Time to buy Fairfax again?

[ERICOPOLY]

And Buffett has a saying about what happens when good management tackles bad business.

 

But he also has repeated many times how results of the insurance business in particular depend on good management! Hasn't he?

 

Gio

 

The market is already pricing in Fairfax's good management of it's insurance businesses.

 

It is asking for the same multiple that the owners that sold to Fairfax asked for -- somewhere in the 1.3x range.

 

The market has not discounted the value of those businesses after they came into the Fairfax fold.  So there is no "bad manager" discount.

 

The only thing that is missing is the "seer of the stock and bond market future" premium.  Well, that's a tall ask.

[giofranchi]

Take that to it's logical conclusion -- people aren't going to pay "intrinsic value" for Fairfax when that value depends on them being six-sigma "seers" of the stock and bond markets.  It's a ludicrous expectation to hold for Mr. Market.

 

Eric,

if I had said that, I would have predicted an expansion in the multiple FFH will be priced tomorrow. Have I said that? No! Only thing I have said is: if at the end of the 25-30 years period PW is working for he turns out to be very successful, then and only then the market might reward FFH with an higher multiple.

What’s wrong with that?

 

Gio

 

[ourkid8]

September 23, 2014

September 24, 2013

September 24, 2012

September 22, 2011

 

Want me to continue?

 

Tks,

S

 

You might say this doesn’t mean anything and the repurchase of Subordinate Voting Shares is very limited indeed… Yet, it strikes me as an odd circumstance FFH declares the intention to repurchase some of its shares just 2 days after I asked if it were a good idea to buy FFH again… ;)

 

Gio

[ERICOPOLY]

Take that to it's logical conclusion -- people aren't going to pay "intrinsic value" for Fairfax when that value depends on them being six-sigma "seers" of the stock and bond markets.  It's a ludicrous expectation to hold for Mr. Market.

 

Eric,

if I had said that, I would have predicted an expansion in the multiple FFH will be priced tomorrow. Have I said that? No! Only thing I have said is: if at the end of the 25-30 years period PW is working for he turns out to be very successful, then and only then the market might reward FFH with an higher multiple.

What’s wrong with that?

 

Gio

 

Everybody knows that if they earn 7% on their investment portfolio the returns will be terrific.  However, not everyone knows that their returns will be 7%, and so not everyone is as enthusiastic as you.

 

That's basically the crux of it as I see it.

 

[giofranchi]

The only thing that is missing is the "seer of the stock and bond market future" premium.  Well, that's a tall ask.

 

I am not talking about repricing FFH!!! How can I explain this???

 

I am only talking about what I think they could achieve during the next 2-3 decades.

 

You don't believe they could? Fine! We simply disagree.

 

Gio

 

[ERICOPOLY]

Take that to it's logical conclusion -- people aren't going to pay "intrinsic value" for Fairfax when that value depends on them being six-sigma "seers" of the stock and bond markets.  It's a ludicrous expectation to hold for Mr. Market.

 

Eric,

if I had said that, I would have predicted an expansion in the multiple FFH will be priced tomorrow. Have I said that? No!

 

Yeah, sorry.

 

Richard said it.

 

Richard believes the appropriate valuation is to DCF their future six-sigma returns. 

 

Perils of multitasking with you guys.  I apologize if I misrepresented your position for Richard's.

[giofranchi]

That's basically the crux of it as I see it.

 

Exactly!

We have spent two days on something we simply disagree… People disagree on a whole range of topics every day… Without necessarily making all this fuss… Right?! ;)

 

Gio

 

[ERICOPOLY]

The only thing that is missing is the "seer of the stock and bond market future" premium.  Well, that's a tall ask.

 

I am not talking about repricing FFH!!! How can I explain this???

 

I am only talking about what I think they could achieve during the next 2-3 decades.

 

You don't believe the could? Fine! We simply disagree.

 

Gio

 

Gio,

I don't disagree that HWIC is the secret sauce. 

 

I just disagree when somebody complains about the low PB multiple, because I think it's actually a fair arms-length price for Fairfax for the reasons I listed.

[merkhet]

And Buffett has a saying about what happens when good management tackles bad business.

 

But he also has repeated many times how results of the insurance business in particular depend on good management! Hasn't he?

 

Gio

 

Munger has mentioned multiple times that insurance is a perfectly terrible business -- except in the hands of Buffett. Every now and then, you might be able to find a person who can run a perfectly terrible business in a good way -- Ajit Jain, Warren Buffett -- but statistically, it's unlikely.

