Viking

Here is some constructive feedback: 1.) my guess is Fairfax earns $160/share in 2023. That is a 5.2 PE. I expect earnings per share to grow in 2024 and 2025. So Macy’s is not cheaper today. 2.) liquidation value. My guess is if Fairfax started to sell off its many assets it would realize significant value for shareholders. Of course that isn’t going to happen so it is kind of a useless exercise. My question: is Macy’s going to liquidate parts of the company? 3.) management: the management team at Fairfax has been executing exceptionally well the past 5 years (best in class among insurance companies). They are going to be getting in the range of another $11.3 billion in net earnings over the next 3 years. I have no idea how good the management team at Macy’s is… but are they that good? 4.) insurance is in a hard market. Retail is… in a terrible market that might get worse ( although i did buy a little Aritzia recently). Sanjeev, my read is you are significantly underestimating the current earnings power of Fairfax - like many of the posters on this board. And i love it. Stocks usually climb the wall of worry. PS: i will admit i do not follow Macy’s… but i will do some reading on the weekend. Your banging of the table is what got me back into Fairfax in late 2020. And more recently you nailed META.

The evolution of Fairfax - the multiple streams of high quality income phase Last week in my long-form post we learned that Fairfax’s operating earnings have spiked to a much higher base level. - https://thecobf.com/forum/topic/19861-fairfax-2023/page/45/#comment-528496 Let’s broaden the discussion out a little bit. Let’s look at all of Fairfax’s sources of income. What are they? What is their quality? How are they changing? Why does sources of income matter? ‘Quality earnings’: of all the sources of income, operating income are generally considered to be the highest quality for P&C insurance companies because the sources are considered to be predictable and durable. Companies that generate the majority of their total earnings from operating income are considered to be higher quality. As a result, the the stock prices of these companies usually trade at a premium valuation to peers. If we understand sources of income and their trend that should provide us with another important piece of information to help us understand a company’s valuation, especially when compared to peers. Fairfax has 5 streams of income: Underwriting profit Interest and dividend income Share of profit of associates (primarily Eurobank, Atlas, Exco, Stelco, GIG) Non-insurance subsidiaries (primarily Recipe, Fairfax India, Thomas Cook, AGT, Grivalia Hospitality, Dexterra) Net gains/losses on investments (mark to market equities, derivatives, fixed income, asset sales, including insurance) The first three streams when added together give us all important operating income. Let’s look at the average of these income streams over a 6-year period from 2016-2021 to see what we can learn: Size: From 2016-2021, Fairfax generated in total an average of about $2.5 billion per year from the 5 income streams listed above. The total amount was quite volatile year-to-year. Composition (split) of the average from 2016-2021: Net gains on investment was by far the largest income stream at 49% of the total. Interest and dividend income was the second largest bucket at 28%. Underwriting profit was the third largest largest at 12%. Share of profit of associates was 6%. Non-insurance subsidiaries was 4%. Operating income was a total of 46%, or less than half. These splits fit the narrative of the company at the time (2016-2021): The vast majority of income at Fairfax was being generated by ‘gains on investments’ and these gains had massive swings each year (up and down) so Fairfax’s reported results were quite volatile year to year. Lots of volatility year to year = low quality earnings. From 2016-2021, Fairfax earned an average of $44/year. Book value averaged $474. Its stock traded around $500 during this time. Fairfax was valued at around 1.05 x BV and a PE of around 11.4. These multiples were well below peers. Important: net gains/losses on investments - in the chart above an average number was input for each year from 2016-2021. Large negative annual numbers mess up the ‘split’ calculations. Importantly for our analysis, using an average number allows us to get a 6 year average that is a good representation of the split of the various income streams. Let’s look at the income streams for 2022: We are going to look at 2022 on its own. 2022 was an anomalous year for global financial markets - we had the largest bear market in history in fixed income and, at the same time, a bear market in stocks. As a result, Fairfax had a $1.7 billion loss on investments in 2022. This was largely offset by a $1.2 billion gain from the sale of its pet insurance business (pre-tax). So the final loss on investments came in at only $514 million. Operating income spiked higher to $3.1 billion. This number on its own was now larger than the average of the total of all income sources from 2016-2021. In 2022, the impact of rising interest rates has been fully reflected in Fairfax’s income statement and balance sheet. As a result, the fixed income portfolio/balance sheet has been largely de-risked from the impact of spiking interest rates. At the same time, a significant shift in the composition of Fairfax’s income streams that started in 2021 accelerated in 2022 - each of the 3 components of operating income all increased to record levels in 2022. Despite bear markets in both bond and stock markets, Fairfax was still able to deliver a total of $2.6 billion from its 5 income streams. Let’s look at my estimates for the earnings streams for 2023-2025: This is where things get really interesting. Especially when compared to 2016-2021. Size: From 2023-2025, my estimate has Fairfax generating an average of $5.9 billion per year from the 5 income streams. This is an increase of 139% over the run rate of $2.5 billion from 2016-2021. Composition (split) 2023-2025 compared to composition from 2016-2021: Interest income is now the largest single item at 36% up from 28%. Underwriting profit is up nicely to 21% from 12%. The big mover, though, is share of profit of associates which increased from 6 to 20%. Operating earnings are now 77% of the total. That is a massive increase from 46% from 2016-2021. Gains on investments are still a solid 20%. My estimate for this bucket of income is likely far too low - this is the one of the big reasons why I think my total earnings estimate for 2023-2025 will be proven to be too low. Non-insurance subsidiaries could grow significantly in the coming years. I think income of $400 million/year from this bucket (collection of companies) is attainable looking out a couple of years. Were this to occur, Fairfax would have a meaningful 5th income stream. Conclusion: Two stories are playing out simultaneously at Fairfax right now: a total earnings story - earnings are spiking. a quality of earnings story - the quality of earnings has improved dramatically in recent years Importantly, the increases in both the size and quality of earnings is sustainable. Having multiple sources of income does a couple of things for the company: provides important diversification across both insurance and investments. makes the whole company more resilient to both insurance and economic cycles. generates much more consistent cash flows over time allowing the company to be highly opportunistic with capital allocation. This should make Fairfax a more valuable company. It should trade today at a valuation multiple more in line with peers (if not a premium to some). What is reflected in Fairfax’s valuation? Investors have been warming to the Fairfax story. The stock price has increased 145% over the past 31 months (since Dec 31, 2020). However, Fairfax currently trades at a 5.2 x multiple to my 2023 estimated earnings. It is also trading at about 1 x book value. These are very low multiples and much below peers. This suggest to me that: Mr. Market is starting to understand the spiking earnings story at Fairfax. Mr Market does not yet understanding the much improved quality of earnings story at Fairfax. And that is because multiple expansion has not yet happened at Fairfax. Mr Market does get things right over the medium term. My guess is as investors come to more fully understand ‘new Fairfax’ we will get multiple expansion in the coming years and Fairfax will trade at a multiple closer to peers. If this happens it would (along with continued growth in earnings and share buybacks) help power the price of the stock to much higher levels. The hard market in insurance There is a lot of hand wringing among investors today about the status of the hard market in insurance. When will it end? What will it mean for insurers? Do we get a sideways insurance market (not too hot or too cold)? Or do we a rapid descent into insurance hell - and a full-on soft market. Underwriting profit makes up about 50% of total income for most insurers (with investments making up the other half - mostly from fixed income). So what happens to insurance pricing in the future will impact the financial results of most insurance companies in a significant way. For Fairfax, as we have just learned above, underwriting profit only makes up about 20% of total income from expected sources. As a result, where insurance pricing goes in the future will impact Fairfax far less than its insurance peers. Fairfax’s total earnings are now of a size, diversity and quality that maintaining strong underwriting profitability (perhaps mid-90’s CR) can be even more of the focus moving forward at the insurance operations. Unlike other insurance companies, Fairfax’s future will not be tied primarily to the insurance cycle. Its future will be tied to how well it does capital allocation. Capital allocation is increasingly becoming Fairfax’s competitive advantage. The insurance business model used by Fairfax: Fairfax uses the float of the insurance companies to buy non-insurance companies. These companies generate earnings. These earnings allow Fairfax to buy more insurance companies which increases float. This increase in float allows Fairfax to buy more non-insurance companies. Rinse and repeat… As we have seen above, Fairfax is now generating a record amount of income from its 5 income streams. At the same times, the quality of income has never been better. As i stated in my post last week, through the flywheel effect, Fairfax has now achieved ‘breakthrough’. My current estimate is Fairfax will generate a total of about $11.3 billion in net earnings (attributable to Fairfax shareholders) - mostly from high quality sources - over the next 3 years. Fairfax has never been better positioned as a company than it is today. Fairfax has been trying to get to this exact place for 38 years. It has finally arrived. What we are witnessing in real time is the beginning of the next phase of Fairfax’s evolution as a company. It is reminiscent of a much younger Berkshire Hathaway. (Of course, Fairfax’s business model is uniquely its own.)

