Viking

Food for thought for those who are convinced the hard market in insurance HAS to end soon. Imagine a world where Fairfax continues to grow top line insurance by 8% in both 2023 and 2024 (further increasing float). And interest rates remain higher for longer. That is probably a reasonable base case today.

US P&C Insurance Market Report: Profitability to remain elusive in 2023 - https://www.spglobal.com/marketintelligence/en/news-insights/research/us-pc-insurance-market-report-profitability-to-remain-elusive-in-2023

Like Indiana Jones, today we are going to set out on an adventure in search of long lost treasure. Something that most investors appear to have forgotten about. What do the legends tell us? Does it really exist or is it just a myth? What am i talking about? P/C insurance float (I’ll just call it ‘float’ moving forward). Float is such a big (and important) topic we are going to tackle it in two posts. The first post (below) will focus on the theory - what it is and why P/C investors should care. The second post will then apply the theory to today using a real company - Fairfax Financial. My plan is to have the second post completed and out on Sunday. Ancient history Thirty years ago, talking about float was all the rage for P/C investors. Read old articles on investing in P/C insurance companies and a discussion of float will usually be front and center. And the champion of float from that era was, of course, Warren Buffett and his company Berkshire Hathaway. So what happened? Why has float apparently settled into into the dustbin of history and become a relic of the past? Due to competitive insurance markets, industrywide underwriting profit has remained illusive for the past decade. At the same time, top line organic growth slowed to a crawl. Returns on investments fell: P/C insurers put most of their investments into fixed income instruments. In their battle with deflation, global central banks took interest rates all the way into negative territory. The US 10 year treasury traded at a yield below 0.60% in August of 2020 and traded with a yield below 1.5% for much of 2021. S&P Global: US P&C Insurance Market Report Float lost its value Breaking even on underwriting for a decade while returns on investments plummeted made having float far less valuable than at any point in recent history. Another smaller factor: over the years, P/C insurance has become a much smaller part of Berkshire Hathaway’s business model. What did Buffett have to say about float in his 2022 letter to shareholders? Float is mentioned 4 times in one short paragraph - telling investors to go somewhere else if they wanted to learn more. Does this sound important to you? So ‘float’ also lost its biggest cheerleader. Does this mean… Float is dead? Long live float? No, of course not. Just because float is no longer appreciated (or followed) doesn’t mean it doesn’t matter. In fact, for those paying attention, the world has changed again. The conditions that made float a big deal 30 years ago have returned: Insurance has been in a hard market since about Q4 of 2019 - above average insurance companies are seeing improving underwriting results (cost of float) and significant top-line growth (supply of float) over the past four years. Global central banks now have an inflation fight on their hands - and ‘higher for longer’ is becoming the new mantra for interest rates. Fixed income yields have spiked higher across the curve. The 10 year US treasury closed today with a yield of 4.32%, a level where it last traded at in 2007. As a result, returns on float are improving greatly. Both of these developments make having float today extremely valuable. Except remember… pretty much everyone has forgotten about float. What’s old will be new again. Well, my guess is this is about to change. I think investors are going to get interested in float again. What is going to cause the change? A new generation of investors are about to discover something Warren Buffett hit on when he bought National Indemnity back in 1967: float, under certain conditions, can be a license to print money. Those ‘certain conditions’ have returned. And in recent years some insurance companies have started up the printing presses and are now starting to print money. More than anyone imagined possible. ========== P/C insurance float: the basics Let’s first do a quick review of float. Float is deceptive. It is kind of like compound interest as a concept. It is easy to define but very hard to actually understand. Who better to teach us about P/C insurance float than the old master, Warren Buffett himself. Float: the basic building block to use to evaluate a P/C insurance company Back in the 1990’s, Warren Buffett was using P/C insurance as the core engine to drive Berkshire Hathaway’s profit growth. GEICO was purchased in 1996 and General Re was purchased in 1998. Given P/C insurance’s importance to Berkshire Hathaway shareholders, Buffett provided the following as a guide to help them understand P/C insurance as an investment. BRK 1998AR: “With the acquisition of General Re — and with GEICO’s business mushrooming — it becomes more important than ever that you understand how to evaluate an insurance company. The key determinants are: 1.) the amount of float that the business generates; 2.) its cost; and 3.) most important of all, the long-term outlook for both of these factors.” Well, Warren appears to be saying float is the most important thing to understand when evaluating an insurance company. Interesting, given how little press float gets today from analysts and investors. What is float? BRK 1998AR: “To begin with, float is money we hold but don't own. In an insurance operation, float arises because premiums are received before losses are paid, an interval that sometimes extends over many years.” Float is money a P/C insurer has that it can use to invest. It is an asset but it is a liability (not equity). It is kind of like a very sticky deposit at a bank (a deposit is also a liability for the bank). Because float is a liability, it is also leverage. Like all leverage (i.e. debt), float can be both good or bad - and this depends on the cost paid over time to hold the float. What is the cost of float? BRK 1998AR: “Typically, this pleasant activity (the insurance business) carries with it a downside: The premiums that an insurer takes in usually do not cover the losses and expenses it eventually must pay. That leaves it running an "underwriting loss," which is the cost of float. An insurance business has value if its cost of float over time is less than the cost the company would otherwise incur to obtain funds. But the business is a lemon if its cost of float is higher than market rates for money.” Underwriting determines the ‘cost’ of float. This point is critical. Over time, if an insurer can produce an underwriting profit on its insurance business that means the cost of its float is actually a benefit - that is better than free. That means the insurer is actually getting paid to hold the float. This is far better than ‘the cost the company would otherwise incur to obtain the funds.’ Float is a pile of money that an insurance company can actually earn two income streams from: underwriting (if float is obtained at a benefit) and investing. Sounds like Buffett was on to something. To summarize: according to Buffett, a good P/C insurance company: Has a large amount of float Is a good underwriter - is able to generates the float at a favourable cost (ideally a benefit) Has a good long term track record - of both growing float and as a solid underwriter Buffett’s secret sauce: P/C insurance float Buffett’s genius has really been two pronged: Use P/C insurance float as an ever-increasing low cost (free) source of capital/leverage used to push profits even higher. These growing profits were then continuously reinvested into great companies/equities (outside of insurance) that have also become compounding machines over time and pushed profits even higher. OK. So there is a quick review of float, explained with the help of Warren Buffett. To help us understand float even better, let’s look at it now from a balance sheet perspective. ========== Float and the balance sheet Let’s create an imaginary insurance company - called Random P/C Insurance Co - and create a fictitious balance sheet. Our company has $80 billion in assets, with $60 billion in liabilities and $20 billion in common shareholders’ equity. Of the total liabilities of $60 billion, float is $30 billion. The summary of the balance sheet is below: We are also going to assume common shareholders’ equity = book value. We are going to make up more numbers below. We are using numbers that make our calculations easy. Please don’t focus too much on the exact numbers. Instead, focus on the information they are trying to convey - especially about leverage. Cost of float Let’s assume our insurance company is a slightly above average underwriter with a combined ratio (CR) of 96 - this translates into a ‘benefit’ of float (better than free - our company is actually getting paid to hold their float). Return on investments (which includes float) Let’s assume our insurance company is above average in terms of the return it earns from its total investments (which includes float) - let’s assume it earns 8% on average. We are also going to assume there are no taxes. The return of Random P/C Insurance Co When we put the two together we get: Benefit of float (CR of 96) Return on investments = 8% Let’s assume Random P/C Insurance Co earns a total return of 10% on its float. This means our insurance company is earning the following: $30 billion float x 10% = $3 billion. Can we calculate the actual leverage provided by the float? Yes. Total earnings from float of $3 billion will flow though the income statement and increase retained earnings, which will then flow though to the balance sheet and increase both assets and common shareholder equity by $3 billion. So a return from float of 10% results in an increase in common shareholders' equity of 15%. The leverage can be calculated as follows: total float / common shareholders' equity. In our example float of $30 billion / common shareholders' equity of $20 billion = 1.5 x leverage Common equity, debt and total investments The above increase in common shareholders' equity was driven solely by float. A company is also going to generate earnings from its common shareholders’ equity - the funds provided by shareholders. Perhaps it also uses a little debt to generate more earnings. Any returns generated by its other investments (those other than float) need to be added to the numbers above. ========== Below Buffett summarizes how float fits into the big picture Berkshire Hathaway 1995AR: “In more years than not, our cost of funds has been less than nothing. This access to "free" money has boosted Berkshire's performance in a major way. “Any company's level of profitability is determined by three items: 1.) what its assets earn; 2.) what its liabilities cost; and 3.) its utilization of "leverage" - that is, the degree to which its assets are funded by liabilities rather than by equity. “Over the years, we have done well on Point 1, having produced high returns on our assets. But we have also benefitted greatly - to a degree that is not generally well-understood - because our liabilities have cost us very little. An important reason for this low cost is that we have obtained float on very advantageous terms. The same cannot be said by many other property and casualty insurers, who may generate plenty of float, but at a cost that exceeds what the funds are worth to them. In those circumstances, leverage becomes a disadvantage. “Since our float has cost us virtually nothing over the years, it has in effect served as equity. Of course, it differs from true equity in that it doesn't belong to us. Nevertheless, let's assume that instead of our having $3.4 billion of float at the end of 1994, we had replaced it with $3.4 billion of equity. Under this scenario, we would have owned no more assets than we did during 1995. We would, however, have had somewhat lower earnings because the cost of float was negative last year. That is, our float threw off profits. And, of course, to obtain the replacement equity, we would have needed to sell many new shares of Berkshire. The net result - more shares, equal assets and lower earnings - would have materially reduced the value of our stock. So you can understand why float wonderfully benefits a business - if it is obtained at a low cost.” Float is better than equity? This question is a bit of a mind bender. Because of its unique ‘cost’ (i.e. low cost or even a benefit), in the past Buffett has said that he views float as being better than equity. BRK 1997AR: “Since 1967, when we entered the insurance business, our float has grown at an annual compounded rate of 21.7%. Better yet, it has cost us nothing, and in fact has made us money. Therein lies an accounting irony: Though our float is shown on our balance sheet as a liability, it has had a value to Berkshire greater than an equal amount of net worth would have had.” Well, suggesting float is better than equity is perhaps a bridge too far. However, I think we can conclude that float matters a great deal. Especially today (in a high interest rate world). Conclusion OK. So now we know what float is and the key metrics to use to evaluate P/C insurers. Who should we start with? That is an easy question to answer. In our next post (coming Sunday), we will do a deep dive on float at Fairfax Financial to see what we can learn. ========== How Warren Buffett Achieves Great Returns Every Year - Advantages of Insurance Float

