Viking

racemize, nice summary. Please feel free to incorporate anything I have written on the various topics that you find useful :-) I appreciate the opportunity to discuss and share ideas to the benefit of other board members. Here are a couple of thoughts on your paper: - C has stated they expect to return $60 billion over 3 CCAR cycles; the first cycle is almost over so they have a little over $40 billion to return to shareholders over the next 2 to hit their $60 billion total. Readers of your article may think that C has communicated there is $60 billion coming over the next 3 years. - revenue: I think the most important driver of bank top line revenue growth is GDP. If US and global GDP growth is strong the big banks should see solid revenue growth. A second factor driving top line growth is rate increases by the Fed (this is also tied to GDP). If investors feel US GDP growth will be solid then US banks would make a good investment choice. A third factor are all the investments the various banks are making in their business. It is only in the last couple of years that C and BAC were able to really get focussed on driving growth as prior to this they had their hands full dealing with legacy issues. - expenses: I think the most important driver of bank expense discipline is technology. It appears the banking industry as a whole will be a big beneficiary as technology continues to be implemented. This will allow the US banks to hold (in BAC’s case) or lower (moving forward in C’s case). A second driver of lower expenses may be the Trump administrations recent appointments to the various regulatory bodies and we should find out later this year how the regulatory environment will be streamlined which should lower expenses further. - the net result of higher revenue combined with flat to falling expenses is the operating leverage that Moynihan has been talking about every conference call. I noticed that The C CEO is also starting to talk up operating leverage. -lower taxes are also a very big deal for earnings growth in 2018. The banking sector benefitted much more than most other industries. Regarding capital return you may want to add a paragraph on the dividend for each of the big banks and how much it has gone up the past three year and how much it will continue to go up in the next couple of years, especially for the banks like BAC and C that are well under the 30% payout ratio. High dividend payouts is a big deal. Significantly growing dividend payouts is an even bigger deal. My guess is the continued growth in dividends will be a big factor in the market over time loving the big banks once again. Looking at share repurchases over a couple of years is also very powerful. C especially. C is reducing its outstanding shares by two hundred million every year or about 8% per year. Simply amazing. A 3 year chart showing how much the share count has been reduced is very powerful. Regarding credit quality, I think Mike Mayo has commented repeatedly that the loan books of the big banks are higher quality than they have been in decades; this should help provide some comfort that in the next recession losses will be much better for the big banks than they were in 2008.

Vote today was 3-0. It appears changes will be coming later this year that will reduce compliance costs for the big banks. Another change that will improve their profitability. The ‘story’ for the big banks just keeps getting better. :-) “The Federal Reserve Board, now led by Trump appointees, is set to take the most concrete step yet to roll back the Volcker Rule, which was key to Washington’s efforts to make the industry safer after the 2008 meltdown. The Fed’s vote, scheduled for Wednesday, would kick off an administrative process aimed at significantly reducing compliance costs for financial firms.” http://fortune.com/2018/05/30/fed-proposal-volcker-rule-trading-limits/

Real estate moves in very long slow cycles. Boomer generation experienced one end of the extreme with interest rates at +20%. The flip side of this is house prices were low and size of total debt was also low. In the past 35 years interest rates have fallen from +20% to sub 2%. And (no surprise) house prices have skyrocketed. Boomers who owned a house have hit a financial home run. First time buyers today are getting generationally low interest rates but they also are paying historically high prices and taking on record amounts of debt. As interest rates now normalize higher to 4 or 5% many first time buyers with massive mortgages (and little equity) are going to see their payments skyrocket. This is all after tax dollars. There likely will be a number of lessons that will be learned by the current generation of first time buyers. The lesson will be total amount of debt matters. Interest rates matter. And housing is not a sure fire road to riches (as it was for the boomer generation). Leverage is a wonderful thing when the trade is moving your way like it has for the past 35 years); however, leverage can also be financially devastating when it moves against you.

When Calculated Risk called the top of the US real estate market (I think he did this in 2005 or 2006) one of the key stats he was following was housing inventory. Significantly growing inventory was key to calling to turn. I have not been following the real estate market super close but I did take a look at my region recently (Fraser Valley, Greater Vancouver). Inventory for all property types is starting to climb year over year. http://www.fvreb.bc.ca/statistics/Package201804.pdf I still believe interest rates are key. If interest rates (and mortgage rates) in Canada continue to move higher something will have to give. Housing is such a large part of the Canadian economy any slowdown will not be good. The million dollar question is what can a Canadian (in a high priced market) do to protect themselves? 1.) sell. This is not an option for me today (my family would lynch me). Fortunately our mortgage is small and, if prices crash, our loss would be a fall in the equity of our residence. (Easy come easy go?) 2.) ? I have one strategy that I been executing is I have all of my investments in US $. If I sell a position and raise cash I leave it in US$. My thinking is if housing in Canada tanks then our economy will also tank. In this scenario I would expect the US economy to out perform the Canadian economy and US$ to out perform the CAN $. Not very sophisticated but it has worked very well the past 5 years.