@Spekulatius that is a great podcast on the current state of China. It was a very sober discussion - the CCP certainly looks like it has its hands full. I love the historical perspective the guest offers (so important when trying to understand China). i also found this comment at the end quite illuminating: “The fundamental tension… for years the CCP justified its control (of society) by promising economic growth so you have that social contract. But I think the difficulty is what if that control is coming now at the expense of economic growth. If a lot of the currently difficulties are in fact, a political economy problem then I think it raises that question and becomes extremely tricky for the CCP to actually navigate.” The discussion around the massive sovereign wealth funds (China, Saudi Arabia etc) was also very interesting. They limit the autocratic regimes from doing anything crazy… because the significant assets they own in the West will simply get seized by Western governments. This would be another check on China potentially invading Taiwan.

Meadow Foods web site: "MEADOW HAS GROWN OVER 30 YEARS INTO A £550M VALUE-ADDED INGREDIENTS BUSINESS SPECIALISING IN THE DAIRY, CONFECTIONERY, ICE CREAM, PREPARED FOODS AND PLANT-BASED INDUSTRIES." https://meadowfoods.co.uk/about/ Meadow Foods just completed an acquisition: https://www.exponentpe.com/node/711

@petec So you are saying psychology and price should drive an investors decision? Yes, a few people on this board are optimistic on Fairfax. And the stock price has gone up a lot. But really? I think facts should be the primary driver of an investors decision. What are earnings going to be? What is their quality? How durable are they? How good is the management team at capital allocation? Fairfax trades at a PE of 5.2. The earnings are high quality (mostly operating) and durable. The management team has been best in class ofr the past 5 years in terms of capital allocation. Those are the facts. The stock trading at a 5.2PE suggests to me that investors in Fairfax are still VERY bearish. Yes, there are a few people posting positive things about Fairfax on this board - that is a tiny sample size. Go survey the institutional guys - my guess is they are still very bearish on Fairfax (and underweight with their holdings). People are seriously arguing that Fairfax should trade at a 5.2PE because it will be earning too much over the next 3 years? The stock needs to be penalized because it is earning too much? I am sorry, that is crazy talk. You penalize a stock because it is underperforming. Fairfax really is becoming the Rodney Dangerfield of insurance. If other insurance companies were trading at a 5PE i would get it. Every other quality insurance company trades at a PE of at least 10 and most are higher. Fairfax is the clear outlier. And based on the facts, that makes no sense to me.

@petec Why do you think FFH’s operating earnings are in large part rate-dependent? What do you see that is going to cause a big fall off in 2026 and later? Recession? 1.) underwriting income 2.) interest and dividend income 3.) share of profit of associates Interest rates especially further out on the curve have been moving higher over the past 2 months. That is very bullish for Fairfax. That means interest and dividend income is likely going even higher as a significant amount of bonds likely mature each quarter and are reinvested likely at much higher rates. Fairfax’s fixed income portfolio has an average duration of 2.4 years (very low compared to peers). What if they extend this in 2H 2023 to 2.75 or even 3 years? They likely couldn’t extend duration in Q2 partly because they had to come up with $1.8 billion to buy the PacWest loans. But Q3? We will see. My point is it looks to me like you are assuming rates come down rapidly over the next year and Fairfax gets caught flat footed (operating income falls dramatically in 2025 and later). My view is for every risk there will be opportunity. If we get a recession, yes, treasury rates will likely fall. But credit spreads will also likely widen out. And that will allow Fairfax to flip into corporates and higher yields. My point is i think you are thinking about downside risk. And not giving any credit for the value of active management being able to take advantage of the mouth watering opportunities that will present themselves.

@SafetyinNumbers Given the run that Fairfax has had the past 3 years, it does not surprise me that some investors are looking to lighten up, especially if Fairfax is now too big of a weighting in their portfolio. I call that a ‘first class’ kind of problem to have. Personally, i think Fairfax is still ‘dirt cheap.’ I love the push back from others on this board who feel that Fairfax is no longer ‘dirt cheap.’ Sorry, you haven’t convinced me (yet) with your pushback. My read is earnings are going to be much more resilient looking out 3 or 4 years than you think. We will see in another 12-24 months who is right. And that is what i love about investing (and this board). We share ideas and discuss/debate. We all do our own analysis. We place our bets. And we live with the results. Hopefully we earn enough along the way to be able to keep playing the game. Best of luck to everyone.

@StubbleJumper My point with the PE in my post was to highlight that it is absurdly low for Fairfax right now. Fairfax's stock price today of $828 makes sense if Fairfax was earning about $80 per year (and assuming earnings grow modestly in the future). It is a well run P&C insurer so trading at a PE of 10 is hardly an aggressive multiple to attach. My current estimate is Fairfax will earn $160 this year. And with slightly conservative assumptions, earnings will grow in 2024 and 2025. That is not in the same universe as $80 in earnings. So a buyer of Fairfax's stock today at $828 is getting $80 in estimated 2023 earnings for free ($160-$80). That is one hell of a discount for something that might or might not happen in 2026 or later. It doesn't make any rational sense. It is too large. Yes, my earnings estimate for 2023 might be a little high. And it also might be a little low. We are almost 8 months through the year. My thesis is investors are way underestimating what a 'normalized' amount of earnings is for Fairfax today. Yes, the future is uncertain. There are risks. But there are also opportunities. Some income streams will face headwinds. At the same time other income streams will experience tailwinds.

@petec you are a night owl! My view is the true anomaly was the period 2010-2020 and zero interest rates. Interest rates appear to be normalizing. This is causing the investment world to return to a more normalized environment… one where active management, when done well, matters (can deliver serious outperformance). Something Fairfax has historically been very good at. So i give the management team the benefit of the doubt for the very good decisions they have made in recent years. The part of your comment i do not understand is: “And I think the stock looks fairly cheap on that basis.” My estimate is the stock is trading at 5.2 x 2023 earnings. That is not ‘fairly cheap’… that is crazy cheap. Do you not think $4.3 billion is a reasonable estimate for operating earning for 2023? Or is it more a weighting issue… where Fairfax is getting too big and you want to lighten up to rebalance your overall portfolio? Regardless of fundamentals or what the stock might actually be actually worth?