The tricky thing about inflation is just when you think you have it licked it pops higher again. At least that was the experience in prior inflationary episodes. Central banks are starting to look and sound like they think they have inflation licked. I am not so sure. Here in Canada we have record government spending.. that continues to increase. We also have a severe housing shortage so all levels of government are now rallying to try and get more housing units built (yes, at the same time the Bank of Canada is trying to slow housing). Rental prices continue to increase (at least in Vancouver) driven by record low vacancy rate. Minimum wages in almost all jurisdictions are up meaningfully year over year. Wealth effect has minted millions of millionaires (housing bubble) over the last decade - these people continue to spend. Much higher interest rates is spiking interest income of savers (like my mother-in-law) and that new meaningful income stream is leading to increased spending. Oil spiking is now feeding through to increases at the gas station…. In my province we are building a massive hydro dam in the north east of the province. We are building two large pipelines (one to Vancouver and the other to Kitimat) thousands of miles long at something like triple the original cost. A LNG facility is being built in Kitimat. The Province is also doing a massive rebuild of the infrastructure destroyed by record flooding 2 years ago (all over the province). Forest fires just wiped out hundreds of expensive houses in the interior - now those all will get rebuilt. Oil and gas and mining is all doing well. I could go on and on. This is just my long winded way of saying that i agree with you. This suggests to me we might see higher for longer when it comes to interest rates. Like perhaps well into next year. And if inflation actually pops again perhaps we see central banks actually tighten even more. I really have no idea. So no strong conviction. But it is super interesting…

@Hamburg Investor thank you for coming over to the dark side and joining CofBF. The more discussion and debate we can get the better. We are all trying to learn (and hopefully make a little money along the way). Your post above outlines a major flaw with my 3 year forecasts for Fairfax: i am likely being too conservative for 2024 and 2025. Part of this was by design. When i started at Kraft many years ago one of my first bosses taught us newbies the art of sandbagging when building a forecast (very important when your quarterly bonus payout was tied to it). On reflection i likely need to make some adjustments to parts of my 3 year forecast (i feel a little like i am getting my hand slapped by senior management - a little sandbagging was ok… but too much got you into trouble). What am i missing? Two things: 1.) capital allocation skills of Hamblin Watsa: they have been hitting the ball out of the part since 2018 when it comes to capital allocation. 2.) power of compounding - well understood by members on this board: - a 15% return per year is a double in less than 5 years. - a 20% return is a double in about 3.5 years. So yes, i need to get more realistic with my estimate for how fast investments (and returns from those bigger numbers) will be growing in the coming years. Growth of growth is the secret sauce that is now kicking in at Fairfax (due to double digit growth in insurance and investments AND improving underwriting and much higher investment returns). Today, Fairfax is delivering a 20% ROE. I think they will be able to deliver a high teens ROE over the next three years (2023-2025). I like my earnings per share estimate of $160/share for 2023. My estimates for 2024 ($165) and 2025 ($174) need to move higher.

@SafetyinNumbers thanks for posting. It is nice to see the backbacks happening again. I am hopeful Fairfax can keep taking out a minimum of 2% of effective shares outstanding each year - keeping the trend in recent years going. The buybacks also signal the company continues to see their shares as being undervalued. Obviously shares aren’t as cheap as prior years but the company’s earnings and prospects have improved greatly in recent years.

@glider3834 thanks for posting. I missed this last transaction. Great news. I was wondering if Eurobank was going to have to pay an additional premium to get over 50% and the answer is no. When they went to €2.35/share they had their ducks in a row to get +50%. Smart.