Ericopoly, I have been on this board since 2003. I copied Cardboards quote because it captures my thoughts exactly. From reading your posts over many years I never had the impression that you were a professional investor. I hope you are successful as you work your way through your current challenges :-)

To go back to the original question, my read is the small investor has never been in a better position to ‘beat the market’. 1.) costs are pretty close to zero. Not too long ago I was paying hundreds of dollars for my full service broker to execute a sell order and the same amount to execute a buy order. It now costs me $10 a trade which given the size of my ordered and the (in) frequency of my trades puts my annual costs pretty close to zero. 2.) information available to small investors has never been as easily accessible or of the quality it is today. Company web sites are amazing with quarterly and annual reports, conference calls and industry conferences. I deal with RBC and their research is pretty good and costs me nothing; I am likely going to open an account with another bank just so I can have access to their research free of charge. There are very good investing web sites out there like this one. There are very good Economic web sites out there like calculatedrisk. Etc. Many good sites cost nothing (reinforcing point 1). 3.) business schools, the investment industry and business tv continue to teach the same things today that they did 10 and 20 years ago (much of it wrong in my humble opinion). 4.) large institutional investors are still bound by all the constraints Peter Lynch covered 30 years ago in his great book One Up On Wall Street. 5.) Small/retail investors are as dumb as ever - getting taught/fleeced by 3.) above. Most people still go through their entire life without learning the basics of money and investing. 6.) in Canada, about a decade ago the government gave small investors a gift called the TFSA. When combined with RRSP and RESP individual investors are able to pick from a menu of different options to maximize future after tax earnings. 7.) because of how the investment industry works (see 3, 4 and 5 above) small investors will continue to be given wonderful opportunities to make money buying stocks - just like the past 100 years! Note: there is a definite ebb and flow to investing... it was much easier to find crazy cheap buys in 2008 and 2009 when the stock market was bottoming (and everyone was panicking). Today in 2018 the bull market is likely in its later innings so it should not be surprising if it is more difficult to find crazy cheap companies. Do not despair... cheaper prices will return... :-)

US economy continues its to chug along... not too hot and not too cold. Should be very supportive for solid earnings for the big US banks who begin reporting results on Friday. With tax reform now in place BAC and JPM should report earnings per share growth of +30%. Amazing :-) “It is early, but currently it looks like 2018 is unfolding as expected - although, based on Q1 data, employment gains might be slightly higher than I originally expected.” http://www.calculatedriskblog.com/2018/04/q1-review-ten-economic-questions-for.html

Thanks for posting. Very interesting to hear Munger’s thoughts on portfolio concentration and building wealth.

Thanks for doing the research... always good to get the facts :-)

I also wonder if this is why we are not seeing more aggressive share buybacks today. Buying the remainder of Allied World is also part of the bigger plan. The challenge is what is Allied World worth today? Given the size of the losses reported and the poor underwriting, it must be worth less than what it was purchased for. OMERS is going to want a premium.

They are not bullish. They still hold lots of cash. That is why they will never be able to achieve 15% with yields as low as they are today. But if they even achieve 10% priced at book value today, and hoping for a rerating at one point in time to 1,5 times book, that would still be a great investment. Investment performance has been poor on the equity (and hedging) side, but on the bond portion of the portfolio they are amazing. The fact that they sold everything just before Trump got elected when long term yields were at 1,5% is a master stroke. For an insurer the fixed income part of the portfolio is essential, and with Fairfax you have the best. Steph, yes, FFH has absolutely excelled with their bond portfolio decisions over the past 18 months. Their total portfolio is about $40 billion. Only $9 billion is currently in bonds; of this amount only $1 billion is 5-10 year duration and $2 billion is more than 10 year duration. It will be very interesting to watch where US interest rates go in 2018. If the long end (10 year plus) continues higher then bond losses will start to hit insurance companies book value when they report Q1 earnings. In a rising rate environment the size and average duration (years) of bond portfolios will become very important metrics for investors moving forward. Fairfax’s investment portfolio is ideally positioned for a rising rate environment. If long bond yields increase enough, and spreads widen on junk debt, it may hit book values enough to support a harder market in insurance pricing.