Fairfax and the Transition from Good to Great: The Flywheel Effect Warning: Mr Market might be right. And I might be completely wrong. This post is not intended to be financial advice. It is intended to educate and entertain. Please contact your financial advisor before making any stock purchases. Fairfax’s stock trades today at a PE of 5.2 (to my estimate of 2023 earnings). Of course, it is not normal for a stock to trade at a PE of 5.2. The PE multiple for the S&P500 is currently 20. So Fairfax’s stock could double in price and it would still be trading at a 50% discount to the S&P500. Fairfax’s PE of 5.2 screams that one of two things is clearly wrong: 1.) the price of the stock is way too low. 2.) the estimated earnings are way too high (and not ‘durable’) Let’s take a look the stock price first. Fairfax has been one of the best performing stocks over the past 31 months (since Dec 31, 2020). Over this time period, Fairfax is up 143% while the S&P500 is up 16%. Fairfax has outperformed the S&P500 by 127%. That is stellar outperformance. After a run like that, Fairfax’s stock price must now be fairly valued - in fact, it might even be overvalued. Looks like we might have our answer to our question above. If the stock is fairly valued then that means the earnings estimate must be way too high. Let’s take a look at earnings estimates. After Fairfax released Q2 earnings, I updated my three year earnings estimate for Fairfax and came up with the following: 2023 = $160/share 2024 = $166/share 2025 = $174/share My forecast is for earnings to go up each of the next 3 years. Clearly, my estimates must be too high. Right? I actually think they might prove to be conservative. Why? Because every forecast I have done for Fairfax for the past 30 months has proven, in hindsight, to be too conservative and usually by a lot. Why have my estimates been too low? Because i have been consistently underestimating the management team at Fairfax and the earnings power of the collection of assets they have today. So i trust my earnings estimate looking out three years. A lot. So what explains Fairfax’s current PE of 5.2? Despite a 143% gain over the past 31 months, the stock price of Fairfax is still dirt cheap. Yes, that probably sounds like crazy talk. How can a ‘still dirt cheap’ stock price be explained? Operating earnings are the holy grail for insurance companies because it is made up primarily of predictable items. And these items tend to be durable. Let’s focus on this bucket of earnings at Fairfax and see what we can learn. The average for total operating earnings at Fairfax from 2016 to 2020 was $1 billion per year ($39/share). But this dramatically changed beginning in 2021. in 2021, operating earnings doubled to $1.8 billion or $77/share (from 2016-2020 average) in 2022, operating earnings tripled to $3.1 billion or $132/share (from 2016-2020 average) in 2024, operating earnings are forecasted to quadruple to $4.3 billion or $185/share (from 2016-2020 average) The increase in operating earnings at Fairfax has been like a goat climbing straight up the steep side of a mountain. Let’s now do some historical comparisons to see what we can learn. From 2016 to 2020, Fairfax’s stock price averaged about $500/share (I am ignoring the covid drop in 2020). Over this same 5-year period, operating earnings at Fairfax averaged about $1 billion per year ($39/share). So investors over this 5 year period thought $1 billion in operating earnings (let’s call that baseline earnings) at Fairfax was worth a stock price of about $500. Back then, Fairfax’s stock was considered to be fairly valued. In 2023, operating earnings at Fairfax will be about $4.3 billion ($185/share). Operating earnings for 2023 are up 330% compared to the old 5-year baseline trend from 2016-2020, or 374% on a per share basis (the share count has come down over the past 5 years). Fairfax’s stock price closed Friday at $828. Fairfax’s stock price is up only 66% compared to the 5-year trend from 2016-2020. So operating earnings per share at Fairfax have increased a staggering 374% over the 2016-2020 trend while the share price has increased a modest 66%. I think we just learned something useful. The increase in Fairfax’s stock price has not kept up with the increase in operating earnings. And ‘not kept up’ is a big understatement. What is Mr Market missing? Mr Market clearly is not understanding the new trajectory for operating earnings at Fairfax. This is likely because Mr Market is still looking at Fairfax’s financial performance through the rear view mirror - focussing primarily on past reported results. That approach makes sense for most companies. But it makes no sense for Fairfax today. Because it completely misses (ignores) all the significant positive changes that have been happening at Fairfax over the past 5 or 6 years - the benefits of which are only just now fully flowing through to reported results. The good news is Mr Market will eventually figure things out at Fairfax. Earnings are the key. And as Fairfax keeps reporting stellar results quarter after quarter, Mr Market will price Fairfax’s shares appropriately. What is causing the massive increase in operating earnings? What we are seeing today, with record operating earnings at Fairfax, is the cumulative effect of slow, organic (internal) change that has been happening at Fairfax for many years - a process of continuous improvement. It is the result of the conscious choices and actions being taken at all levels of the organization - senior management, the insurance operating companies, the investment team at Hamblin Watsa and the CEO’s of the various equity holdings. All parts of the organization are working in a disciplined way towards the same end purpose - the consistent delivery of solid results leading to the improvement of the long term performance of the company. It is the slow methodical process of doing what needs to be done. For Fairfax the process also involved some soul searching - there were lessons that needed to be learned. Fairfax stopped doing the things that were not working (like the equity hedges and short positions). It got better with its new equity investments. The improving operating earnings are also not due primarily to circumstance. But active management (taking advantage of circumstance) is an important part of Fairfax’s business model. The record operating earnings we are seeing at Fairfax today is simply the end result of years of good decisions and hard work. What is the new baseline for operating earnings at Fairfax today? The level of operating earnings at Fairfax have likely reached an inflection point - a breakthrough of sorts - given their size. Significant sums are now being reinvested every year (billions). The seeds that are being planted will grow new streams of operating earnings for Fairfax in both insurance and investments in the coming years. Compounding will work its magic. Fairfax looks like it is now in that virtuous circle where success begets more success. My estimate for operating earnings for 2023 is $4.3 billion and I think that is a reasonable number to use a new baseline for Fairfax moving forward. Why? Because all the inputs I use are reasonable and mildly conservative. How durable is $4.3 billion in operating earnings? My guess is it is quite durable. At least as durable as operating earnings at other insurance companies like WR Berkley, Markel or Chubb. Why wouldn’t they be? In fact, the management team at Fairfax has been best-in-class in terms of overall management of the business in recent years - this suggests that we should have more confidence in Fairfax’s future results than that for peers. I know, that is a very non-consensus view. But it is where logic takes me. As I like to say, the once ugly caterpillar called Fairfax has magically transformed itself into a beautiful butterfly. What thing happened to cause the transformation? There was no one thing. It was a bunch of things. From the butterfly’s point of view, what happened was perfectly natural. Only to the outsider does it look like magic. ————— Jim Collins, in his book Good to Great, has a concept called the ‘flywheel effect’ that describes very well what has been happening ‘under the hood’ at Fairfax for the past 5 or 6 years that has got the company to where it is today. The flywheel effect: “The Flywheel effect is a concept developed in the book Good to Great. No matter how dramatic