 

The results of the insurance business do depend on good management. However, the question is whether good management only makes a terrible business into a mediocre business.

 

I feel like there's a matrix here: (Manager, Business, Results)

 

G=Good

M=Mediocre

B=Bad

 

(G, G, G)

(G, M, G/M)

(G, B, M/B)

 

(M,G,G/M)

(M,M,M)

(M,B,B)

 

(B,G,B)

(B,M,B)

(B,B,B)

[ERICOPOLY]

That's basically the crux of it as I see it.

 

Exactly!

We have spent two days on something we simply disagree… People disagree on a whole range of topics every day… Without necessarily making all this fuss… Right?! ;)

 

Gio

 

BTW, I don't disagree with your 6%-7% returns for them.  That's not what I'm disagreeing about.

 

I only stated that to value the company, you need to value it based on investment returns that are more average (because people shouldn't pay a magic hat premium).

 

Based on the "average" return expectations for HWIC (market-matching returns), FFH seems merely fairly priced.

[gary17]

Gio & Eric

thank you for your views on this - i happened to be thinking about this as well these days.... good timing :)

i think if people like what Prem & company is doing & have faith in their performance over the long term; $450 vs $500 vs $550  cad/share doesn't seem to make a big difference 30 years later....        the US shares have been down because of the stronger $US.  (if you look at the 1 yr chart of FFH.to vs FRFHF.... FFH.to has been relatively flat while FRFHF has been dropping.)  just my 2 cents.

[giofranchi]

The results of the insurance business do depend on good management. However, the question is whether good management only makes a terrible business into a mediocre business.

 

- A mediocre business (insurance underwriting), useful only to generate float at no cost, or even better with a small profit, coupled with a careful investor with a proven track record and a process I understand and like… that, taken as a whole, becomes a good business.

 

- PW and his team are good people.

 

- 1.15 x BV or 1.3 x BV less goodwill and intangibles is a good price, because probably not subject to much more multiple contraction.

 

At least, this is how I see it.

 

Gio

 

PS

Of course 1 and 2 are mixed... But I guess that's just the way it is with insurance underwriting and money management, right?

 

[merkhet]

Yes, but what Eric was saying before is that Banking is a good business whereas Insurance is a mediocre/terrible business.

 

If you have G/M management in banking, you'll do fine. You basically have to have G management to do fine in insurance.

 

That's all I'm trying to explain.

[giofranchi]

Yes, but what Eric was saying before is that Banking is a good business whereas Insurance is a mediocre/terrible business.

 

If you have G/M management in banking, you'll do fine. You basically have to have G management to do fine in insurance.

 

That's all I'm trying to explain.

 

Yes! I understand.

Thank you :)

 

Gio

[Fat Pitch]

Gio,

 

Do you assign any handicaps to your investment thesis for Fairfax? I can see how they can make 15%/yr returns, but I usually assign a probability of it happening. You can discount the ending BV 20yrs from now back to the present with any rate you want as your ROI target, but I like to discount that final number by an additional 25%-70% depending on the investment.

[RichardGibbons]

Richard believes the appropriate valuation is to DCF their future six-sigma returns. 

 

Please don't misrepresent my position.  I've said nothing about the value of Fairfax.  That said, you are correct that I do believe in the ridiculous assertion that fair value of a business is the discounted value of its estimated future cash flows.

 

It is in contrast to your belief that investment businesses are special and should only be valued at the value of their assets.

 

Also, I think your definition of value is different.  For you, it seems to mean, "I would buy this thing at this price".  For me, it means "this is what I think the business is worth".

[giofranchi]

Gio,

 

Do you assign any handicaps to your investment thesis for Fairfax? I can see how they can make 15%/yr returns, but I usually assign a probability of it happening. You can discount the ending BV 20yrs from now back to the present with any rate you want as your ROI target, but I like to discount that final number by an additional 25%-70% depending on the investment.

 

Well, sincerely I don’t think you can assign a probability to the fact a 25-30 years journey will turn-out as expected. I never try to.

 

What I can say is that I think there is a substantial margin of safety. Let me explain:

 

The average annual return FFH achieved on its portfolio of investments from inception is 8.9%. This already taking into consideration the last 4 years which were way below average (2013 was even negative!).

