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Time to buy Fairfax again?


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Yesterday FFH closed at $447.5, while BVPS at the end of Q2 2014 was $386.77: a multiple of 1.157, below the 1.2 x BVPS Buffett is willing to buy back BRK shares.

If FFH has made some money in Q3 2014, that multiple today is even lower.

 

From Q2 2014 Conference Call:

We’re trying to build our company over 25, 30 years.

--Prem Watsa

 

So, here we have a great entrepreneur, who has already built an $8 billion company, who is among the most reliable CEOs in North America, and who is thinking and planning for the next three decades… Don’t you agree with me it is worth more (much more) than 1.15 x BVPS?

 

Cheers,

 

Gio

 

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So, here we have a great entrepreneur, who has already built an $8 billion company, who is among the most reliable CEOs in North America, and who is thinking and planning for the next three decades…

I thought what is described fits Jack Ma of alibaba quite well,too.

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Yesterday FFH closed at $447.5, while BVPS at the end of Q2 2014 was $386.77: a multiple of 1.157, below the 1.2 x BVPS Buffett is willing to buy back BRK shares.

If FFH has made some money in Q3 2014, that multiple today is even lower.

 

From Q2 2014 Conference Call:

We’re trying to build our company over 25, 30 years.

--Prem Watsa

 

So, here we have a great entrepreneur, who has already built an $8 billion company, who is among the most reliable CEOs in North America, and who is thinking and planning for the next three decades… Don’t you agree with me it is worth more (much more) than 1.15 x BVPS?

 

Cheers,

 

Gio

Perhaps Prem should announce a good-until-close buy back order at 1.2x or say, 1.5x if that represents a meaningful discount discount to IV. Since the comparison to BRK is being made. The market appears to have taken note and BRK hasn't traded below the 1.2xBV since the announcement.

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Wtf does Buffett's appraisal of Berkshire have to do with Fairfax? They're not even close to comparable.

 

Also, it's not clear why a fair to mediocre insurance operation that has hedged away hundreds of millions (billions?) in investment gains over the last five years should be worth much more than BV.  Certainly not because Buffett thinks Berkshire is.

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Wtf does Buffett's appraisal of Berkshire have to do with Fairfax? They're not even close to comparable.

 

Also, it's not clear why a fair to mediocre insurance operation that has hedged away hundreds of millions (billions?) in investment gains over the last five years should be worth much more than BV.  Certainly not because Buffett thinks Berkshire is.

 

I guess "Wtf" means something not very polite...

 

Anyway, the multiple over BV you should be willing to pay both for FFH and for BRK depends on the rate of BV growth they will achieve during the next 40 years (more or less).

 

What do you think will grow faster:

 

A) an $8 billion company led by a 63 self-made billionaire, who is still very motivated and planning for the very long term... With an equity portfolio hedged for the next 2 or 3 years;

 

B) a $300 billion company led by a genius like Warren Buffett... For the next 10 years.

 

If your answer is B, well then I think you might be right... Unpolite, but right...

 

My answer is A!

 

Gio

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Brk and ffh no comparison,

Brk buying stock at 1.2* book,  ffh selling around book.

Brk underwriting better than ffh.

Ffh borrowing money and declaring dividend,  never made any sense.

If you think about it, where ffh would be if they hadn't made money on their cds few years ago.

The only time they made real money last 10 years.

 

Regards

 

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Anyway, the multiple over BV you should be willing to pay both for FFH and for BRK depends on the rate of BV growth they will achieve during the next 40 years (more or less).

 

Much of FFH's BV growth comes from capital gains -- which don't deserve a multiple IMO.

 

I mean... suppose you find a mutual fund or hedge fund that grows "book value" at supernormal clip because the investor behind the scenes is generating a lot of capital gains.  Well, those gains are not priced at a premium -- you invest in that fund for book value, no matter what... it doesn't matter what the past record of the investor is, it's still done at book value.

 

So for what reason would you pay a premium for capital gains if it's a company instead of a mutual fund? There is no such reason.  Thus, you need to strip out the capital gains from FFH's book value growth before you decide on a multiple -- IMO.

