MMM20

I agree that we should look at normalized earnings. But I don't agree that we should look through what could be a few years of ~$160+ earnings, which is what your methodology implies, because I don't expect them to light those earnings on fire like most cyclical commodity management teams. And that quantum of earnings, even if peak earnings, will be ~95% retained and so should mean a step function in "normalized" earnings a few years out with reasonable capital allocation. I think it's fair to look at it both ways and capitalize Year 4 "normalized" earnings and discount all of it back. That gets me to $2500+ IVPS.

Respectfully, I think this is a fallacy and applying this mental model to Fairfax now is one reason it remains so cheap to intrinsic value. 1) We're not talking about the market paying a market or above-market multiple of peak earnings (if they're even peak earnings). We're talking ~5x, arguably a ~8-10x multiple of mid cycle. "Fair" in that simple sense is probably 50-100% higher anyway. 2) We are not talking about the man with a hammer syndrome that affects many cyclical commodity management teams. Fairfax management are value investors and can literally just park the cash flow (again, we're talking about them potentially adding an absurd ~50%+ to shareholder equity over ~3 years) in short term bonds at 5% and go on offense when it makes sense. And I mean, this isn't speculation - we literally just saw them do exactly that going into this hiking cycle. I think many investors overlook this point, maybe because they don't agree that Fairfax management are great capital allocators. If you have management like OXY's that sends back capital at $90 oil... well, then you see Buffett averaging up!

I think these frameworks need to be combined. The cash flows over the next few years could be so large relative to the current market cap that it's really not fair to wave them away as overearning. If we find ourselves with 50% of market cap in cash flows to the equity over a few years, well, with good capital allocation, that fundamentally changes the normalized earnings power. This is not some procyclical oil management team that'll plow it all back into some $100 breakeven projects at the peak and burn all that capital. So we might be looking at +$1B to normalized earnings power over a few years from this "windfall" (if it turns out that way). What's our NPV if we use a ~10-15x multiple on normalized earnings after our base resets 50% higher? I think this properly bridges the two and by my math still gets us to a $2500-3000+ intrinsic value. That's not to say you never get a 50% drawdown!

Great posts @Viking Here is the long and short of it for me: Buffett's methodology = per share investments + per share pretax operating earnings (from businesses other than insurance and investments) * ~10-13x pretax Buffett has also told us he thinks a dollar of float equates to a dollar of intrinsic value For Fairfax, this equals ~$3,000+ intrinsic value right now This does not even consider (1) some level of consistent underwriting profitability which IMHO should be capitalized (2) any expected future growth in per share float Intrinsic value might therefore be closer to ~$4,000

Doesn't sound like it's worth starting my new P&C insurer yet then. Is that good for FFH? Asking for a friend.

FFH still clearly in the bottom half though. Betting it touches top quartile over the next few years.

This is one of my favorite things to rant about so let me apologize in advance. This isn't a comment about Brett Horn in particular - I don't know him, and maybe he's great. But what I strongly recommend is to look to the broker analysts as a gauge of popular sentiment (if even that) or to understand how brokers drum up business. Nothing more. It is not a coincidence that companies reliant on capital raising tend to get the widest coverage and the best ratings. But since the ostensible separation of research from investment banking (and the removal of skin in the game - analysts ability to actually buy stocks in their coverage universe - in the name of removing conflicts of interest), the job is basically a glorified sales job for trading volumes. And many of them, if they do get a real nugget of information or have an actual insight, share it behind closed doors with whichever client trades the most through their bank. In other words... I wouldn't think that hard about it. The analyst incentive is to not stand out in a bad way and keep making ~$1-2mm/year to keep their kids in fancy schools. Even if one is actually bearish, he/she almost certainly won't stick his/her neck out and risk embarrassment and losing that cushy gig. Sorry, I've done that job as a bright eyed and bushy tailed junior analyst and unfortunately saw how the sausage is made, so maybe I'm too cynical now. Maybe the general takeaway is to keep your expectations low and allow yourself be pleasantly surprised, but the clear and simple fact is that @Viking and others with real insight and skin in the game do a 10x better job than any broker analyst. Maybe this wasn't the case in Lee Cooperman's days at GS (though it was probably even sketchier then) but it is now. At the bare minimum, the pay and prestige aren't what they used to be. The real talent is elsewhere. Expect the sell side estimates to keep climbing higher as Fairfax executes.

+1, this is IMHO the key point many investors overlook by buying the "held to maturity" framing. Look beyond the accounting and ostensible long-termism (and ignore the fact that we weren't thinking long term buying duration in treasuries at historical interest rate lows). There are real economic consequences. Either raise capital at much higher rates or retrench and give up share in a hard market.

Does anyone have an elegant hedge against FFH that they're willing to share? I'm looking at hedging out some of the catastrophe risk, at least through hurricane season. Not really a fan of options as I prefer something where time is on my side. Generac (GNRC) is trading at what seems like a fair-ish high teens NTM P/E and low teens NTM EBITDA for a pretty great business and natural hedge. Seems like it could stand alone as an investment which is ideal… but it's also blunt (and maybe obvious). Anyone have a better idea? Sorry if already a topic!