the end result, good-to-great transformations never happen in one fell swoop. In building a great company, there is no single defining action, no grand program, no one killer innovation, no solitary lucky break, no miracle moment. Rather, the process resembles relentlessly pushing a giant, heavy flywheel, turn upon turn, building momentum until a point of breakthrough, and beyond.” https://www.jimcollins.com/concepts/the-flywheel.html ————— What are some of the decisions/actions made by Fairfax in recent years that have caused the Fairfax 'flywheel' to pick up more and more speed? To provide some context, we are going to separate the decisions/actions into Fairfax’s three economic engines: insurance investments - fixed income investments - equities/derivatives Each on its own is driving earnings for Fairfax. Together, they help illustrate why Fairfax is delivering record operating earnings - and why the Fairfax flywheel has now likely reached ‘breakthrough’ speed. Economic engine 1: insurance Turn 1: 2015-2017: rapid growth - driven by international expansion by acquisition Turn 2: 2017: strategic pivot in India - sold ICICI Lombard for significant gain ($950 million) and seeded Digit with an investment of $154 million that is now worth $2.3 billion.. Turn 3: 2019-today: rapid organic growth - driven by hard market. Turn 4: 2022: increased ownership in Allied World from 70.9 to 82.9% Turn 5: 2023: increasing ownership in Gulf Insurance Group from 44% to 90%. Strategic; secures Fairfax’s position in MENA. Turn 6: ongoing: methodically improving quality of the insurance businesses. Resulting in improving CR. Net written premiums have increased from $8.1 million in 2016 to an estimated $24.1 billion in 2023, an increase of 198%. At the same time, the combined ratio has improved from an average of 98 from 2016-2020 to an average of 95 the past three years. Much higher net written premiums and a lower CR has resulted in much higher (record) underwriting profit. Underwriting profit averaged $191 million per year from 2016-2020. It was $801 million in 2021, $1.1 billion in 2022 and is forecasted to be $1.3 billion in 2023. This increase is sustainable (with some volatility in both directions). Economic engine 2: investments - fixed income Turn 7: Dec 2021: average duration of fixed income portfolio was reduced to 1.2 years. In 2021, sold $5.2bn in corporate bonds at a yield of 1% for a realized gain of $253 million (most were purchased in March/April 2020). Avoided billion in unrealized losses on $40 billion fixed income portfolio as interest rates spiked higher in 2022 and 2023 (protected the balance sheet). Turn 8: 1H 2023: average duration of fixed income portfolio extended to 2.4 years. This locks in more than $1.5 billion in interest income for each of the next three years (this estimate is low). Turn 9: 2020 and 2023: real estate debt platform partnership established with Kennedy Wilson. $4 billion portfolio is delivering an average return of about 9% total = $360 million, mostly in interest income. Driven by the significant increase in the insurance business, the size of the fixed income portfolio at Fairfax has doubled in size from $20.3 billion in 2016 to $40 billion today. From 2016-2022, the average yield of the fixed income portfolio was 2.4% and today the average yield is 4.8%. As a result of the two doubles (portfolio size and rate of return), interest income is spiking higher. Interest income averaged $650 million per year from 2016-2021. It was $874 million in 2022 and is forecast to come in at $1.8 billion in 2023 and $2.1 billion in 2024. This increase is sustainable (with some volatility in both directions). Economic engine 3: investments - equities / derivatives Turn 10: 2016: ending the ‘equity hedge’ in late 2016. Turn 11: 2020: closing out the final short position in late 2020 These two programs cost Fairfax an average of $494 million per year on average from 2010-2020. Ending these two programs eliminated what was essentially a $494 million annual expense for the company (meaning Fairfax became $494 million more profitable). Fairfax has also said multiple times that they have learned their lesson and that they will no longer short indices or individual stocks. Turn 12: 2014-2017: poor equity purchases - Fairfax made a string of poor equity purchases from 2014-2017. Turn 13: 2018-today: very good new equity purchases - Fairfax has been hitting the ball out of the park with their more recent new equity purchases. Turn 14: 2020- present: Fairfax also have been taking advantage of recent bear market low stock prices by adding significantly to many of the equity holdings they already own. Fairfax has done a great job over the last 5 years fixing their poor equity purchases from 2014-2017. These holding were burning about $200 million per year in cash (losses/write downs/restructuring etc) and now they are all largely fixed and delivering solid returns for Fairfax shareholders. Eurobank is the shining star in this group. The equity purchases from 2018-today have been performing well. And Fairfax has been aggressively adding to positions in equities they already own - buying at bear market low prices. Share of profit of associates at Fairfax averaged $151 million per year from 2016-2021. It was $1 billion in 2022 and it is forecast to come in at $1.1 billion in 2023. This number should grow nicely in the coming years (with some volatility in both directions). The quality of Fairfax’s total portfolio of equity holdings has likely never been better than it is today. Turn 15: late 2020/early 2021: purchase of total return swap giving Fairfax exposure to 1.96 million FFH shares at an average cost of $372/share. This one investment has delivered to Fairfax an unrealized gain of more than $900 million since inception. Asset sales: Turn 16: 2020/2021: sold Riverstone UK (runoff business) for $1.3 billion (plus $230 million contingent value instrument). Turn 17: 2022: sale of pet insurance business delivered a $1 billion after tax gift to Fairfax shareholders. Turn 18: 2022: sale of Resolute Forest Products for $626 million (plus $183 million CVR) at top of lumber cycle. Asset sales (insurance and investments) have always been an important part of the capital allocation framework at Fairfax and have delivered significant value to shareholders over the years. Stock buybacks: Turn 19: 2021: dutch auction - Fairfax purchased 2 million shares at $500/share. Turn 20: 2018 to present - via NCIB, Fairfax has bought back about 2.5 million shares via the NCIB at about $490/share. Share count at Fairfax peaked at 27.75 million in 2017. Since that time Fairfax has reduced effective shares outstanding by 4.55 million or 16.2%. Share count has returned to about where it was in 2016 fully offsetting the dilution caused by the Allied World acquisition. As a result, shareholders today enjoy the full benefit of the significant growth Fairfax has achieved since 2016. As well, all 4.5 million shares were repurchased at a very attractive average price of around $490. Fairfax shares closed today at $828 (BV is $834). Conclusion: As you can see from the list above there is no one thing (action, event, luck) that is driving record operating earnings at Fairfax. Rather, it is the cumulation of many, many things that have happened over the past 5 or 6 years. But it is only now that the impact of these many actions are becoming fully visible to outsiders - because now they are all together ‘all of a sudden’ showing up in record underwriting profit, record interest and dividend income and record share of profit of associates. The flywheel has achieved breakthrough. And Fairfax as a company has made the leap from good to great. Is Fairfax’s stock fairly valued at a PE of 5.2 (to 2023 estimated earnings)? You decide. ————— The Benefits of active management: Above is a list of 20 actions taken by the management team at Fairfax in recent years. A significant number of the actions mentioned have on their own delivered $1 billion or more in value to Fairfax shareholders. Each on its own is an impressive accomplishment. But when you put them all together… well that is simply an amazing collection of accomplishments. And a big reason why i am so confident Fairfax’s new baseline for operating profit is likely around $4.3 billion. It clearly demonstrates the huge impact active management, when done well, can have on a company like Fairfax.