 

You are paying a premium for a business -- and capital gains is not a business.  Underwriting profit is a business.  Investment income from float is a business.  Capital gains is not.

 

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You are paying a premium for a business -- and capital gains is not a business.  Underwriting profit is a business.  Investment income from float is a business.  Capital gains is not.

 

Imo a business is nothing but a machine to generate earnings. If those earnings are retained, they go to increase equity. And at the end of the next 40 years all that matters is how much equity will have grown. What will be the source of those retained earnings that go to increase equity is irrelevant – IMO.

 

Gio

 

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The only time they made real money last 10 years.

 

Unfortunately, what happened during the last 10 years won’t help you very much to understand what will probably happen during the next 30 years.

 

Insurance operations:

During the last 10 years they had to deal with burdensome legacies of the past. Watsa has often posted a slide in his AM presentations, in which he underlines how contracts written during the last 10 years have constantly and reliably been profitable. CRs over 100% were caused by unsound policies written before FFH acquired those companies.

Now all of that is almost over. Under the general supervision of Barnard, if the huge success of Odyssey Re is any guide, we will probably see insurance operations solidly profitable for many years to come.

 

Investment results:

Many people feel that because of our – and I highlighted that in my prepared comments that because of the fact that with that cash, it’s also 85% hedged and we have few corporate bonds, that we can’t make any money. Well that is – this is not right under certain circumstances we can make that ton of money.

 

We’ve done it in the past; we can’t tell you when we’ll do it, when we can – we can’t predict the quarter, the year that will happen. But the first two quarters they are example of that. Under certain circumstances, we can make a lot of money for our shareholders. And I remarked in my prepared comments that these interest rates in Europe are 200 year lows. That means the German 30-year, we call it bonds long bond government bonds are selling below 2%, you’ve to go back 200 years.

 

So that just telling you that these markets are something is happening on the marketplace, when you’ve 200 year lows that no inflation to speak of and the last number in Europe was 0.4% and the U.S is running around 1%. So there is – with all of this QE1, QE2, QE3 inflation is very muted, very low. And the economy by the way and you saw the 4% in the second quarter 1.7% of that goes to inventory buildup. So it’s more like 2.3%, but if you look at the half, nominal GMP for the United States, nominal for the first half is 2.5%, real GDP for the first half is 0.9%.

 

So still very tepid in spite of all of this monetary easing, and we are of the opinion that you’ve to protect yourself from that. We never want to look for money and be in a position where we get blind sighted. And we continue to be that grand client, and I know in the last few years that was not necessary, and perhaps we’ll muddle through and perhaps that won’t be necessary.

 

But we worry about this, perhaps one other point that I could make is, in China there is a few numbers suggesting that there is a little bit of a pickup. I just thought I have talked about it in our annual report. But Dave raised to me an interesting point is – have written a little article where he said, China used more cement in the last three years than the U.S – United States used in the entire 20th century, that is 100 years.

 

China used more cement in the last three years than the United States used in the entire 20th century. And then you’ll be interested anyone who looked at Japan in the 1990s will be interested in these two comments that an Executive from one of China’s largest real estate companies met in London. The first time and he said was the total land value in Beijing that is only Beijing is 62% of U.S GDP.

 

Total land value in Beijing is 62% and the second comment you made of China’s house production a 1,000 head of population reached 35. It reached 35 in 2011. And the figure is below 12 in most developed economies even when the housing market is hot, no country has had a figure of greater than 14. This is the house production per 1,000 head of population. So this is staring us in the face we think and we just want to be careful and conservative. We’re trying to build our company over 25, 30 years. We have to go through periods like this where you’re not going to be – where you have to be careful. But in spite of that, we do have many things in our portfolio, including recent purchases of common stock that can do well for our shareholders.