I think it's fair to call it a workaround, just not a scalable one. Few people are in a position to just set aside an extra ~$1.5mm (or even $500K or whatever) and essentially self-insure. That's the whole point of insurance! It just gets scary when people with zero savings can't or won't get coverage for whatever reason. If that piece grows, the whole system becomes a bit more fragile, and maybe it's a sign that rates are becoming a bit stretched.

True, but you could've said the same think about BRK for many decades. The critical point that can't be emphasized enough (I've tried) is that insurance float is very different than broker margin or even corporate credit. It's a sustainable source of free or negative cost (or even just plain cheap) leverage, even through drawdowns that might blow up a bank or hedge fund, as long as they can underwrite to breakeven or better (or even a little worse) through cycles. Rather than a negative thing, what you're pointing out is a (maybe *the*) major structural advantage from the POV of a long term FFH equity investor, and even more of an absolute and relative advantage now than a few years ago with 1) so much more of it, in the wake of smart growth ahead of and into the hard market, and 2) borrowing costs otherwise off the lower bound. IMHO that *highest quality* leverage is the overarching reason why FFH has been and should continue to be a compounder… and a still misunderstood one still trading at 5-6x sustainable (though, yes, volatile) earnings. That's my elevator pitch at least. Sorry, I can't help but chime in b/c this is my favorite subject.

Does this apparent elasticity of demand make a dent in the hard market? The beginning of the end? https://www.wsj.com/personal-finance/americans-are-bailing-on-their-home-insurance-e3395515 Homeowners are increasingly forgoing home insurance, gambling that the likelihood of a disaster isn’t high enough to justify the cost of a policy. Some skipping insurance say they are doing so because they can no longer afford the rising premiums. The national average for home insurance based on $250,000 in dwelling coverage increased this year to $1,428 annually, up 20% from 2022, according to Bankrate. … Twelve percent of homeowners in the U.S. don’t purchase homeowners’ insurance. About half of them have annual household incomes of less than $40,000, according to a 2023 survey by Insurance Information Institute, an industry trade group, and the reinsurer Munich Re. … People with money are finding ways around the problem. A client of Angie Newman in coastal Florida figured that the total cost of replacing his vacation home and all of its contents would be about $1.5 million. His longtime insurer recently didn’t renew his policy. The only remaining insurer in the area was offering a policy with flood insurance for about $17,000 a year, up from about $7,000 a year that he paid previously, says Newman, a financial adviser at UBS Financial Services in Florham Park, N.J. The client separated the possible costs of repairs and rebuilding from his other investible assets and invested the funds instead. He assumed he could make an average return of about 6% on the roughly $1.5 million while waiting for some other insurers to re-enter the market, Newman says.

https://www.wsj.com/finance/insurance-catastrophe-reinsurance-hurricane-77a69eab The industry needs to be talking about the plausibility of $200 billion nominal loss years, which might be more of a near-term possibility than we realize,” says Steve Bowen, chief science officer at brokerage Arthur J. Gallagher & Co.’s Gallagher Re. The net result, says catastrophe-modeling veteran Karen Clark, is that the industry is facing a turning point akin to Andrew’s wake. And she would know: Back in 1992, Clark faxed around an estimate for Andrew’s loss based on a computer model she had developed that was twice what other industry sources at the time were saying. Her number proved to be the right one. Insurers’ struggle today to price what she calls “frequency peril” risks like wildfires are “a déjà vu moment,” Clark says. “I never thought I would see a disrupted market like after Andrew. But here we are.” Part of the challenge has been insurers or their clients relying on models like those developed in the 1990s for hurricanes or earthquakes to understand other kinds of risks, including secondary perils like wildfires or “social” risks like litigation. There has also been a glut of capital in the insurance industry, which has helped depress risk pricing. Superlow interest rates led investors to seek out yield in strange places, like “cat” bonds and other insurance-linked securities that paid high rates but bore the risk of catastrophe losses. Reinsurers globally failed to earn back their cost of capital in five of the six years from 2017 to 2022, according to estimates by S&P Global Ratings. Now, things are changing. Rising interest rates are making it less attractive for investors to pour money into insurance risks when they can get higher yields on simpler things. That has given the upper hand to big reinsurers, which have pushed through big price increases this year. Reinsurers are also often changing the structures of their coverage by raising the so-called attachment points at which they will start to absorb losses, enabling them to focus on the more extreme, existential risks to insurers’ capital. Also aided by the prospect of higher interest rates on their investment portfolios, reinsurers such as Everest Group, RenaissanceRe, Munich Re and Swiss Re have seen their shares rally sharply in the past year. But with rising attachment points, primary insurers—firms like Allstate or Progressive, which sell policies to consumers or businesses and often buy reinsurance to cover their tail risks—can end up more exposed to these frequent-but-smaller catastrophes. One way they can compensate is to continue to raise the premiums they charge their customers. Another is to pull back from the trickiest markets, like when State Farm said it would stop writing new homeowners’ policies in California. Clark says insurers will need to adapt to newer kinds of models that help price risks like thunderstorms or wildfires. Her firm is updating its wildfire model as often as once a year. So whether a big one hits or not, this hurricane season is going to be an important measuring stick for insurers. A quiet season or two could actually make things more volatile for the industry if a sense of complacency sets in and pricing momentum slows. As the underwriting adage goes, there is no such thing as a bad risk; only a bad price.