In Dec 2021, Fairfax sold down their position in IIFL Finance and Wealth. Selling down IIFL Securities now follows this trend. Regulators in India do not appear to like 'cross' holdings... i.e. owning the same security in both Fairfax India and Fairfax. I wonder if one of the drivers of these collection of moves is to reduce their cross holdings of Indian securities (their IIFL holdings). This also 'cleans up' Fairfax's holdings of Indian stocks. They still directly own legacy holdings Thomas Cook, Quess and Quantum Advisors (an investment manager purchased in late 2015 for $46 million). But the rest of the Indian portfolio of stocks is now primarily owned through Fairfax India. Pretty clean and easy to understand. Of course, Digit is also owned at the Fairfax level - because it is an insurance company.

Thomas Cook (India) Limited (TC) recently reported quarterly results (to June 30, 2023) that were very good. It appears people in India are travelling again. Since June 30: the share price of TC is up about 47% from 76 rupees to 112 rupees. Fairfax’s position in TC is up $146 million to $458 million. This makes TC a top 10 equity holding for Fairfax with a weighting of 2.7% of its $16.8 billion equity portfolio. Fairfax owns 72.34% of TC. In 2021, TC need cash to help it get through Covid and Fairfax stepped up with a $60 million preferred share investment. This investment has returned more than 100% to Fairfax shareholders in about 2 years. It was an opportunistic deal for Fairfax. But also much needed at the time by TC. From Fairfax’s 2022AR: “During 2021, Thomas Cook India raised $60 million from Fairfax through optionally convertible redeemable preference shares with a 10.7% dividend yield, a seven-year tenure and an option to convert into ordinary shares of the company at 47.30 rupees per share within 18 months from the date of issuance. Thomas Cook India chose to convert the entire amount over two tranches resulting in Fairfax’s ownership increasing to 73.3%.” Covid caused TC to aggressively cut costs. With its businesses now rebounding in 2023, that lower cost base is spiking profits at TC which we saw when they reported a couple of weeks ago. From Fairfax’s 2022AR: “Thomas Cook India implemented extensive cost saving initiatives combined with enhanced automation to mitigate the drop in business and improve profitability as normalcy returns. We are pleased to note that total costs were down 40% compared to pre-pandemic levels, while a permanent saving of 20% in overheads compared to the pre-pandemic levels is envisaged.” Covid also caused Sterling Resorts, owned by TC, to lower costs and re-imagine its business model. The results at this subsidiary at TC have been extraordinary and are another reason profit is spiking at TC in 2023. From Fairfax’s 2021AR: “You will recall from my letter in 2014 that Thomas Cook acquired Sterling Resorts in 2014, mainly because of Ramesh Ramanathan, the CEO of the company. As you can imagine, Sterling faced difficult times in the last two years during the COVID-19-inspired lockdowns. Ramesh did a remarkable job in managing cash flow, allowing the company to stay self-sufficient throughout this period. Also, Ramesh used this time to reorient Sterling’s business model and transform it into a holiday experience company.” From Fairfax’s 2022AR: “Sterling Resorts, a subsidiary of Thomas Cook India, reported its best ever results, thriving as it remained a premier leisure hospitality brand in India with 39 resorts, 37 destinations and more than 2,300 rooms besides offering vacation time share. You will recall that my letter last year reported on the leadership transition at Sterling, and we are happy to report the smooth transition from Ramesh Ramanathan to Vikram Lalvani, with excellent results achieved at Sterling during the year. Under Vikram’s leadership, Sterling emerged out of two years of pandemic with a revival in the resort business in 2022 surpassing the performance of the pre-pandemic period, despite some impact due to the third wave of COVID in Q1, reporting 18% growth in revenue over the year 2019 and 21% over 2021. Its EBITDA of $15 million in 2022 is over fifteen times the $1 million it reported in 2019, and it grew 66% over 2021 on a normalised basis. The operating free cash flow doubled during the period. It ended 2022 with surplus cash and investments of $11 million besides achieving debt reduction of $4 million during the year. Sterling is focused on scaling the resort business by increasing non-member occupancies, boosting revenue from room rates and increasing food and beverage sales. Non-profitable resorts are being dropped from the portfolio, alongside a decreased focus on volume in favour of quality. With the Sterling experience getting appreciation from non-members, the focus is going to be on the quality of growth and enhancing the brand experience at the same time.” Fairfax demonstrates it is a very good partner TC is good example of a Fairfax equity holding that was negatively impacted by Covid (BIAL and Recipe are two other Fairfax holdings that were also severely affected by Covid). Fairfax supported the company when times were tough. TC got to work and has emerged today stronger (and more profitable) than ever. Fairfax shareholders are now reaping the reward. An earnings turnaround at equity holdings negatively impacted by Covid is another reason why reported earnings at Fairfax continues to ‘surprise’ to the upside. A headwind to reported earnings for Fairfax in 2020 and 2021 has now become a tailwind in 2023. Fairfax 2022AR: “We are happy to note a substantial recovery in Thomas Cook India’s businesses during 2022. With excellent leadership by Madhavan Menon, Thomas Cook India exited the year reporting a 90% recovery in its forex business, 79% recovery in its outbound travel business and 84% recovery in its inbound travel business. This is following a difficult year in 2020 when COVID-19 caused its travel business to decline by 90% and its forex business to decline by 75%, and an incipient recovery of 53% in forex business and 27% in travel business in 2021. Business recovery combined with cost reductions resulted in its results improving – a pre-tax loss of $2 million in 2022 compared to a pre-tax loss of $46 million in 2021.” What is Fairfax’s holding in Thomas Cook India valued at? At Dec 31, 2022, TC had a carrying value at Fairfax of $214 million. With a market value today of $458 million, the excess of market value over carrying value is about $244 million. This $244 million is not captured in the book value of Fairfax. Who is Thomas Cook (India) Limited? TC is the leading omnichannel travel company in India offering a broad spectrum of services including Foreign Exchange, Corporate Travel, MICE, Leisure Travel, Value Added Services and Visa Services. Company presentation: https://resources.thomascook.in/downloads/SEINTIMATION_TCIL_V2.pdf Below is a brief history of Fairfax’s investment in Thomas Cook India: TC was Fairfax’s first large purchase in India. In 2012, Fairfax purchased 87.1% for $173 million. TC subsequently made three large acquisitions to round out its portfolio of assets: Feb 2014: Sterling Resorts for $140 million plus shares (Fairfax invested $81 million to help with this acquisition). Aug 2015: Kuoni India and Kuoni Hong Kong for $64 million March 2019: Digiphoto Entertainment Imaging (51% interest) for $21 million. Fairfax 2020AR: “As you will recall, our first major acquisition in India was the purchase of a 77% interest (later reduced to 67%) in Thomas Cook India, led by Madhavan Menon. Thomas Cook, first set up in India in 1881, is the leading integrated travel and travel-related financial services company in India, offering, through its 4,700 employees, a broad spectrum of services that include foreign exchange, corporate travel, leisure travel, insurance, visa and passport services and e-business. With the 2015 purchase of Kuoni’s Indian travel business and then its operations all over the world, Thomas Cook India is today one of the largest high-end travel service provider networks headquartered in the Asia-Pacific region. With the 2019 purchase of Digiphoto Entertainment Imaging (‘‘DEI’’), Thomas Cook has emerged as a complete travel solutions company. DEI provides imaging solutions for the entertainment industry, giving Thomas Cook India an opportunity to package DEI products with Thomas Cook Tours. Established in 2004, DEI has offices throughout the Far East, as well as in the Middle East, India and the U.S., and has a network of 130 entertainment partners.” The IKYA/Quess Home Run: In 2012, Fairfax designated TC as the vehicle through which it was going to be investing in India. In May of 2013, TC purchased a 77.3% interest in IKYA (renamed Quess) for $47 million. In 2017, TC sold 5.4% of Quess for $97 million. In December 2019, TC spun out all of Quess. Fairfax current owns of 35% of Quess, with a value of around $225 million. IKYA/Quess has been a very good investment in India for Fairfax. Strategic Shift Modi’s election in 2014 caused Fairfax to shift its strategy in India. Fairfax wanted to accelerate its investments and TC’s structure was too limiting. In 2015, Fairfax India was born and it was decided this platform would house all of Fairfax’s future non-insurance investments in India. However, legacy investments like TC and Quess would continue to be owned directly by Fairfax. Fairfax also directly owns Digit - its insurance vehicle in India.

I am in the process of converting my two LIRA’s to LIF’s. LIRA (locked in retirement account). LIF (life income fund). Funds in a LIRA can’t be touched. Funds in a LIF must be withdrawn (min/max levels set by government). This thread will mean more to Canadian readers. What do readers think about the strategy? What high dividend stocks am i missing from my list below? (I am looking for more high conviction ideas.) I like the idea of stuffing both accounts with a basket of high dividend stocks, given yields are so high right now. And then setting the withdrawal rate for each LIF at the dividend yield of the portfolio. I have started down this path and my current dividend yield is 5.7%. So i get a perpetual monthly stream of income that will grow over time (as the dividends are increased). My guess is the capital appreciation of the equity holdings will keep up with inflation so the total real value of the two accounts will stay flat. The income stream received will likely come in at about 50% of what my wife and i need for a very good retirement. My total portfolio is also of a size today that i want to take pieces of it and ‘set and forget’ (and not actively manage). My two LIRA’s seem like a good place to start. Doing this would also check the estate planning box as my wife is not interested in stock picking. I want to get some of our financial assets in ‘dummy’ type portfolios. I know dividend stocks are supposed to be in taxable accounts because of the favourable treatment they receive in Canada… my ‘problem’ is most of my investments are in tax free accounts. So, yes, any income received from the LIF will be taxed as income. My wife and i have a lot of flex in what our reported income is so i am not worried about taxes (they will be reasonable). So many stocks (and sectors) today in Canada offer high dividend payouts. I am not sure that this will continue indefinitely. Here is where i am at in terms of holdings (as of today): - telecom: Telus, BCE, Rogers - energy: SU (should probably add CNQ) - utilities: Atco, Enbridge, TC Energy, Pembina - financials: BMO, CM, BNS, CWB, Citi Canadian bank stocks are a small weighting. As they report in the coming weeks i am hoping for a sell off so i can add more (i have some though as a few companies are trading at or near 52 lows).