--Prem Watsa, Q2 2014 Conference Call

 

So, they have been too conservative over the last 10 years. Ok, we all know that. Now the only thing that matters is: what comes next? Easy money either leads to asset bubbles… or it does not. In a 2 or 3 years time we will finally know for sure. If bubbles inflate then burst, 3 years from now we will be here singing praises to Prem & Company; if instead we muddle through, there will be no more reasons to behave so cautiously and it will be business as usual once again… well, not exactly: it will probably be much better, with much stronger insurance operations than before and with some operating companies they are starting to acquire.

 

Gio

 

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You are paying a premium for a business -- and capital gains is not a business.  Underwriting profit is a business.  Investment income from float is a business.  Capital gains is not.

 

Imo a business is nothing but a machine to generate earnings. If those earnings are retained, they go to increase equity. And at the end of the next 40 years all that matters is how much equity will have grown. What will be the source of those retained earnings that go to increase equity is irrelevant – IMO.

 

Gio

 

It would be a lot easier to explain the concept if we had them divest of the insurance operations and just invested the cash on the balance sheet.

 

They would be making lots of money from capital gains, and you would be arguing that it was worth a huge premium to book value because after 20 years, you would say, all that would matter is how much the equity had grown over time.

 

However everyone else could plainly see that it was just a portfolio of equities and would just price it as such.

 

The market prices those equities every single day, and yes... to the market they are worth exactly what the market says they are worth.  They are not worth a penny more simply because they are on the balance sheet of FFH.

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Sum of the parts valuation, in other words.

 

What sort of a premium will you pay for their fractional ownership in company X, when company X's shares trade on the open market.

 

Zero. 

 

Let's say they invest all of their equity into just one company -- Bank of Ireland shares for example.  Are you going to pay 1.3x book value for FFH (while arguing they are good at stock picking and thus it's a "business") when you could just pay 1.0x for Bank of Ireland shares directly instead?

 

 

 

 

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It would be a lot easier to explain the concept if we had them divest of the insurance operations and just invested the cash on the balance sheet.

 

Maybe… But those insurance operations are here to stay. Actually, they are getting bigger and bigger (the majority of operating companies they have bought recently are in fact insurance companies).

 

And the truth is they have $24 billion in assets with only $8 billion in equity, and a Total Debt / Total Capital ratio of merely 25%. And a 15% increase in equity is achievable with just a 6%-7% return on their portfolio of investments. This is a result of their insurance operations.

 

Gio

 

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It would be a lot easier to explain the concept if we had them divest of the insurance operations and just invested the cash on the balance sheet.

 

Maybe… But those insurance operations are here to stay. Actually, they are getting bigger and bigger (the majority of operating companies they have bought recently are in fact insurance companies).

 

And the truth is they have $24 billion in assets with only $8 billion in equity, and a Total Debt / Total Capital ratio of merely 25%. And a 15% increase in equity is achievable with just a 6%-7% return on their portfolio of investments. This is a result of their insurance operations.

 

Gio

 

"just" a 6-7% return... 

 

I suppose the investment portfolio looks similar in makeup and management to that of a pension fund.

 

Are pensions valued based on a 7% investment return right now?  What rate is Sears Holdings allowed to use for it's pension fund?

 

 

 

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Well, of course also the quality of management matters... And I highly doubt the average pension fund is managed by someone of the caliber of Watsa & Company!

 

They could do many things... They can increase the equity percentage of their portfolio, and Bradstreet is not exactly the average bond portfolio manager, right? They will go on buying entire businesses, etc.

 

Most of all a 6% for a pension fund is... 6%, for FFH it means 15%... Put whatever multiple to BV you want on that, but I don't think 1 is the right choice!

 

Gio

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Put whatever multiple to BV you want on that, but I don't think 1 is the right choice!

 

Gio

 

It isn't 1.

 

Book value itself is a multiple to common equity of about 1.2x.

 

Strip out the goodwill and intangibles and book value is $322 at latest report.

 

So the USD price of $447 is 1.39x book value (after stripping out intangibles).

 

I believe that's not too far off from the multiples they have been paying when they acquire wholly-owned insurance businesses from owners who know their operations really well.  So perhaps it's close to the private-party valuation.

 

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Strip out the goodwill and intangibles and book value is $322 at latest report.