@glider3834 great summary. So at Eurobank’s price of €2.35/share Hellenic Bank is valued at €1 billion and it is on track to earn €260 million after tax in 2023. That looks pretty good. There are so many interesting layers to this transaction… - I think the acquisition will take up to 12 months to be approved. So Hellenic Bank will likely be a much more valuable bank when they actually fork over the money next year. Especially if interest rates stay higher for longer. - Eurobank still will not have more than 50% control. I wonder if they already have the next purchase lined up to get over 50%. - Eurobank sold the bank they owned in Serbia recently (at a pretty decent price if i remember correctly). Essentially flipped from being a smaller player in Serbia (8% market share) to being the largest player in Cypress (depending on metric being used). Proceeds from Serbian sale (70% of €280 million) will pay for a chunk of the Hellenic purchase. Looks like good strategy and good capital allocation. The management team at Eurobank has been executing well for years.

@hardcorevalue i am not sure how long you have followed Fairfax India. The stock has just had an amazing run higher from $9.65/share a year ago to over $14/share recently. Yes, since December the stock has moved mostly sideways. I have followed Fairfax India for years. I have no idea how the stock trades. I do think Fairfax India has an exceptional management team. They continue to make good decisions and build value for shareholders. I own some shares (not a big position). Where will the stock go from here? I have no idea. But my guess is in 5 years time shareholders will probably do well (from current levels) - and possibly very well. But week to week or month to month (and perhaps year to year) the sideways movement is hard to make and sense of (for me anyways). So i don’t try.