Canadian telecom stocks have been taken out behind the woodshed: Telus, BCE and Rogers. All are trading at or close to where they were trading 5 years ago. At current prices, investors get an average dividend yield of 5.6% with decent chance of capital appreciation (especially if interest rates go lower in 2024 or 2025). Telus = 6.3% current dividend yield BCE = 7% Rogers = 3.6% Historically, Canadian telecom is an oligopoly where the players want to make money (but not too much). BCE and Rogers also own significant assets (sports franchises) so they are not just a telecom play. The big news from a competitive standpoint is the #4 player (Shaw) just got bought by Rogers. The two big risks i see are interest expense (these guys carry a lot of debt) should interest rates stay at current levels for another 4 years or longer. And regulatory risk (Trudeau does something stupid). But even then, my guess is the players will simply adjust their models so they continue to hit their return targets. My strategy is to simply buy a basket of all three (skewed towards T and BCE because of the higher yield) as i do not have enough knowledge/conviction to know who is better valued today. Would love to hear what others think.

Here are the swings I see in Q2 (from the 13F). Exited Bank of America. Not surprising given what we learned over the past 4 months (lots of negative headwinds for this sector). Buffett was also aggressively selling his bank holdings. Proceeds from BAC and CVX sales were rolled into Occidental, where position size was doubled, when oil shares in general were weak. Net/net, Occidental is now close to a $400 million position for Fairfax. This puts it around 2.5% of Fairfax's equity portfolio or #10 holding by size. Still pretty small in the big scheme of things. But if you add EXCO and Ensign, energy is close to $1 billion = 6.1% of the total equity portfolio. That looks like a decent weighting towards energy. The Vanguard Index 500 - VOO - is a tiny position. It will be interesting to see if this purchase is one and done or if they grow the position size meaningfully.

@StubbleJumper Yes, i did not discuss where the money came from to fund the $6.2 billion buying spree. I thought the post was already long enough Here are some quick thoughts: 2020-2021 - FFH TRS purchase has been a home run. Yes, at the time, Fairfax did not have the cash. Hence, the genius of this investment. And with Fairfax shares today trading at 5.3 x 2023E earnings i think this investment has much further to run. Yes, there is a cost to hold this position. But I trust that Fairfax is laser focussed on this and they will exit the TRS at an appropriate time. With the significant earnings coming in each of the next three years Fairfax has the ability to help the share price get closer to what they believe is intrinsic value (by cranking up buybacks). My guess is Fairfax holds this position for a couple more years. Late 2021 - Dutch auction taking out 2 million shares at $500 million was also a home run. At the time Fairfax did not have the cash. Another very good investment with book value today at $834/share and likely on its way to $900 by year end. To fund it, yes, they had to sell 10% of Odyssey in a funky deal with partners (OMERS) who i think get a fixed return of around 8%. However, in return i think Fairfax is able to buy back the stake at a fixed price (set when the deal was struck). And (i believe) Fairfax keeps 100% of the growth in value of the underlying business, including the 10% owned by the minority partners. So the 8% ‘cost’ is likely much less (as long as the business grows in value). Not really sure - just my guess. 2022 - The sale of the pet insurance deal will do down as one of the biggest heists in the insurance industry in recent years. So yes, Fairfax ‘sold an asset.’ But that was a criminally good deal for Fairfax investors. The sale of Riverstone UK is a little more nuanced. I think it was a very well run operation. However, a run off business is never going to be valued anywhere close to an appropriate level by Mr Market. Bottom line, i also like this sale given what Fairfax was able to do with the proceeds. I think i look at things a little differently than you. When looking at the individual transactions it is always through the lens of Fairfax as a whole. Is their total level of debt today ok? Yes. Especially considering the likely trajectory of operating earnings (2023-2025). Are they reducing ‘minority interest’ in insurance subs? Yes. As you point out, with some puts and takes. I expect this trend to continue in the coming years - Fairfax will continue (on balance) to take out more of its minority partners. Insurance asset sales (pet insurance, Riverstone UK, Ambridge) are delivering significant value to shareholders. This is not a negative, this is a big positive. Non-insurance asset sales are the same (Resolute Forest Products). I expect this to continue. The net/net of all the moves over the past 3 years is Fairfax is a much, much stronger company today than it was June 30, 2020. Were all the decisions perfect? No, of course not. But taken as a whole, they have hit the ball out of the park. They are delivering a clinic in value investing. Now where the Fairfax story gets really interesting is right about now. In the past, Fairfax was capital constrained. Not anymore. My current forecast is for Fairfax to deliver net earnings of around $11.3 billion in 2023, 2024 and 2025 (total over these three years - after minority interests). For reference, my past estimates have been on the low side and i think that could well be the case here too. Today, being short of capital is not a concern for me for Fairfax.

What kind of an investor is Fairfax? Most people would answer: ‘value investor.’ That is the right answer but it doesn’t really tell us much. What kind of a value investor? To answer this question we are going to look at what Fairfax has been doing. What have they actually been buying? What can we learn? We are going to go back three years (June 30 2020, to Aug 11 2023). ————— But first, let’s set the table. 1.) "The single most important thing (when investing in the stock market)… is to know what you own." Peter Lynch The problem with Peter Lynch is he says so many smart (and funny) things that his ‘most important thing’ gets lost in the shuffle. This is the ‘north star’ of everything else he writes. From this naturally flows another of Peter Lynch’s nuggets of gold. 2.) "The best stock to buy is the one you already own." Peter Lynch This makes intuitive sense. You have already done the research on the stocks you own. You know ‘the story’ and you like it (that’s why you own it). Assuming the fundamentals are still solid, then buying more should be a no brainer. Buffett takes this idea a little further with the following quote: 3.) "Diversification may preserve wealth, but concentration builds wealth." Warren Buffett The idea is to invest with conviction around you best ideas. Especially if the stock is on sale. This leads us to our next point. 4.)"‘The three most important words in investing are margin of safety." Warren Buffett Ben Graham introduced ‘margin of safety’ as the central concept of investing in Chapter 20 of his book, The Intelligent Investor. The idea is to only purchase stocks when they are trading at a big discount to their intrinsic value (buy something for $0.50 that is worth $1.00). This approach limits your downside if you are wrong and it provides significant upside if you are right. What do we get when we combine these four points? Often, your best investment is to simply buy more of something you already own - especially when it is on sale. One added twist: 5.) "If you search world-wide, you will find more bargains and better bargains than by studying only one nation." John Templeton Invest wherever in the world the best opportunities are. ————— What does all of this have to do with Fairfax? Well, guess what Fairfax has been doing for the past 3 years? It has invested close to $6.2 billion in stuff it already owns. Yes, during this time Fairfax has been investing in new ventures but the amount spent is much smaller. In short, Fairfax has been feasting at the buffet of companies it already owns. Let’s review the actual investments that Fairfax has been making the past 3 years (Aug 2020 to Aug 2023) that fit this theme to see what we can learn. 1.) Buy Fairfax stock = $2.26 billion Late 2020/early 2021: purchased total return swaps giving them exposure to 1.96 million Fairfax shares Total investment = $732 million (notional) = $372/share Late 2021 - dutch auction: purchased 2 million Fairfax shares Total investment = $1 billion = $500/share June 30, 2020-June 30, 2023 - SIB purchase of an additional 1.133 million shares Total investment = $535 million = $490/share Over the past 3 years Fairfax has ‘purchased’ 5.09 million shares of Fairfax, 19.3% of total effective shares outstanding, at an average cost of $445/share. With shares trading today at $843, the value creation for Fairfax shareholders has been $2 billion. Fairfax saw incredible value in their shares. They invested with conviction (backed up the proverbial truck). Shareholders are now making out like bandits (the value created by Fairfax is flowing though to a much higher share price). Value investing at its best. Who does this string of purchases remind you of? Not Lynch, Buffet or Graham. Who then? Henry Singleton. Who is this guy? From Prem’s letter in Fairfax’s 2018AR: ““I mentioned to you last year that we are focused on buying back our shares over the next ten years as and when we get the opportunity to do so at attractive prices. Henry Singleton from Teledyne was our hero as he reduced shares outstanding from approximately 88 million to 12 million over about 15 years.” At the time, many laughed at Prem for making this comment. I don’t think these same people are laughing at Prem today. 2.) Increase Ownership of Insurance Businesses - Buy Out Partners = $1.9 billion Insurance is the most important economic engine Fairfax has. Top line growth in the insurance businesses is critical to sustainable profit growth at Fairfax over time. And profitability is what determines the share price over the medium to long term. Fairfax is slowly and methodically taking out the minority partners in its insurance companies. They spent $1.9 billion over the past 3 years doing this. As a result they own a larger share of (growing) future earnings of these high quality companies. 3.) Increase Ownership of Equity investments: Consolidated Equities = $0.67 billion These are the equity investments that Fairfax exerts a great deal of control over. They invested $666 million the past three years. The big purchase was taking Recipe private and being able to buy the stock at a big pandemic discount. Remaining Equity Holdings = $1.4 billion These are the equity investments Fairfax doe not exert a great deal of control over. They invested $1.4 billion the past three years. The biggest deal was expanded the partnership with Kennedy Wilson in real estate, with the 2 transactions below being part of much the bigger deal (debt platform and PacWest loans). There are lots of solid single type of investments on this list. In total, over the past three years, Fairfax has invested a total of $6.2 billion to increase ownership in companies it already owns. Many of the investments were opportunistic and made at bear market low prices. Investments were made all over the world - value drove the decision, not geography. As a result Fairfax (and its shareholders) now own a greater proportion of the future earnings streams of these many businesses. The returns on the investments made in recent years are starting to come in and they are very good (in aggregate). With lots of upside in the future. Conclusion: What did we learn? How Fairfax is investing right now is incredibly simple. Invest in what you know. Buy at a discount. Act with conviction. Cast a wide net (global). Boring. Safe. Generating a very good return for shareholders. Something i think the masters would approve of. In short, Fairfax has been putting on a master-class in value investing over the past three years. So, after all that, let’s get back to our initial question. What kind of an investor is Fairfax? Fairfax is a value investor. Their approach is a hybrid of 5 masters: Lynch, Buffett, Graham, Templeton and Singleton. ————— Some of the companies Fairfax owns are doing the same thing: The best example is Stelco who has reduced shares count by 38% over the past 2.5 years, which has increased Fairfax’s stake in the company from 14.7% to 23.6%. Actions like these provide additional benefits to Fairfax and its shareholders. When combined with what Fairfax is doing, they have a ‘multiplicative’ effect for Fairfax shareholders (in terms of owning larger proportion of future earnings).