 

FFH has a long history of not overpaying for assets. Therefore, I don’t see why goodwill and intangibles should be an issue. Of course, if you strip out goodwill and intangibles by default, that’s a different story… But I don’t think they should.

 

On the contrary, investments in associates were recorded at $1.85 billion, while their market value at the end of Q2 2014 was $440 million higher. $440 million is another 5.37% of shareholders equity.

 

Btw, Eric, do you know of any pension fund which increased its equity 17% during the first 6 months of 2014? … Hard to think FFH holds the same investments of the average pension fund! ;)

 

Gio

 

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Wtf does Buffett's appraisal of Berkshire have to do with Fairfax? They're not even close to comparable.

 

Also, it's not clear why a fair to mediocre insurance operation that has hedged away hundreds of millions (billions?) in investment gains over the last five years should be worth much more than BV.  Certainly not because Buffett thinks Berkshire is.

 

I guess "Wtf" means something not very polite...

 

Anyway, the multiple over BV you should be willing to pay both for FFH and for BRK depends on the rate of BV growth they will achieve during the next 40 years (more or less).

 

What do you think will grow faster:

 

A) an $8 billion company led by a 63 self-made billionaire, who is still very motivated and planning for the very long term... With an equity portfolio hedged for the next 2 or 3 years;

 

B) a $300 billion company led by a genius like Warren Buffett... For the next 10 years.

 

If your answer is B, well then I think you might be right... Unpolite, but right...

 

My answer is A!

 

Gio

 

Ajit Jain, Tad Montross, Tony Nicely et al have been running BRK's insurance biz for over 20 years. They have managed the CR, profitable float etc for that entire time. The next 10 or 30 years is likely no different. So, BRK's insurance business promise over the next 50 years has very little to do with WEB's age.

 

Prem has not run a good insurance operation at all over the comparable timeframe. Yes, Odyssey has brought some insurance wherewithal to FFH and thus it is all conjecture at this point that ORH insurance prowess is readily scalable across FFH. I sold out of FFH waiting to see how they do as an insurance operator. Five years at least for me.

 

The only real comparison between BRK and FFH is what would happen if there are two or 3 years of disasters, like KRW & Earthquakes & floods. The insurance clock will be reset then. The largest Insurers of today, State Farm, Allstate are said to be vulnerable. Will FFH be found with or without clothes when that tide goes out? Berkshire will do fine. Especially in the aftermath. What's the probability of this happening? It is non zero. It has happened in the last 100 years.

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Prem has not run a good insurance operation at all over the comparable timeframe. Yes, Odyssey has brought some insurance wherewithal to FFH and thus it is all conjecture at this point that ORH insurance prowess is readily scalable across FFH. I sold out of FFH waiting to see how they do as an insurance operator. Five years at least for me.

 

I'm not sure that being correct on your decision to sell, necessarily equates to Prem not running a good insurance business during that time period.  During the financial crisis, there were only two companies that would have been left standing and would have been the last two to fall...Berkshire...and many might call it dumb luck because of the credit default swaps...and Fairfax.  But the rest of their portfolio was also extraordinarily prepared...so how dumb was it really?

 

And then let's examine the second part of that period...what if central banks weren't able to deleverage as easily as they did or if there had been some reluctance in Europe?  Then how would the last five years have looked? 

 

In terms of an operating business, whether the gains have been through investments or insurance are irrelevant, since in any good insurance company, the results are measured by accumulated losses, investment gains and operating costs.  In those terms, Fairfax has averaged 21.3% annualized increase in book per share.  But the critics often like to pick and choose, so they regularly say throw out Fairfax's first year.  Even then, they've compounded at a terrific 17.6% in book per share.  What's past is prologue! 

 

The only real comparison between BRK and FFH is what would happen if there are two or 3 years of disasters, like KRW & Earthquakes & floods. The insurance clock will be reset then. The largest Insurers of today, State Farm, Allstate are said to be vulnerable. Will FFH be found with or without clothes when that tide goes out? Berkshire will do fine. Especially in the aftermath. What's the probability of this happening? It is non zero. It has happened in the last 100 years.