What is the best way to value Fairfax today? Peter Lynch: “What possible assurance do you have that (a stock you own) will go up in price? And if you are buying, how much should you pay? What you’re asking here is what makes a company valuable, and why it will be more valuable tomorrow than it is today. There are many theories, but to me, it always comes down to earnings and assets. Especially earnings.” One Up On Wall Street ---------- Fairfax has been an exceptionally difficult company for investors to value for the past three years. And especially right now (given the sharp rise in the stock price). Even investors who have followed the company closely for many years are having a hard time. New investors don’t stand a chance. Mr Market is saying Fairfax has a fair value today of $827/share (that is where it closed Sept 1, 2023). I think the stock is still wicked cheap. Others on this board feel the stock is only mildly cheap. What is the fundamental problem? There is no consensus of what level of earnings the collection of assets that Fairfax currently owns can deliver on a regular basis moving forward. Or what to expect for the next 3 to 5 years. Most investors prefer to use book value as their primary tool to value Fairfax. It is an insurance company after all. And using book value is supposed to be the proper way to value an insurance company. Using book value also conveniently allows an investor to largely ignore earnings (coming up with an estimate). And given the lack of consensus around earnings for Fairfax… well isn’t that a good thing? Well, easy and good are not the same thing. What is the best way to value Fairfax today? Just like any job, we need to pick the right tool. To do this we need to answer the following question. Is Fairfax an insurance company or a turnaround play? No, this is not a trick question. The answer, of course, is that Fairfax today is both. But we are talking here about how to value Fairfax as a company. My view is that today Fairfax should be valued primarily through the lens of a turnaround play. Not as an insurance company. Does it make that much of a difference? It makes a huge difference. Using book value (P/BV and ROE) to value insurance companies with relatively consistent financial results over a 5 or 10 year period makes a lot of sense. But using book value (P/BV and past ROE) as the primary measure to value a turnaround like Fairfax makes little sense especially when they are still in the middle of the earnings part of the turnaround. The problem with book value (P/BV and ROE) is it is a ‘rear view mirror’ valuation measure - it does a great job of telling you what has happened. And for lots of insurance companies what ‘has happened’ is likely to continue to happen in the future. So using book value (P/BV and ROE) as a primary valuation tool makes sense. But for a turnaround like Fairfax, where a massive amount of change is happening - which is leading to much higher earnings - focussing primarily on the past is going to mess investors up. It is going to cause them to way under estimate future earnings. This in turn is going to cause them to under value the company. And that is going to lead to poor investment decisions. A lot of investors who follow Fairfax are probably wondering how they missed the big move in the stock over the past 31 months (since Jan 1, 2021). My guess is the key issue is too much ‘rear view mirror’ analysis and not enough ‘looking out the front windshield’ analysis. The difference between valuing a stodgy insurance company versus valuing a turnaround. How should an investor value a turnaround? Let’s look to Peter Lynch for some insight. Peter Lynch loved turnarounds. It was one of the 6 buckets he used to classify his stock investments. Classifying stocks properly at the beginning of the process is critical. Because the classification determined the proper method to use to analyze the stock. To value a turnaround it is critical to: First, understand what went wrong. Second, confirm that whatever went wrong has indeed been fixed. Third, focus in on evaluating the assets and estimating the trajectory of future earnings. What went wrong at Fairfax? Fairfax has three economic engines: insurance, investments - fixed income and investments - equities/derivatives. Fairfax’s insurance business has been a solid performer over the past decade. And their investments - fixed income economic engine has also performed well. The issue at Fairfax was the investments - equities/derivatives engine. The good news for Fairfax was the solution to their poor performance was fully within their control. They just needed to stop doing some really dumb things (putting it politely) in one part of the company. What was the fix? To right the ship in the equities/derivatives engine, Fairfax did a few things: 1.) end the equity hedge/shorting strategy. The equity hedge positions were exited in late 2016. The final short position was sold in late 2020. Done. 2.) make better equity purchases. This started in 2018. Done. 3.) fix poorly performing equity purchases from 2014-2017. This started in 2018 and looks like it was completed in 2022. Done. But Fairfax didn’t stop here. They did even more: 4.) since 2020, they have made at least one brilliant decision each year: Late 2020/early 2021: initiated the FFH total return swap position, giving exposure to 1.96 million Fairfax shares at $373 share (resulting in a $900 million pre-tax gain to date) Late 2021: buying 2 million Fairfax shares at $500/share (book value is currently $834/share and intrinsic value is likely well over $1,000). June 2022: sale of pet insurance business for $1.4 billion (resulting in a $992 million after-tax gain). And the insurance gods have also been smiling on Fairfax: 5.) a hard market in P&C insurance started in Q4, 2019. And it looks like it will continue into 2024. And if all that wasn’t enough, the macro gods also decided to smile on Fairfax, delivering to the company their biggest gift yet: 6.) after dropping interest rates to close to zero in late 2021 they pivoted and spiked rates to more than 5% in 2023. Fairfax navigated their $38 billion fixed income through the treacherous storm perfectly - and the gold ($billions) is literally raining down today. So Fairfax not only stopped doing dumb things, they also started hitting the ball out of the park. At the same time both the insurance and macro gods started smiling on the company. Each of these things on their own has causing earnings to grow significantly over their historical trend. Stacked one on top of the other - well earnings have exploded higher. In short, the turnaround at Fairfax that began back around 2018 now looks complete. But importantly, the lift to earnings will likely take a few more years to fully play out. What is happening to earnings at Fairfax We are going to focus on operating income given this is considered the high value part of earnings for an insurance company. Operating income averaged $1 billion ($39/share) each year for 5 years from 2016-2020. From this base it has: Doubled to $1.8 billion in 2021. Tripled to $3.1 billion in 2022. Is on pace to quadruple to $4.3 billion in 2023. Is estimated to be $4.7 billion, or $207/share, which would be a quintuple from $39/share (average from 2016-2020). How would an investor focussed primarily on book value have seen any of this coming? The answer is easy… they would have completely missed it. They probably still are. What are we learning about Fairfax’s collection of assets? Beginning as far back as 2021, investors were getting glimpses that something good was happening at Fairfax. In 2022, is was obvious that ‘new Fairfax’ had arrived - but the good news was masked in the top line results by the bear market in financial markets and the large unrealized losses in fixed income and equities. But the change was obvious to those of us who followed the company closely. In 2023, the story continues to improve. And 2024 looks even better. What we are learning is Fairfax was significantly under earning on its collection of assets for much of the past decade. But all the shackles that were holding earnings down have now been removed. Management is executing exceptionally well. For the first time in the company's history, the three economic engines are all delivering record results at the same time: insurance, investments - fixed income and investments - equities/derivatives. Investors are just starting to get a look at what the true earnings power of Fairfax is on a go forward basis. And the total number is far higher than anyone dreamed possible. So what is the valuation of Fairfax today? Board members probably wonder why I have been so focussed on earnings in my analysis of Fairfax the past two years. Well, now you know why. I view Fairfax currently as a turnaround type of investment - and a heavy focus on earnings and assets is the only rational way to analyze the company today. It’s not that I don’t pay attention to book value. I do. I just have never trusted how useful it is a tool to value Fairfax today or to help me better understand its earnings power as a company. My current estimate is Fairfax will earn $160/share in 2023. I think that is a good baseline to use for earnings moving forward. If my analysis is right then that means Fairfax is trading at a PE of 5.2 x E2023 'normalized' earnings. Yes, that is nuts. What does the future hold? Peter Lynch: “Companies don’t stay in the same category forever. Over my years of watching stocks I’ve seen hundreds of them start out fitting one description and end up fitting another.” One up on Wall Street Over the next couple of years we will all come to better understand Fairfax. And what its collection of assets are capable of delivering. What the true ‘normalized’ earnings power of the company is. At that point in time, the turnaround will long be over. And Fairfax will revert to being another predictable, boring old insurance company. And at that time, the valuation metrics (like book value, P/BV and ROE) generally used for valuing boring old insurance companies will again be appropriate to use for Fairfax. If Fairfax is able to deliver strong earnings growth in the coming years the much improved results will slowly get baked into its historical numbers. That is when more traditional insurance investors will start to 'discover' how well managed Fairfax is. And how cheap the stock is. As this process plays out the P/BV multiple will likely expand significantly from 0.99 today to something more in line with peers, perhaps north of 1.3 (perhaps higher). ————- Another reason Peter Lynch liked turnarounds: Peter Lynch “The best thing about investing in successful turnarounds is that of all the categories of stocks, their ups and downs are least related to the general market.” One Up on Wall Street Fairfax is up 143% since January 1, 2021. S&P500 is up 20%. Fairfax’s outperformance over the S&P500 over the past 31 months has been an amazing 123%. Yes, that Peter Lynch is one smart dude. ————— Peter Lynch on Turnarounds “These are stocks that are battered down or they are hated companies, or they have been forgotten about. They are depressed in price but you have determined some one thing or a few things that have the potential for reversing this company’s fortunes independent of the industry getting better, or the economy getting better. “You always have to do a balance sheet check on any company. This includes turnarounds. Do they have enough cash to make it through the next 12 months or the next 24 months? Do they have a lot of debt that’s due right now? These are important questions to answer. “Make sure you understand and believe in the plan to restore corporate profits. It is all internal. They are doing something, either a new product, new management, cutting costs, getting rid of something. Something inside the company that allows them to improve themselves. “Lots of turnarounds never happen, but a few winners can make up for a lot of losers. What’s important is to wait for the actual evidence of the turnaround occurring, not just the symptoms. (With) the turnaround, you have plenty of time. So just don’t buy on the hope. Wait for the reality. Turnarounds are so big it is worth waiting to get some real evidence.”

