carrying value’ of associate and consolidated equity holdings, which was $1.9 billion ($86/share pre-tax) at September 30, 2024. And 2024 estimated EPS of $160/share for Fairfax does not include the change in ‘excess of fair value over carrying value’ for associate and consolidated equity holdings in 2024, which was $900 million ($41/share pre-tax) at September 30, 2024. In 2024, Fairfax’s economic results are tracking to be much better than their accounting results. This makes Fairfax’s stock look even cheaper from a valuation perspective. But, hey, we all know Mr. Market is always right. Right? Except of course when Mr. Market is completely wrong. That is called a fat pitch by some country bumpkin who lives in Omaha. But hey, that is a story for another day. ————— What did Fairfax do to drive all that top-line growth in NPW? In our next post, we will dig into exactly what Fairfax did to drive all that top-line growth in net premiums written over the past decade: Phase 1: Acquisitions – International expansion (2015-2017) Phase 2: Organic - Hard market (2019-2024) I will also explain why I am optimistic about growth in the coming years, even though it appears parts of the hard market in insurance are slowing. Phase 3: Take-out of minority partners (2022-2026) What we learn should help us better understand Fairfax and their P/C insurance business. And its growth prospects in the coming years. In turn, this should help us to properly value the company. The next post should be out in the next week

I have re-established small positions in: - Canfor (CFP.TO) - Saputo (SAP.TO) Is this the worst bear market for lumber ever? Worse situation than covid? Stocks are cheaper today than they were in Covid. Higher interest rates? Gasoline on this dumpster fire. Probably early. But lumber is getting interesting again. Saputo is hitting 52 week lows. It is trading where it was trading back in 2013. Canada is their cash cow and Trump will be coming after Canada's heavily protected dairy market, likely soon (perhaps that is why it has been selling off recently). So this one could go lower. But the turnaround they have been trying to execute for the past three years (yes, it has taken that long) looks like it is coming to a close (yes, we have heard this before). Deleveraging is complete (balance sheet has been fixed). We could see a rebound in profitability of US market in the coming year (as they shift production from old plants - which will be closed - to new plants). At C$25.40/share, the risk/reward now looks skewed to the upside. If the new management team is any good (Lino Jr recently stepped down from CEO role), this could be a strong performer in the coming years.

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?

@kodiak , I have brought a part of your post in the Fairfax India thread over here. You mentioned Fairfax is the 7th most profitable publicly traded company in Canada. This doesn’t surprise me. Do you have a source? Not that I don’t trust you, i would like to use this fact in a future post. ————- “On final note, while Fairfax Financial is about the 25th largest company based upon market capitalization and that alone should make us the most likely next company to be added to the TSX 60, we are the 7th most profitable public company in Canada. I learned that fact today and it makes perfect sense. What other big company in Canada is trading for 8 times earnings. I still think Fairfax Financial and Fairfax India represent two of my absolute favorite investments in my portfolio.” ————— If Fairfax is indeed the 7th most profitable publicly traded company in Canada what can deduct from this? My assumption is Fairfax’s earnings today are roughly ‘normal’ - I.E. they are not over-earning today. Certainty of earnings. This is the elephant in the room that I don’t see anyone discussing today. Buffett says this is one of the most important inputs to use when valuing a company. Fairfax has this (certainty of earnings for the foreseeable future) which means it should trade at a premium. The 7th most profitable company trading at the 26th market cap does not sound like it is trading at a premium to me. Let’s overlay a few more things regarding Fairfax today: Quality of earnings? High quality sources. Past performance? (5year change in BV) Best in class. Capital allocation? (Last 5 years) Best in Class, and by a country mile. Future prospects? Very good. Lots of people look at Fairfax through the lens of a value investment. I think that is a big mistake today. I think it is too narrow. I think the better way to look at Fairfax today is with a ‘quality’ framework. This broadens the analysis from primarily looking at earnings and fundamentals and includes multiple (the ‘right’ multiple) as an equally important factor in the valuation process. Multiple expansion is where the big money is made for investors. Importantly, this dynamic can take years to play out.

@MarioP, thanks for sharing. Elasticity is key. As @SafetyinNumbers has said many times, who are going to be the marginal sellers of Fairfax moving forward? This will have an important impact on the share price. And the concept of a Giffen good is a real mind bender. Especially when it comes to modern portfolio theory. My read is the big winners of the shift to indexing are the fast growers - but by fast growers, I mean as measured by market cap. These types of stocks have many different tailwinds: Strong earnings and improving fundamentals. Expanding multiple. Demand from momentum investors. Demand from index investors. As this process plays out over years, the company becomes a stock market darling. It gets viewed as being a very high quality company. This is when the multiple expansion story really gets going. And this brings more of the momentum and index investors in, pushing the stock higher yet. Success begets more success. Who are the losers? The ‘value’ investors. Because they sell a winning position way too early. My guess is this is what has happened to a lot of Fairfax investors. In 2022. And 2023. And again 2024. What was the mistake made? They were wedded to a narrow mental model (value investing). And this stopped them from understanding what was happening at Fairfax and the proper way to value the company. Because Fairfax has changed from a turnaround to a value play. And now it is morphing into a quality play. This is where I think it is important to have an open mind. To adopt Munger’s latticework model. This approach has two big advantages for an investor: Position size - it allows you to stay concentrated longer. Holding period - it allows you to hold the position longer.