Reading the letter, it appears to me that Prem is less promotional and more fact oriented. Nice to see. Can someone explain to me what impact the following transaction will have on Thomas Cook India and also Fairfax? From page 9: “Quess has had a phenomenal run since we acquired our interest in it in 2013. Thomas Cook India invested $47 million in Quess in 2013, sold 5.4% last year for $97 million and retains 49%, which is currently worth over $1 billion. Because of Quess’ great success, Thomas Cook India intends to spin its holding in Quess out to its shareholders during 2018 so that Quess can be run independently as a public company under the leadership of Ajit Isaac. A big thank you to Madhavan Menon for nurturing Quess under the Thomas Cook India umbrella as it became large enough to be a freestanding company. Today, Quess is India’s leading integrated business services provider. With over 250,000 employees, the company has a pan-India presence with 65 offices across 34 cities, along with an overseas footprint in North America, the Middle East and South East Asia. It serves over 1,700 customers across five segments – Industrials, Global Technology Solutions, People and Services, Integrated Facility Management and Internet Solutions.”

John, I still like the big US banks - they are my risk on favourite. I like FFH at current prices - my turn around favourite. I am warming to the idea of BRK at or below $200 - my ‘instead of holding a bond’ favourite (I think Buffett would approve of this logic for BRK given what he wrote in his letter yesterday.)

I think BRK is the company they should buy. Stock repurchases are such a no brainer, especially at the current price.

Spekulatius, yes, Buffett’s age is the 800 pound gorilla in the room (and has been for years). My guess is the price of BRK would quickly fall to 1.2xBV and at that point the stock buybacks would kick in. Where the stock went from there would depend on the new leadership team and how they performed. It will be a very tough act to follow and expectations will be high. Very sad to think about...

longinvestor, great estimate of BV :-) Actual number = $211,750 John Hjorth also came up with identical numbers. Both of us were trying to point out that some around here were missing the massive single quarter jump that is now published. But the bigger story is the tax reform taking us to a higher plateau of earnings which is recurring, which makes the BV discussion the silly syllabus. It gets even sillier if one thinks along the lines of Semper Augustus re unreported earnings. I do. Buffett has a very old habit of understating his hand. longinvestor, I agree, “the bigger story is the tax reform taking us to a higher plateau of earnings which is recurring”. Do you have thoughts on what normalized earnings look like for BRK post tax reform? Or have you come across any good estimated you can link me to?

“Nice story. Need stories like yours being a concentrator myself. Would you please elaborate on why extreme concentration does not fit with capital preservation. Is it worry of permanent loss or underperformance with larger sums or something else? Just trying to understand.” longinvestor, when I read Buffett’s quote in Cardboard’s post I added the words extreme concentration because it fits for me :-) “Our aversion to leverage and extreme concentration has dampened our returns over the years. But Charlie and I sleep well. Both of us believe it is insane to risk what you have and need in order to obtain what you don’t need."

Cardboard, solid advice I need to pay more attention to... Viking, are you in the business - at all - of using leverage? John, I have a small mortgage on my house, currently at a rate of 2.7%. I could be mortgage free but I have been able to generate an average annual return of about 15% over the past 20 years. Other than this example I have never used leverage. The strategy I have used with great success over the years is concentration. And I have even been 100% invested in one company a few times in the past 20 years and every time it has worked out very well. My portfolio is now getting to a size that capital preservation is becoming a higher priority than return. Extreme concentration does not fit with capital preservation and so I need to retrain my brain. I especially liked Cardboard’s comment “When things go your way for years (almost 2 decades), delivering 10-20%+ above index returns (pre-leverage) and appear easy, you are highly subject to make over-confidence mistakes and to ignore some risks.“

longinvestor, great estimate of BV :-) Actual number = $211,750

Cardboard, solid advice I need to pay more attention to...