@nwoodman , your post on Thomas Cook motivated me to do an update. As of Aug 9, Fairfax's equity holdings (that I track) are up about $522 million ($22.51/share) so far in Q3. Great start to the quarter. Split by accounting treatment can be seen below. I have attached my Excel file if you want a closer look. Top 5 Movers? All up this quarter: FFH TRS = $169 million Eurobank = $108 million Thomas Cook India = $102 million John Keells = $51 Mytilineos = $33 Fairfax Aug 9 2023.xlsx

@backtothebeach Yes, I also found the footer to be annoying. I changed the footer as you suggested. I also did a re-write of Chapter 1, making the information current. Scroll up to the first post in this thread to view the new (updated) PDF file. Please keep the suggestions for improvement coming.

Fairfax just reported Q2-2023 results. The surprise for me? Underwriting profit, interest and dividend income and share of profit of associates all came in higher than I expected. As a result, I decided it was time to update my earnings estimates for Fairfax for 2023, 2024 and 2025. I have the highest confidence level in my 2023 forecast. My 2025 forecast is largely an educated guess. A lot can change in 2 years (both good and bad). Please keep this in mind as you are reading. Conclusion: Let's skip ahead to the conclusion. My rough estimate is Fairfax will earn about $160/share in 2023. This is up from my last estimate which was $145/share (made in early July). The increase reflects the better-than-expected operating earnings Fairfax reported for Q2. For 2024, my new estimate is $166/share and for 2025 it is $174/share. The big ‘miss’ with my estimates in 2024 and 2025 is likely capital allocation. We don’t know what the management team at Fairfax is going to do with all the earnings (around $3.6 billion) that is likely coming in each of the next 2.5 years. Looking at the last 5 years, the management team has been outstanding with capital allocation. My guess is they will continue to make good decisions (on balance) and this will benefit shareholders - providing a possible tailwind to my forecasts. I am also assuming interest rates remain roughly at current levels. Of course, this will not be the case. But if rates rise - or go lower - Fairfax will have lots of puts and takes. Below is an 8-year snapshot for Fairfax. It communicates in a concise manner dramatic transformation that has happened at this company, beginning in 2021. It is a pretty amazing story. What are the key assumptions? 1.) underwriting profit: Estimated to increase to a record $1.3 billion in 2023. I am forecasting Fairfax’s combined ratio (CR) to remain flat at 94.5 in 2023 (the same as 2022). When the Gulf Insurance Group transaction closes in 2H-2023, Fairfax should get a nice boost to its insurance business. I think GIG will add about $1.7 billion to net written premiums, which should drive low double-digit top-line growth in 2024. The hard market will end at some point. But do things quickly turn ugly? Probably not, but I am not sure. 2.) interest and dividend income: Estimated to increase to a record $1.9 billion in 2023. The average duration of the fixed income portfolio was increased to 2.4 years in 1H-2023. GIG should add about $2.4 billion to the total investment portfolio. PacWest loans will deliver incremental interest income (of $80-$90 million?), with half coming in 2H-2023 and the other half in 1H-2024. Eurobank: the plan is to start paying a dividend in 2024. If this happens, we might see dividend income increase by $40 to $50 million. Potential headwind: Short-term treasury rates might come down in 2024. If this happens, interest income on cash/short term balances could fall. 3.) Share of profit of associates: Estimated to increase to a record $1.1 billion in 2023. Earnings at Eurobank, Poseidon/Atlas, EXCO, Stelco and Fairfax India, in aggregate, should continue to grow nicely. 2023 headwind: Sale of Resolute Forest Products - Contributed $159 million in 2022. 2024 headwind: I estimate GIG will contribute $100 million in 2023. When Fairfax’s purchase of Kipco’s stake is approved the financial results for this holding will be reported with Fairfax’s insurance operations. In anticipation of this deal closing later in 2H-2023, I removed $100 million from my 2024 estimate. 4.) Effects of discounting and risk adjustment (IFRS 17). Interest rate changes drive this bucket. My estimates here could be a little messed up. Given I am forecasting interest rates to remain about where they are today, I am leaving this number the same over the forecast period (at my estimate for June 30, 2023). 5.) Life insurance and runoff. This combination of businesses lost $167 million in 2022. I am forecasting this bucket to lose $200 million in each of the next three years. 6.) Other (revenue-expenses): improving results from consolidated holdings. In the near term, we could get write downs in both Boat Rocker and Farmers Edge. With Covid in the rear-view mirror, earnings at Recipe could move higher ($100 million per year?). Earnings at Dexterra are growing again. AGT is a sleeper holding. Grivalia Hospitality is in its peak investment phase; earnings could grow nicely looking out a year or two. This bucket is poised to grow nicely for Fairfax in the coming years. 7.) Interest expense: A slight increase. 8.) Corporate overhead and other: A slight increase. 9.) Net gains on investments: Estimated to come in around $900 million in 2023. My estimates assume (this is very general): Mark-to-market equity holdings of about $7.8 billion increase in value by 10% per year, or $800 million. A small bump of $200 to $250 million per year for additional gains (equities and fixed income). ---------- My estimated total return on the investment portfolio for each year is as follows: 2023 = 8.0% = $4.5bn / $56bn 2024 = 7.6% = $4.5bn / $59bn 2025 = 7.8% = $4.7bn / $61bn What is the math? For each year, add the following line items: 2.) + 3.) + 6.) + 9.) and divided the total by the estimated value of Fairfax’s investment portfolio. These estimated annual percent returns, while high compared to recent years, are driven largely by the spike in interest and dividends and share of profit of associates. ---------- 10.) Gain on sale/deconsol of insurance sub: This is a wild card. This is where I put the large asset sales. In 2022, it was the sale of pet insurance business. In 2023, it was the sale of Ambridge and the pending purchase of GIG (resulting in a write-up of the existing holding). For 2024 and 2025, I estimate no gains from sales/write up of assets. There could be something: Perhaps we get a Digit or AGT IPO. Perhaps Fairfax sells another holding for a large gain. This ‘bucket’ is perhaps where I will be most wrong with my forecast. Developments here will likely have a material positive impact to Fairfax’s reported results (earnings and book value). 11.) Income taxes: estimated at 19% 12.) Non-controlling interests: estimated at 11% (not really sure) 13.) Shares Outstanding: Estimated that effective shares outstanding is reduced by 500,000 per year. This is in line with a normal year from Fairfax. Notes: Underwriting profit: Includes insurance and reinsurance; does not include runoff or Eurolife life insurance. Interest and dividends: Includes insurance, reinsurance and runoff.