Another update of my book/collection of posts on Fairfax is attached below. The big updates were to Chapter 2 (earnings) and Chapter 10 (consolidated equity holdings). Lots of other smaller updates have also been made - as this continues to be a working document for me. I don't re-read the entire document when I post updated versions. If you see any big errors please let me know. The document is now almost 550 pages. My goal is not size - but I will continue to add material that I think adds value for those interested in learning more about Fairfax. Please note, not everything in the book has been brought up to date. That would have required a couple of months of work… and by the time it was done, much of it would be out of date again. My current plan is to keep updating parts of the document as time goes by. The bottom line, this document should be a much better resource for board members / investors than what existed before. I hope you find it useful. --------- For members who enjoy reading my posts on Fairfax I have attached at the bottom of this post two documents: Fairfax - The Emergence of a Wonderful Company: PDF file contains more than 90 of my best posts on Fairfax from over the past 2 years, organized into 17 chapters. Excel workbook: Companion document to the PDF file, contains 14 worksheets (see below for details). Sanjeev, thanks for everything you do running this board. For all the members on this investing forum, ‘thank you’ for breaking bread on a daily basis and sharing your thoughts on investing and life. Over the years, it has been a life changing experience for me and my family. What is contained in this document is the collective wisdom of this group. Let’s hope i have captured it reasonably well. I always appreciate getting some feedback… maybe one or two things you like and one or two things you don’t. What is missing? Thank you. A message from the legal department: Both documents are incomplete and contain errors. What is contained in the attached documents is not intended to be investing/financial advice. Its purpose is to educate and entertain. ----------- The Excel file contains 14 worksheets: FFH-24: lists and tracks many of Fairfax's equity holdings in real time Size: ranking of Fairfax's equity holdings by size Moves: detailed compilation of many on Fairfax's transitions going back to 2010 - organized by year Earnings Estimate: detailed 2024 & 2025 earnings estimate Premiums: the build for 'underwriting profit' Interest: the build for 'interest and dividend income' Associate Equities: the build for 'share of profit of associates' Consolidated Equities: Non-insurance Consolidated Companies Investments: the build to calculate the return on the total investment portfolio Shares: reviews 'effective shares outstanding' Excess of Fair Value over Carrying Value: for the non-insurance associate and consolidated holdings Float: the build for float 13yr View: A 13 year view of many key metrics for Fairfax IFRS 17: Effects of discounting and risk adjustment - quarterly summary of historical numbers used in earnings forecast Fairfax Financial Volume 2 - Dec 2 2024.pdf Fairfax Dec 1 2024.xlsx

Don't get me wrong... I love the fact that Fairfax is vacuuming up a significant amount of BIAL at a very attractive prices. My question is why is Siemens selling 10% for 'only' $255 million? Could it be: 1.) I think Fairfax has right of first refusal if partners sell their stake to external party... could that be it? Effectively stopping serious bids from coming? 2.) BIAL already has a majority owner... Fairfax. So anyone buying will be a minority owner... minority stakes are valued at a discount? 3.) Siemens wants out - so forced seller with limited buyers? 4.) Other?

@dartmonkey , what i find so fascinating about index investing is how it works. It throws sand in the gears of how everyone thinks financial markets work. The ‘clearing mechanism’ for indexes is market cap. The ‘clearing mechanism’ for financial markets is price. As indexing continues to grow in size does this mean market cap will start to distort the market? Is it already happening? Lots of smart people think indexing is the devil. The fact that people who know nothing about investing or financial markets can now outperform 80% of professional advisors is nuts. Is it ‘too good to be true?’ ————— Lots of very wealthy, smart people have enormous amounts of money invested with financial advisors - and not in index funds. And their portfolio is underperforming the broad based indexes. Year after year after year… That makes no sense to me. The current industry model looks broken to me. What is the solution? Ban broad based index investing (or something similar). Or take Vanguard out (so fees to ‘manage’ index funds can increase). Just trying to be open minded…

@73 Reds , to me the big winners are the large components of the index that are growing the quickest (in terms of market cap). They get two benefits: 1.) The new money coming into indexing. Significant. 2.) The reallocation within the index. From those who are shrinking to those who are increasing in weighting. The laggards that are in the index will see new money. But if their weighting within the index is shrinking this will be a headwind. I wonder if this does not result in structurally higher multiples for the largest good performing companies. And a structurally higher multiples = ‘high quality’.