So... (clears throat)... uh... $BB Did I do that right?

I think it depends how much they actually care about their stock trading at something remotely close to fair value... so many puts and takes go into that. But it sounds like NYSE will never happen again after the prior experience.

Does Fairfax have a good track record on acquisitions from private equity? I'm not familiar with Exponent, but with any acquisition from private equity i reflexively worry that the company has been juicing profits one way or another ahead of a sale. A lot of good businesses in the UK seem cheap right now. I guess it comes down to price. Happy to see it as long as it's not a turnaround!

Yeah, I actually agree. It was a bad attempt at being facetious. The share price will take care of itself over time.

Not sure I agree that it's not worth thinking through the scenarios, but I hear you and appreciate the good reminder that "[to] invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework." - The Intelligent Investor I did just make a lunch bet with a friend on FFH vs AMZN over the next 5 years. EPS growth should be similar but maybe FFH valuation expands ~3x while AMZN's contracts ~3x. We'll see. My best guess is FFH valuation expands over the next few years as higher earnings power translates to sharp growth in per share accounting book value... b/c it trades on book value. The bottom line IMHO is there is a completely reasonable case to be made that FFH earnings power doubles and valuation triples over that timeframe. Still, I get the skepticism!

So... time to list on NYSE?

Doesn’t this come down to how much of the improvement in earnings power is structural vs cyclical? It seems like FFH has taken pricing and share as many others have been semi-permanently(?) weakened. If true, the stock may be cheaper now than back then. Like, maybe the range of outcomes was super wide ~2-3 years ago before rates and weather related losses spiked, and now we’re on an upside path in that decision tree. Does that makes sense? And looking at competitors and the supply/demand dynamics, it seems like we might still be in the early days of an insurance supercycle (at least in some pockets) in which demand constantly outstrips supply due to a confluence of factors including weather/climate losses, migration patterns, ESG(?) and regulation warding off new entrants, the impact of higher rates on balance sheets and capital formation, etc. Famous last words, I know… not my base case. Knowing what we know now, with all the commentary we are seeing from various management teams, macro and micro factors — would it be shocking if pricing in certain big pockets ~1.5-2x’d (and well ahead of expected losses) over the next ~5 years, generating a whole lot more negative cost float… and oh yeah, coincident with investment income spiking higher? This is just a hypothesis and doesn’t need to be true for us to do very well from this price... maybe just one truly lollapalooza returns scenario. And I am not in the insurance biz so looking for more insider views on how this compares to prior cycles as of now.

Where are BRK and MKL trading on owners earnings multiples? Also ~4x?

Respectfully, I disagree. If you talk to 100 investment professionals, 90 have no opinion, and they’re still called bums or dinosaurs by, like, 9 of the other 10. A few of us weirdos here are just the 1%! Occupy Wellington Street!

@petec in the outside world, we are still generally looking at a mix of indifference, skepticism and disdain and that is still reflected in valuation... let’s see if the Vikings of the world see the light, not just our own @Viking...

I am valuing it on a mix of a 2-3 year earnings assuming (i think conservatively) that they’re partially a windfall and then something normalized thereafter. What’s it worth if in ~3 years we are looking at ~$1400 BVPS and then capitalizing durable normalized earnings power off of ~5% spreads between investment returns and cost of float from there? IMHO that's the right way to think about it b/c the earnings power per share should nearly double over the next few years, whether driven by a "1x windfall" or not. That is durable in the sense there's no reason to think such a step up, it it does continue to play out that way, would evaporate in the next soft market... right? I'm fully prepared to look like an idiot on this one... clearly there's absolutely no guarantee it plays out that way.

Maybe in theory better operating conditions immediately attract new entrants who drive profitability down, but we have just come from an unprecedented environment in which both 1) rates moved the quickest ever off the lower bound and 2) weather (climate?) losses are all time high and going higher. And so with the collective industry balance sheet so hobbled and required returns higher, this was already happening much more slowly and that dynamic might even be accelerating (decelerating?) now. It’s sort of a perfect storm for FFH and few others to continue taking share at much higher pricing. Maybe recent cycles are not really representative. Time to stay patient and not unnecessarily interrupt the 8th wonder of the world… the hardest part of this. Just my hypothesis at least.