 

I don't think Fairfax can handle such circumstances as well as Berkshire, but I think they will be handle it better than most critics think.  The insurance operations are changing and you can see it in the underwriting since Andy's been given control.  Does that mean we'll continue to see such results...only time will tell.  But the fact that they are moving away from acquiring shitty insurers at less than book, and paying up for better quality insurers, is surely a step in the right direction to strengthening their insurance business.

 

Fairfax is not Berkshire and never will be.  Just like the Pabrai Funds and Dhandho will never be like the original Buffett Partnership or Berkshire.  But these earnest people doing the best they can at replicating the model will prove to be successful.  They may not always do it the same way or as well, but a certain level of success over their peers will most likely occur.  Markel is another example of copying the model.  They don't have to be as great as Berkshire to have success...they just have to be really good!  Cheers! 

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Prem has not run a good insurance operation at all over the comparable timeframe. Yes, Odyssey has brought some insurance wherewithal to FFH and thus it is all conjecture at this point that ORH insurance prowess is readily scalable across FFH. I sold out of FFH waiting to see how they do as an insurance operator. Five years at least for me.

 

I'm not sure that being correct on your decision to sell, necessarily equates to Prem not running a good insurance business during that time period.  During the financial crisis, there were only two companies that would have been left standing and would have been the last two to fall...Berkshire...and many might call it dumb luck because of the credit default swaps...and Fairfax.  But the rest of their portfolio was also extraordinarily prepared...so how dumb was it really?

 

And then let's examine the second part of that period...what if central banks weren't able to deleverage as easily as they did or if there had been some reluctance in Europe?  Then how would the last five years have looked? 

 

In terms of an operating business, whether the gains have been through investments or insurance are irrelevant, since in any good insurance company, the results are measured by accumulated losses, investment gains and operating costs.  In those terms, Fairfax has averaged 21.3% annualized increase in book per share.  But the critics often like to pick and choose, so they regularly say throw out Fairfax's first year.  Even then, they've compounded at a terrific 17.6% in book per share.  What's past is prologue! 

 

The only real comparison between BRK and FFH is what would happen if there are two or 3 years of disasters, like KRW & Earthquakes & floods. The insurance clock will be reset then. The largest Insurers of today, State Farm, Allstate are said to be vulnerable. Will FFH be found with or without clothes when that tide goes out? Berkshire will do fine. Especially in the aftermath. What's the probability of this happening? It is non zero. It has happened in the last 100 years.

 

I don't think Fairfax can handle such circumstances as well as Berkshire, but I think they will be handle it better than most critics think.  The insurance operations are changing and you can see it in the underwriting since Andy's been given control.  Does that mean we'll continue to see such results...only time will tell.  But the fact that they are moving away from acquiring shitty insurers at less than book, and paying up for better quality insurers, is surely a step in the right direction to strengthening their insurance business.

 

Fairfax is not Berkshire and never will be.  Just like the Pabrai Funds and Dhandho will never be like the original Buffett Partnership or Berkshire.  But these earnest people doing the best they can at replicating the model will prove to be successful.  They may not always do it the same way or as well, but a certain level of success over their peers will most likely occur.  Markel is another example of copying the model.  They don't have to be as great as Berkshire to have success...they just have to be really good!  Cheers!

Sanjeev,

Your summary is very close to mine. I was merely responding to Gio's thesis on WEB's age and BRK's future prospects. FWIW, I sold out of my 10 year holding of FFH to buy more BRK, because it was easy versus FFH being "too hard" with the hedging, macro calling, BBRY etc. I still admire Prem but would rather be on the sidelines waiting for them to build an insurance business. BTW, I think that their insurance business purchases around the globe, especially in Asia is worth watching. My increase in BRK ownership has been nicely vindicated, so there's no remorse. Don't expect any for a while yet.

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You are paying a premium for a business -- and capital gains is not a business.  Underwriting profit is a business.  Investment income from float is a business.  Capital gains is not.