Fairfax's equity holdings (that I track) are up about $597 million so far in Q3 (9 of 13 weeks = 69%). Shaping up to be another quarter of solid performance. Split by accounting treatment can be seen below. I have attached my Excel file if you want a closer look. Top Movers? All up this quarter: Thomas Cook India = $156 million FFH TRS = $154 million Eurobank = $110 Broad based gains: 6 different equities are up more than $20 million Stelco = ($43) million: the largest decliner Fairfax Sept 1 2023.xlsx

Lots of insurers are still sitting on large losses in their bond portfolio. The underwater fixed income securities are held in their held to maturity bucket so the losses have not flowed through the income statement. And the company line is ‘we will hold to maturity so it does not matter’. And that, of course is stupid. And makes no sense. Of course there are significant costs today for all companies that were buying fixed income duration in 2020 and 2021. Saying ‘it doesn’t matter’ is just a crafty psychological trick. So you buy a 4 or 5 year bond in 2020 or 2021 at a 2.5% yield. Yes, an insurer can hold this bond to maturity. But you hold a fixed income instrument to make money. 1.) what is the real yield on all these bonds? With inflation running 4 or 5%? You are losing money (in terms of purchasing power) on a significant part of your fixed income portfolio. For years. These losses/positioning matter (just ask the ratings agencies). 2.) what is the opportunity cost? If you have a long duration portfolio of 4 or 5 years you also have a limited ability to reinvest at much higher rates. This also means earnings for these insurance companies are messed up. If you don’t book the loss today, it effectively means your earnings in prior year periods is overstated. There is no free lunch. This also means historical ROE’s from most recent years are overstated. In the current environment of much higher rates, Fairfax is a huge winner. Because of the actions of its management team. Their management of their fixed income portfolio has been best in class - and it is not debatable. My current estimate is Fairfax is tracking to deliver a return of 8.6% on its $56.5 billion investment portfolio in 2023 and better than 8% in both 2024 and 2025. That is going to blow insurance peers out of the water. Yes, Fairfax’s stock continues to trade at a severe discount to peers. Efficient markets once again demonstrating how inefficient they can be at times.

@gary17 i have a question for your. Lets pretend Fairfax delivered an ROE of 15% per year on average for the past 5 years. This year they are on track to deliver an ROE of around 19%. Prospects for 2024 and 2025 look good (mid teens ROE). What multiples (PE and P/BV) would be reasonable to pay today?

@newtovalue yes, my estimate for the investment portfolio is low and probably way low: 2023 = $56.5 billion 2024 = $57.5 billion 2025 = $58.5 billion When the GIG acquisition closes that will cause a material increase to the investment portfolio. Continued organic growth in insurance will help as well. And as earnings roll in each quarter and are reinvested (further growing insurance and non-insurance buckets). My estimates are pretty dynamic… constantly changing as we get new information. Some numbers will be high and others low. My goal is to get the direction and total reasonably close. So far most of my estimates have been too low and often by quite a bit. So i took things up a fair bit with my last set of revisions. We will know more when Fairfax reports Q3.