@StubbleJumper and @Tommm50 , great comments. I have said many times, i am not an insurance guy. So i really appreciate hearing from those who work(ed) in the industry. I appreciate the colour. And please point out the flaws in my logic in my posts… otherwise i will just keep repeating my mistakes. Thank you.

@StubbleJumper i have enormous respect for your knowledge about all things insurance. So please keep the comments coming. I agree there is a risk that the hard market could quickly reverse and become a shit show - which would hit underwriting income. But what is the probability of that actually happening? My understanding is when the last hard market ended things went sideways for 3 or 4 years - it did not deteriorate into a shit show. My point is risks need to be considered. And probabilities attached. Insurance companies are laser focussed on generating an acceptable return for shareholders. Pricing (rate increases) look like it actually accelerated a little higher in Q2. With my estimates/forecasts i lean heavily on what i think i know. That is why i only like to look out about 2 years. As new information becomes available i will make updates.

@StubbleJumper i agree that the insurance market will soften at some point in the future. I also think the investment side of Fairfax is being underestimated. Investors don’t know what they are going to do with all the cash that will be rolling in so they are very conservative with their return estimates from investments. My big miss with Fairfax the past couple of years is how well they are executing on the capital allocation front and the impact that is having on earnings. As a result my past earnings estimates (looking foolishly high when made) have been too conservative. I expect Fairfax will continue to allocate capital well in the coming years. My guess is increasing returns from investments will more than offset any slow down in underwriting profit looking out a few years.

The key to forecasting is getting the ‘big rocks’ right. From an earnings perspective, there is no more important item to Fairfax today than ‘interest and dividend income.’ This one ‘bucket’ now represents about 40% of Fairfax’s total pre-tax earnings. Next year it could be as high as 45% of pre-tax earnings. So, if we can get can get our estimates for this part of earnings modelled properly we should be well on our way to coming up with a quality earnings estimate for the company as a whole. When looking at ‘interest and dividends’ for Fairfax, dividends represent about 7% of the total. Interest income represents about 93% of the total, so that is what we are going to focus on. Two items drive interest income: The size of the fixed income portfolio The average yield earned on the investments held in the portfolio It is quite simple. It is relatively easy to calculate. It is not volatile quarter to quarter. And it is predictable, looking out a couple of years. This is why ‘interest and dividend income’ is considered the highest quality source of earnings for an insurance company. So, let’s look at Fairfax and see what we can learn. How big is the fixed income portfolio at Fairfax and how fast is it growing? The fixed income portfolio at Fairfax is about $40 billion today. In 2016, it was $20.3 billion. Over the last 7 years, the size of the portfolio has doubled, which is growth of about 10% per year. Growth in 2024 should be similar (at 10%, or $4 billion). The GIG acquisition will add around $2.4 billion to investments when it closes later this year. Earnings are coming in strong and we are still in a hard market, which should also support modest growth of the fixed income portfolio in 2024. Next, let’s review the average yield. From 2016 to 2022, Fairfax earned an average of about 2.4% on its fixed income portfolio (see chart below). Yes, that is a low number. Fairfax has been very conservative with the positioning of their fixed income portfolio over the past 7 years (low duration and high-quality holdings). What about 2023? The average yield in 2023 is estimated to be about 4.5%. What about 2024? The average yield in 2024 is estimated to be about 4.8%. The average yield that Fairfax is earnings on its fixed income portfolio has doubled. This is important: The size of Fairfax’s fixed income portfolio has doubled over the past 7 years. At the same time, the rate of return that Fairfax is earnings on its fixed income portfolio looks like it is also poised to double. Investors are getting served up a double-double with Fairfax’s fixed income portfolio (that line will only make sense to Tim’s coffee drinkers). What does it mean for Fairfax? Interest income is poised to increase from $514 million in 2016 to an estimated $2.1 billion in 2024. That is a 300% increase over 8 years. Exactly what you would expect when the size of the portfolio doubles and the rate of return also doubles. Average duration In the first quarter we learned that Fairfax had materially extended the average duration of their fixed income portfolio and as of June 30, 2023, it was at 2.4 years (from 1.6 years at Dec 31, 2022, and 1.2 years at Dec 31, 2021). This is important because it locks in the rate of return on a large part of the portfolio for a couple of years making the earnings stream more durable. What does this mean for investors? The most important bucket of earnings for Fairfax (for a P&C insurer), interest and dividend income, is poised to deliver a record amount in 2024. And 2025 looks promising as well. Efficient Market Theory Of course, everything I have written above is from publicly available information. So, it is priced into the share price of Fairfax’s stock today. Right? Fairfax’s Price Earnings Ratio = 5.6 = $843 / 2023 $150E per share (as of Aug 4, 2023) My current estimate (another word for guess) is Fairfax could earn about $150/share in both 2023 and 2024 (that will be the topic of a future post). Given my analysis of interest income above, I trust my earnings number (please note, that doesn’t mean you should!). So, the appropriate question for me to ask: “is 5.6 an appropriate multiple to pay to get $150 in estimated earnings from Fairfax.” Mr. Market thinks so. I disagree. I think the multiple is too low. My guess is Mr. Market does not yet fully grasp the significance of what a fixed income double-double means for the future earnings of Fairfax. Dividends Extending its close partnership with Kennedy Wilson (KW), Fairfax also invested $200 million in preferred shares of KW with a 6% dividend. This will deliver an incremental $12 million in dividend income to Fairfax each year. Eurobank would like to start paying a dividend, likely in 2024. As a result, I have added $40 million in dividends to my forecast for 2024. Interest & dividend income = interest income + dividend income - investment expenses. ————— Interest rates are once again moving higher Interest rates have moved higher in recent months. As a result, Fairfax will have the ability to continue to re-invest maturing bonds at higher yields. This suggests interest income has not peaked.

@StubbleJumper i agree with everything you said. There are a few analysts out there who clearly do not follow Fairfax all that closely. But they are at least smart enough to raise their price targets over time (to reflect improving quality of earnings). The problem with Morningstar is they are sticking with C$790/share fair value estimate for the stock. That makes them look like idiots. It reflects badly on Morningstar as a company. RBC uses Morningstar as part of its research coverage offered to investors. So it also makes RBC look foolish, given Fairfax is a very large Canadian company. The solution is for Morningstar to end coverage of Fairfax. But to @Parsad ‘s comment, some investors probably make decisions based on what companies like Morningstar have to say - and that just creates fat pitches for other investors. So i guess i should welcome their idiocy.