 

Imo a business is nothing but a machine to generate earnings. If those earnings are retained, they go to increase equity. And at the end of the next 40 years all that matters is how much equity will have grown. What will be the source of those retained earnings that go to increase equity is irrelevant – IMO.

 

Gio

 

It would be a lot easier to explain the concept if we had them divest of the insurance operations and just invested the cash on the balance sheet.

 

They would be making lots of money from capital gains, and you would be arguing that it was worth a huge premium to book value because after 20 years, you would say, all that would matter is how much the equity had grown over time.

 

However everyone else could plainly see that it was just a portfolio of equities and would just price it as such.

 

The market prices those equities every single day, and yes... to the market they are worth exactly what the market says they are worth.  They are not worth a penny more simply because they are on the balance sheet of FFH.

 

I tend to agree with Gio on this one.  I think what he is saying is that there is some premium to be paid for an outstanding investor / manager.  After all, when you make an investment, it is the future cash flows that really matter, not the prior ones.  If you are convinced that an investor/manager is extremely skilled, then his cash/equity portfolio may be worth more than book, based on the skill of the manager.  As a simple example, consider equity fund A of $10 million run by Warren and Charlie, and equity fund B of $10 million run by me.  I think it is fair to say that equity fund A would command a higher premium to book in the marketplace than B (B might sell at a discount to book).  Thus if someone thinks Prem and company can grow their cash/stock pile at much greater than the market over a lengthy period, then doesn't it deserve to sell at a premium to book?

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Besides the growing insurance empire, don't forget, there are some strong non-insurance companies under the cover as well:  William Ashley, Arbor Memorial, CARA, Keg Restaurants and Thomas Cook India.  These companies have significant growth potential ahead of them. 

 

The problem we all have with Fairfax has been the macro bets, hedging and the significant stake in Blackberry.  I wish Prem and company would admit they made significant mistakes and the team has learned from them and will ensure it does not happen again.  That message would calm shareholders nerves and allow the company to focus on what they do best compounding capital at a 15%+ clip for the next 25 years.  (Blackberry was a huge distraction to the team)

 

tks,

S

 

Prem has not run a good insurance operation at all over the comparable timeframe. Yes, Odyssey has brought some insurance wherewithal to FFH and thus it is all conjecture at this point that ORH insurance prowess is readily scalable across FFH. I sold out of FFH waiting to see how they do as an insurance operator. Five years at least for me.

 

I'm not sure that being correct on your decision to sell, necessarily equates to Prem not running a good insurance business during that time period.  During the financial crisis, there were only two companies that would have been left standing and would have been the last two to fall...Berkshire...and many might call it dumb luck because of the credit default swaps...and Fairfax.  But the rest of their portfolio was also extraordinarily prepared...so how dumb was it really?

 

And then let's examine the second part of that period...what if central banks weren't able to deleverage as easily as they did or if there had been some reluctance in Europe?  Then how would the last five years have looked? 

 

In terms of an operating business, whether the gains have been through investments or insurance are irrelevant, since in any good insurance company, the results are measured by accumulated losses, investment gains and operating costs.  In those terms, Fairfax has averaged 21.3% annualized increase in book per share.  But the critics often like to pick and choose, so they regularly say throw out Fairfax's first year.  Even then, they've compounded at a terrific 17.6% in book per share.  What's past is prologue! 

 

The only real comparison between BRK and FFH is what would happen if there are two or 3 years of disasters, like KRW & Earthquakes & floods. The insurance clock will be reset then. The largest Insurers of today, State Farm, Allstate are said to be vulnerable. Will FFH be found with or without clothes when that tide goes out? Berkshire will do fine. Especially in the aftermath. What's the probability of this happening? It is non zero. It has happened in the last 100 years.

 

I don't think Fairfax can handle such circumstances as well as Berkshire, but I think they will be handle it better than most critics think.  The insurance operations are changing and you can see it in the underwriting since Andy's been given control.  Does that mean we'll continue to see such results...only time will tell.  But the fact that they are moving away from acquiring shitty insurers at less than book, and paying up for better quality insurers, is surely a step in the right direction to strengthening their insurance business.