@dartmonkey , thanks for the 'quibble'. I have edited my post to make it more accurate. Much appreciated. I did spend some time reading about how index investing is impacting financial markets. I did not find anything that that really scratched my itch. So I will keep looking. I am wondering if index investing, as it grows in popularity, does not cause some structural changes. Being in an index just seems like such an advantage for large companies - especially those that are growing earnings and where the fundamentals are improving. It results in a virtuous circle - resulting in multiple expansion. And high multiple = high quality.

Fairfax Financial and Index Investors Hat tip: this post was inspired by @SafetyinNumbers many posts on this topic over the past year. Financial markets are constantly evolving. One of the big changes over the past 30 years has been the wide adoption of index investing. How exactly is index investing changing how the stock market works? This is where things get really interesting. The short answer is we don’t really know what impact index investing is having on the stock market or individual stocks. It’s like we are in the middle of a big science experiment and we aren’t sure yet exactly what is going on - how index investing is affecting the stock prices and valuations of individual companies. We likely will have much better answers in another decade or two. But that doesn’t really help us today. What does indexing have to do with Fairfax? There is speculation that Fairfax may be added soon to the big Canadian index, the S&P/TSX 60. With the announcement coming perhaps as soon as December 6, 2024 (with the official add to the index coming 2 weeks later). If Fairfax is added to the S&P/TSX 60 index, will it impact the company’s stock price? And/or its valuation? That is the question we will explore today. What is the best way to look at index investing and understand its impact on a stock’s price? Let’s get out of our comfort zone a little. We are not going to focus on earnings or the fundamentals of a company. Today, we are going to go in a very different direction - we are going to look at the stock price of a company through the lens of supply and demand for its shares. Supply and demand We were all taught in Econ 101 about the law of supply and demand: Supply is the amount of something that is available for sale. Demand is the amount something that people want to buy. The clearing mechanism (how much is actually bought and sold at a point in time) is price. If demand is higher than supply, prices should rise (and vice versa). If supply is higher than demand, prices should fall (and vice versa). The critical assumption built into all of this - is the belief that markets work (and are relatively efficient). The law of supply and demand can be explained simply with a graph, with price on the X-axis and supply on the Y-axis. Where the demand and supply curves intersect on the graph determines the quantity supplied and the price paid. Supply and demand - and shares outstanding We can use supply and demand for shares to explain the stock price of a company at a point in time: a stock price is simply an equilibrium point where both the buyers and sellers of a stock are in agreement. If demand for shares is higher than supply, the stock price should rise (and vice versa). If supply of shares is higher than demand, the stock price should fall (and vice versa). How does index investing impact a stock’s price? There are two basic ways index investing can impact a stock’s price. When a stock is in an index. Ongoing impact. When a stock is added (or removed) from an index. One time impact. Let’s now look at each of these. 1.) What happens to a stock that is in a popular index? Growing demand for shares ETF/index investing has been growing in popularity for the past 30 years and it has now become mainstream, especially in the US. This growth looks structural. As a result, this asset class is poised to continue its torrid growth in the coming years. The growth of this asset class will provide a steady source of new demand for shares of the companies that are in the main indexes like the S&P500 and the S&P/TSX 60. Decline in supply of shares (float) The big broad based ETF/index funds are not market timers. They are largely ‘buy and hold’ investors. As long as the company remains in the index and its weighting remains roughly the same (the business is performing well). As a result, the shares they own are essentially removed from the market. This shrinks the share float for a company - it reduces the supply of shares that are available for sale to the rest of the market. Price agnostic When indexes buy shares they are largely price agnostic - the valuation of the stock doesn’t matter to these buyers. What matters to them is getting their weighting right. This is important. Price is supposed to be the clearing mechanism. But that is not the case for this large and growing group of investors. Let’s now look at the second way index investing can impact a stock’s price. 2.) What happens when a stock gets added to a popular index? The big indexes usually make changes (additions/deletions) each quarter. The winners get added. And the losers get removed. Getting added to an index results in a one-time spike in demand for shares from index funds as they add the stock to get it to the designated weighting. Summary Index investing impacts a stock in many important ways. Short term - When a stock is added to index. One-time increase in demand of shares - price insensitive. Reduction in float (supply of shares available to other investors). Long term - For stocks in an index. Steady demand of shares - price insensitive. Reduction in float (supply of shares available to other investors). The growth outlook for index funds is outstanding. As its popularity grows its impact on financial markets (and individual stocks) will only increase. All things being equal, what do you think this should do to the price of a stock over time? For stocks that