Fairfax’s $56.5 Billion Investment Portfolio: What Will It Earn in 2023 to 2025? Fairfax has two income sources that drive earnings and growth in book value: underwriting and investments. Given their business model (use insurance/float to invest in non-insurance companies) about 20% of their income comes from underwriting and 80% of their income comes from investments. Given its outsized importance to Fairfax, let’s dig into Fairfax’s investment portfolio and try and determine what sort of return it will be able to generate moving forward. This will give us great insight into what Fairfax will earn. And this will enable us to better understand Fairfax’s current valuation. How big is Fairfax’s investment portfolio? It is about $56.5 billion or $2,435/share. Has it been growing in size? Yes. From 2018 to 2022 it increased: in absolute terms by 9.4% per year. per share by 13.5% per year. What is the split today? Fixed income = $40 billion (71%) Equities/derivatives = $16.5 billion (29%) What did Fairfax earn on its total investment portfolio in the past? Prem provided this information in his letter in the 2022AR (attached at the bottom of this post): From 1986-2010, Fairfax earned an average of 9.7% on its investment portfolio. For the first 25 years of its existence, Fairfax’s secret sauce was its return on its total investment portfolio. In aggregate it was very good. From 2011-2016, Fairfax earned an average of 2.3% From 2017-2022, Fairfax earned an average of 4.8% 2010-2020 was a lost decade for Fairfax shareholders. The issue was not the insurance side of the business. The investment side of the company completely messed up (the equities/derivatives part). The big mistake was the equity hedge/short position. There were also lots of poor equity purchases from 2014-2017. Let’s focus on the last 5 years. What Fairfax did 10 years ago is interesting. What they did the past 5 years is much more helpful in understanding the current situation. (Please note, I am not sure of the exact build that Prem used to get to the averages that he put in his letter in the 2022AR. My build is outlined below. There will be differences. However, directionally, the comparisons should still be useful.) From 2018-2022, Fairfax earned an average of 5.1% from their investments (my build is detailed below). Let’s overlay what happened in financial markets over this same time period: historically low interest rates from 2018 to the middle 2022 - this killed returns in the fixed income portfolio for much of the 5 year period. 3 different bear markets in stocks: 2018, 2020 and 2022. historic bear market in bonds in 2022. Given the significant headwinds in financial markets from 2018-2022, the fact that Fairfax was able to deliver a total return of 5.1% each year (on average) is actually pretty impressive. What happened? Hamblin Watsa started to get their investing mojo back. Note: IFRS: I am ignoring for now ‘Effects of discounting and risk adjustment’ = about $480 million to June 30, 2023. What did the management team at Fairfax do from 2018-2022? Internal: Ended equity hedge/shorting strategy. The final short positions (closed out in late 2020) resulted in total losses of $624 million from 2018-2020, or an average of $208 million over each of the three years. The equity holdings from 2014-2017 have mostly been fixed. Beginning in 2022, and lead by Eurobank, these holdings have gone from being a headwind to earnings (losing hundreds of millions every year in total) to now being a tailwind (making hundreds of millions every year in total). That is likely an improvement (swing) of +$500 million per year (my numbers are very rough and intended to be directionally accurate). Since 2018, new equity investments have been very good. They are, in aggregate, performing very well. These holdings are a growing tailwind to earnings. Chug, chug, chug. External: Interest rates bottomed in late 2021: Fairfax sold $5.2 billion in corporate bonds (yielding 1%) and bought short term treasuries and reduced average duration to 1.2 years. Interest rates spiked in 2022 and into 2023: average duration has been extended to 2.4 years. I think they bought some Canadian corporate bonds in Q2, 2023... Covid bear market 2020: got exposure to 1.96 million Fairfax shares at $373/share. Bought back 2 million Fairfax shares in late 2021 at $500/share. Bear market 2022: spent billions buying more of companies it already owned often at bear market low prices. The investment team at Fairfax has been putting on a clinic on the benefits of active management over the past 3 years. The extreme volatility we have seen the past three years has actually been a big tailwind to Fairfax and its investment portfolio. This begs the question: would Fairfax perform better in a ‘safe’ environment or in a ‘shit storm’ environment? Over the medium term (3 year time horizon), i think they would actually do better in a ‘shit storm’ environment. Especially when you include the $3.7 billion in net earnings (much of it from high quality sources that could be reinvested opportunistically) that is likely to be rolling in each year moving forward. That would be ‘buy low’ on steroids. We are going to come back to this point later. But we are getting ahead of ourselves a little. How do things look in 2023? Both equities and fixed income are poised to deliver very good results moving forward - and the table is set for this to last for years into the future. This is the part that most investors still do not get. Why? The significant ‘internal’ drags that were holding down Fairfax’s returns from 2018-2022 are gone. And significant new tailwinds have emerged. Equities: No more losses from the equity hedge/short trade. The equity purchases from 2014-2017 are now delivering very good returns. The equity purchases from 2018 to date continue to performing well. Importantly, Fairfax boosted their stakes in many companies they already own at bear market low prices. This will be a tailwind for future earnings. Covid headwinds have flipped to tailwinds at Recipe, Thomas Cook and BIAL. Bottom line, the underlying earnings power of Fairfax’s $16.5 billion equity portfolio is finally fully delivering on its potential. It was already doing much better in 2022. All an investor had to do was look at