Like Trump or not like Trump it is clear the US today has a much more business friendly government. Taxes have been reduced greatly. Regulation is being stripped away. Optimism of business people in the US is at historic highs. Trump also is implementing a US first trade stance. NAFTA is currently being renegotiated and it is reasonable to assume Canada will be a net loser with any changes made. Oil and gas has been one of the engines that a has powered the Canadian economy the past 15 years; not anymore. Housing has been THE engine of growth powering the Canadian economy the past 8 years but with Canadian household debt to GDP at historic and world highs and interest rates heading higher it is hard to see this continuing. Politically, federally and provincially (I live in BC) we have governments that are spending inherited surpluses to pay off base (who voted them in), raising taxes on businesses and adding more regulation (pipeline in BC is a great example). Moving forward businesses that can set up in Canada or the US will increasingly pick the US. This will take a couple of years to play out. When I weave it all together I see lots of risks for Canada moving forward. As a result 90% of my investable assets are in US$ and will likely stay there for the near term. One possible repreive for Canada is if commodity prices spike higher as usually happens late in an economic cycle (as forecast by Gundlach and others). If this happens our stock market will likely outperform other world markets given its concentration in resource stocks. It is possible we also just muddle through (nothing terrible or good either). I am an optimist generally but am finding it difficult when looking at Canada’s medium term economic prospects.

+1

I was very happy when FFH purchased ORH in 2009. Prem telegraphed the purchase in advance and I think there was a lengthy discussion on this board speculating that a buyout was possible/likely. I think a number of investors made a lot of money. Could the final price have been higher? Sure. Was the final price for ORH at the time fair? My view was yes. Investors in ORH also had the opportunity to roll their money into FFH shares.

Is the culture at Fairfax such that they are able to keep their key people long term? I am very impressed with Brian Bradstreet, Andy Bernard and more. Zenith is a great example of How FFH likes to do acquisitions and the fianancial results at this company post acquisition have been stellar. Looks to me that very smart people at FFH believe in the company; if they did not they would simply leave. There is lots to like about Fairfax and I do believe much of that is due to the culture they have built over many years.

Here are my remaining notes from the conference call. Please correct any errors as you see fit :-) US tax reform: - took a $326 million charge in Q4 (reduced value of DTA) - it sounds like US tax reform will be a solid benefit for FFH. - During the conference call FFH said 60% of their business is in the US but did not provide an estimate for the new expected tax rate. - RBC today lowered their effective tax rate estimate for FFH for 2018 from 26% to 19%; this is a significant reduction. Interest rates: - As short term interest rates move up FFH should see nice growth in interest income given they have about half of the investment portfolio in cash and short term investments. - Prem said FFH has not reached for yield with its investment portfolio while other insurers have - feels higher inflation is likely; interest rates could increase significantly and credit spreads could widen Investment income - Prem talked up recent C-span warrant deal: builds investment income by $15 million per year. With possible capital gains kicker - similar to Corus, AGP? and Altius - like these deals Insurance rate renewals - generally, rates are no longer going down; rates are flat to increasing (varies) - casualty 0-5% increases; - property 10% increases; loss affected areas seeing increases of 20-25% $2.4 billion cash at hold co - NOT looking for acquisitions - looking to buy back stock - Prem said during the Q&A it is highly unlikely dividend will increase - Prem also said they would like to take Eurolife, Brit and Allied 100% private (no timeline given); this did not sound imminent to me but why mention it if it was not on the table for 2018? Allied World: - $50 million Q4 reserve increase was related to one specific claim (casualty) - FFH continues to think they are very well reserved - cat losses were higher than FFH expected; cat losses in the future will be less (FFH does this different than Alied World and Allied World will change to FFH practice) FFH India - FFH performance fee is paid in shares (as per agreement); ownership has increased from 30 to 33%. - if FFH India trades at 2X book value, FFH can take performance fee in cash - Bangalore airport designed for 20 million passengers; currently serves 25 million; under expansion to serve 65 million over next 3-4 years - FFH India building lots of intrinsic value for shareholders Gravilia & Eurobond Investments - as Greece economy moves up continues to improve their investments should do very well - Prem mentioned Ireland as a comparable... when the Irish economy turned for the better their investments there jumped in value significantly Tail macro risks (does not expect any of these to play out) - risks: China, world trade disruption, recession - deflation hedge at $40 million on books; will keep position and hold as insurance for worst case scenario Refinancing their high interest debt (due over next couple of years) at much lower rates available today. Looks to be a very smart thing to do if you are expecting interest rates to move higher. Hits earnings in the short term but positions the company very well for the long term (if I understand the mechanics properly) - At the end of December the company completed an early redemption of its remaining C$388.4 million 7.5% unsecured notes due August 19, 2019 for cash consideration of C$430.6 million recognizing a loss of $26 million which is included in “other expenses.” - On December 4, the company issued C$650 million principal amount of 4.25% unsecured senior notes due December 2027.