 

Fairfax is not Berkshire and never will be.  Just like the Pabrai Funds and Dhandho will never be like the original Buffett Partnership or Berkshire.  But these earnest people doing the best they can at replicating the model will prove to be successful.  They may not always do it the same way or as well, but a certain level of success over their peers will most likely occur.  Markel is another example of copying the model.  They don't have to be as great as Berkshire to have success...they just have to be really good!  Cheers!

Sanjeev,

Your summary is very close to mine. I was merely responding to Gio's thesis on WEB's age and BRK's future prospects. FWIW, I sold out of my 10 year holding of FFH to buy more BRK, because it was easy versus FFH being "too hard" with the hedging, macro calling, BBRY etc. I still admire Prem but would rather be on the sidelines waiting for them to build an insurance business. BTW, I think that their insurance business purchases around the globe, especially in Asia is worth watching. My increase in BRK ownership has been nicely vindicated, so there's no remorse. Don't expect any for a while yet.

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Besides the growing insurance empire, don't forget, there are some strong non-insurance companies under the cover as well:  William Ashley, Arbor Memorial, CARA, Keg Restaurants and Thomas Cook India.  These companies have significant growth potential ahead of them. 

 

The problem we all have with Fairfax has been the macro bets, hedging and the significant stake in Blackberry.  I wish Prem and company would admit they made significant mistakes and the team has learned from them and will ensure it does not happen again.  That message would calm shareholders nerves and allow the company to focus on what they do best compounding capital at a 15%+ clip for the next 25 years.  (Blackberry was a huge distraction to the team)

 

tks,

S

 

 

+1. 

 

That is the reason I sold as well.  I am not comfortable investing alongside someone who believes they can consistently make good investments based on the macro.  Also, I see his current bets on a stock market crash as very different from his subprime mortgage bets.  With his CDS bets there was an identifiable irrationality you could point to - lots of money being loaned to people with terms such that they were very unlikely to repay the loans, and with some foresight you could say that "this is going to end badly".  Certainly we should give Prem credit for seeing this.  But his new bets are just macro bets plain and simple, with no irrationality you can really point to, except perhaps for deficit spending, which has been going on for decades.  With Blackberry, I seriously doubt that he would have invested if Blackberry was headquartered in Dallas, TX.  Thus in my mind the Blackberry investment signals a bit of hubris - that he felt he should go in and save the Canadian technology company.  Investing in tech turnarounds is not how Prem made his fortune, and every experienced value investor knows what a dicey proposition it is.  Hopefully Fairfax has learned from its mistakes.  I wish like you that they would fess up to their mistakes, as acknowledging one's mistakes is the best way to avoid future ones.

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Much of FFH's BV growth comes from capital gains -- which don't deserve a multiple IMO.

 

I mean... suppose you find a mutual fund or hedge fund that grows "book value" at supernormal clip because the investor behind the scenes is generating a lot of capital gains.  Well, those gains are not priced at a premium -- you invest in that fund for book value, no matter what... it doesn't matter what the past record of the investor is, it's still done at book value.

 

So for what reason would you pay a premium for capital gains if it's a company instead of a mutual fund? There is no such reason.  Thus, you need to strip out the capital gains from FFH's book value growth before you decide on a multiple -- IMO.

 

You are paying a premium for a business -- and capital gains is not a business.  Underwriting profit is a business.  Investment income from float is a business.  Capital gains is not.

 

This argument that capital gains shouldn't impact valuation makes no sense.  The value of a business is the discounted value of its free cash flow.  Suppose you were confident that Fairfax, without insurance operations, was able to reliably compound its book value at 1000% a year through investing.  Saying, "that stock is worth book value" makes no sense because its future free cash flows are worth far more than that.

 

It's irrelevant if you choose to value other companies in the industry on a sum of parts valuation.  Given a choice between buying an index mutual fund at book value, and this "compounding 1000% every year" company at 4 times book value, I would take the latter every time.

 

Richard

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