are in the big indexes, this set-up looks like a tailwind. How big? Of course, that is the million dollar question. We don’t know. But my guess is the impact is likely greater than most investors realize today. —————- Let’s now expand our analysis a little to include a couple of other factors. Share buybacks Guess what happens if the company is also aggressively buying back its stock? Aggressively reducing the supply of shares (float) at the same time demand is increasing? All things being equal, yes, that should result in a higher price. Quantitative analysis / momentum investing In addition to index investing, one of the other big changes in financial markets over the past 30 years has been the explosion of quantitive analysis / momentum investing. This crowd loves stocks that go up. And that keep going up for years. Guess what stocks get added to an index? Yes, stocks that have already been going up for years (and growing in market cap). People describe index investing as passive investing. It’s not. In how it impacts financial markets, index investing looks an awful lot like another form of momentum investing. And that is because winners are added and losers are subtracted. And within the index, new cash flows disproportionately to best ‘performing’ stocks (with performance measured by market cap). Guess what happens when both the index crowd and the momentum crowd start buying a stock at the same time? And the company is buying back large amounts of stock? The law of supply and demand suggests we should see the stock price increase. This is when we see multiple expansion. Importantly, this process can play out for years. Especially if the company is performing well (is growing earnings and has improving fundamentals). Let’s add one last wrinkle. From value play to quality play What happens when a stock shifts from being a value play to being a quality play? This happens when Mr. Market falls in love with a stock. This results in another new source of demand for stock. Let’s try and bring this long post to a close. What is the perfect set up for a stock? High and growing demand for shares. With buyers willing to pay up (largely price agnostic). With, at the same time, the supply of shares (float) shrinking. With demand coming from the following sources: Value investors Index investors Momentum investors Quality investors Shrinking supply (float): Index investors. Company is buying back stock. This will push the stock price higher. In turn, this will result in an increase in the market cap of the company. This will result in increased demand for its shares. It becomes a virtuous circle. And it can take years to fully play out. —————- What does all of this to do with Fairfax? There is speculation that Fairfax may be added soon to the big Canadian index, the S&P/TSX 60. With the announcement coming perhaps as soon as December 6, 2024 (with the official add to the index coming 2 weeks later). Fairfax is not in the index today. It is currently the 26th largest publicly traded company in Canada based on market cap. https://companiesmarketcap.com/cad/canada/largest-companies-in-canada-by-market-cap/ If Fairfax is added to the S&P/TSX 60 index it will increase demand for shares. And it will reduce the supply of stock (float) available to other investors. This will be another (of many) tailwind for the stock - and one that should last for years. On October 1, 2024, here is what CIBC had to say in a research note: “After attending the annual advisory panel meeting last week, our internal view is that the likelihood of Fairfax being included in the S&P/TSX 60 has increased significantly. The company’s size now outweighs any obstacles or impediments related to sector balance in S&P’s index methodology. An our view, the prospect of FFH’s inclusion has become a matter of when, not if, and we believe the event could bring close to 1MM shares of demand into the stock (representing 15x its 30-day average daily volume).” On December 1, 2024, the following was reported by the Globe and Mail: “Insurance company Fairfax Financial Holdings Ltd. is likely to replace Algonquin Power in the S&P/TSX 60 Index, as it’s the largest S&P/TSX Composite name not in the 60, Mr. Gauthier said (analyst with Scotia). However, he said the index committee might opt to pick trucking company TFI International Inc. over Fairfax, as it comes from a logistics sector that is under-represented in the large-cap index, which is already heavily weighted toward the financial services industry.” “Adding Fairfax would mean demand for 600,000 shares, or 9.5 days of trading.” https://www.theglobeandmail.com/business/article-tmx-expected-to-add-aecon-drop-algonquin-power-in-index-update/ —————- S&P/TSX 60 Index The S&P/TSX 60 is designed to measure the large-cap segment of the Canadian equity market and is structured to reflect the sector weights of the S&P/TSX Composite. The Toronto Stock Exchange (TSX) serves as the distributor of both real-time and historical data for this index. https://www.spglobal.com/spdji/en/indices/equity/sp-tsx-60-index/#overview Criteria for index inclusion The S&P/TSX 60 advisory panel recently met with analysts to review the criteria they use when making changes to the index. It appears the key factor used is size (market cap). Sector weighting is less important as a factor. S&P/TSX Canadian Indices Methodology https://www.spglobal.com/spdji/en/documents/methodologies/methodology-sp-tsx-canadian-indices.pdf ----------- Buy on the rumour and sell on the news Fairfax shares are up more than 10% since the S&P/TSX 60 advisory panel met with analysts (and CIBC released its report). So perhaps Mr. Market is buying shares in anticipation of Fairfax being added and that is what has been driving the stock price higher over the past month. Perhaps we see Fairfax sell off in the immediate aftermath of what happens on December 6th? Regardless of what we see in the short term, getting added to the S&P/TSX 60 index should be a tailwind for Fairfax's share price in the coming years.