share of profit of associates, which spiked to over $1 billion in 2022, to see the transformation of the companies captured in that bucket. But the improved performance in 2022 was masked by the general bear markets in bonds and stocks and the subsequent large unrealized investment losses that were reported. Fixed income: As good as the story is in equities, it is even better in fixed income. Going short duration of 1.2 years in late 2021 was, with hindsight, pure genius. Probably the best investment decision Fairfax has ever made in its history. Bond yields have since spiked higher. As a result, interest income has been spiking higher. It began picking up steam in 2022. But it has really got going in 2023. And 2024 is shaping up to be even better. And now Fairfax is extending duration. The big increases in the returns in both the equity and fixed income portfolios is now spiking the return on Fairfax’s $56.5 billion total investment portfolio. Most importantly, the increase in earnings we are seeing in the equity portfolio (to higher quality) and the bond portfolio (to longer duration) make these higher earnings durable. Ok. Enough talk. Show me the money! What is the current estimate of what Fairfax might earn on its total investment portfolio in 2023? My current estimate for Fairfax to generate an total investment return of about $4.5 billion in 2023, or a return of 8% on its total investment portfolio. Assumptions to get to $4.5 billion in 2023: We are already half way through the year in terms of reported results. And we are almost 2 months into Q3. So it is a pretty straight forward exercise to come up with reasonable estimates for the remainder of this year: Interest and dividend income was $465 million in Q2. My guess is the current run rate is over $500 million per quarter so $1.9 billion for the year looks about right. $40 billion fixed income portfolio: my estimate for average yield in 2023 is 4.5%. Share of profit of associates was $603 million in 1H. My estimate of $1.1 billion for FY is likely low. Consolidated equities was -$36 million in 1H. This should reverse in 2H, driven by Recipe, Thomas Cook, Fairfax India and other holdings, and finish the year at $50 million. Net gains on investments was $450 million in 1H. I am estimating this to finish the year at $900 million. Gain on sales = Ambridge closed in Q2 and the GIG revaluation is expected to happen in 2H. The assumptions above are hardly heroic. And they get us to an 8% return on the investment portfolio for 2023. What is the current estimate for 2024 and 2025? My forecast is for Fairfax to earn an average of 8% on its total investment portfolio in both 2024 and 2025. And I think this is a conservative number. Why? For all the reasons I outlined above: many of the tailwinds to the equity and fixed income portfolios that are just now fully flowing through to reported results and this improvement should continue into 2024, although at a slower pace. Significant net earnings rolling in: an estimated $3.7 billion per year (mostly high quality). A management team with proven best-in-class capital allocation skills. I am sandbagging my forecast for ‘net gains on investments’ for 2024 and 2025. I am going low with my estimate because, of course, i don’t know where they are going to come from. Today, the management team at Fairfax has so many good options: Buy Fairfax stock trading at 5.2PE (to estimated 2023 earnings) and 1 x BV (which is well below intrinsic value). Shift from treasuries to high quality corporate bonds that are now yielding 6% to 6.5%. Given the increase in rates further out on the curve, continue to extend duration of the fixed income portfolio. Lots of equities are trading at low valuations (the run up in the market averages YTD in 2023 was largely driven by the ‘magnificent 7). Bottom line, it would not surprise me if Fairfax delivers a return of better than 8% on total investments in each of 2024 and 2025. What if my estimate of 8% on average over the next 3 years is approximately right? An 8% return on investments equates to net earnings of about $160/share in 2023. ($160 in earnings also assumes a full year CR of 95). This level of earnings should grow nicely in the future. The stock is currently trading at $834. Book value is $834/share. An 8% average return on investments means the current share price is indeed crazy cheap - sorry to keep repeating this point… but it is what it is. So what is it investors are missing? The total earnings that Fairfax is currently delivering is so big that investors simply don’t believe it. Fairfax’s historical numbers and my estimates do not match up - not even close. It makes sense for most investors to believe that Fairfax’s numbers will revert back over time to their lower historical levels. Investors also don’t believe that the high earnings number, if it actually happens in 2023, is sustainable. So even if a big number happens in 2023, well, it will be a fluke. They say “That baby’s coming down!” Why does the number have to come down in 2024? You pick the reason: ‘Interest rates are coming way down.’ ‘An economic recession is coming.’ ‘A stock market correction in coming.’ 'In 2026 (you fill in the bad thing that has to happen).' The pushback from investors is driven mostly by either disbelief or macro concerns. Nothing to do with Fairfax and what the company is actually doing or based on the results that it is currently delivering. What is it Peter Lynch suggests that an investor should focus on when doing their research on a company? Facts and earnings. What about macro? He thinks investors who focus on macro are nuts. Here is the really interesting thing… even if all of those scary macro things happen… I think they might actually make Fairfax’s future performance even better. Heads I win. Tails you lose. I love that type of bet. ————— From Prem’s letter in the 2022AR:

@tnp20 I think the guest in the podcast nailed it: Xi has destroyed the confidence of foreign investors. He gave the world a glimpse into what the CCP’s end game is (and it doesn’t include foreigners). He was too early. And now he has lost the ability to take advantage of stupid foreigners (well some of them anyways - Macron still seems keen).

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?