 

Now, if some profitability will be achieved from insurance underwriting, as I expect under the supervision of Barnard, the annual return on their portfolio of investments, needed in order to compound BV at 15% each year, is around 6%.

 

Barnard is surely the first reason I think insurance operations might become profitable. The second reason is FFH strategy to purchase insurance companies worldwide, especially in developing countries. In a competitive business, like insurance underwriting undoubtedly is, to be the first entrant is a huge advantage. We know how little penetration insurance still has in developing countries, therefore I think FFH is doing the right thing betting on their markets. In other words, less competition now than in developed countries, and the opportunity to keep competition at bay in the future. In fact Fairfax Asia is always very profitable! Still small, but growing!

 

People generally think because the great secular bull market in bonds is over, it will not be easy for FFH to replicate past investment success… But I asked this exact question to PW at the 2014 AGM, and he answered saying he doesn’t think they were disproportionately helped by the bond bull market in achieving their investment track record. He said he thinks they will go on finding pockets of value. If US government bonds won’t be good value anymore, they will find something else.

 

And thinking about it, I have come to agree with him once more:

I mean, in a world so much loaded with debt there most probably will be distressed debt opportunities… They took advantage of a distressed debt opportunity in 2009, when they purchased municipal bonds in California, a large investment that has turned-out very fine!… And look at what Howard Marks is doing: he is raising funds for distressed debt opportunities… And look at what Dan Loeb has done with Greek and Portuguese government bonds…

 

As other distressed debt opportunities present themselves, the yields on US 10-years and 30-years government bonds will most probably hit new bottoms, following what has already happened in Japan and Germany. It is only logical that in a distressed environment money flows to the (relative) safety of US government bonds. Then, they might sell those bonds and redeploy their proceedings in some distressed debt situations.

 

In this scenario, and to me it seems a very probable scenario, FFH has the possibility to go on achieving investment returns in line with their track record.

 

6%, instead of 9%, is a margin of safety of more than 30%.

 

Gio

 

[petec]

Seems to me that there is a very simple way to reconcile Eric and Gio's views.

 

Eric believes that the market will not attribute a 'seer' premium to HWIC and Fairfax.  I agree with this and don't expect to be able to sell my shares at 1.5 or 2x bv any time soon (although there are periods when maybe the market has attributed a 'seer' premioum, such as the late '90's p/bv ratios).

 

Gio believes that although the market might not attribute a 'seer' premium, 'seer' returns are likely on the investment portfolio (according to his analysis) and therefore he will make a good return buying at this price.  I agree with this, too.

[giofranchi]

Gio believes that although the market might not attribute a 'seer' premium, 'seer' returns are likely on the investment portfolio (according to his analysis) and therefore he will make a good return buying at this price.  I agree with this, too.

 

The beauty, which is also the true value of float, is that you don’t need a ‘seer’ return on investments (6% is far from being a ‘seer’ return) to get a ‘seer’ compound of capital (15% sustained for 25-30 years is a ‘seer’ compound of capital). ;)

 

Gio

 

[giofranchi]

Anyway, Pete, I have understood what you mean. And imo your analysis is correct. :)

 

Gio

[Kraven]

Good to see the discussion of whether or not FFH is undervalued come up again.  It's been a couple months.  I am disappointed however that whether or not they will compound book value at 15% until the end of days hasn't been discussed much this time.  I miss it.

[Kraven]

I guess too that I have never quite understood the superstar status attributed to FFH.  They strike me as being like a band like Bon Jovi.  They were once pretty good and superstar status somehow got attached to them and has never worn off even though it's coming up on 30 years since Wanted Dead or Alive and the rest of Slippery When Wet came out.

[giofranchi]

I am disappointed however that whether or not they will compound book value at 15% until the end of days hasn't been discussed much this time.  I miss it.

 

I have sobered up the discussion shifting from the end of days to only 25-30 years… ;D ;D ;D

 

Cheers,

 

Gio

[giofranchi]

They were once pretty good and superstar status somehow got attached to them and has never worn off even though it's coming up on 30 years since Wanted Dead or Alive and the rest of Slippery When Wet came out.

 

Except that superstar status was attached to FFH merely 5 years ago… not 30 years ago!

5 years in the record biz might look like eternity…

In business and investments they look like the blink of an eye…

 

;)

 

Gio

 

PS

Of course, as I have explained, I don’t attach to them any superstar or ‘seer’ status.

 

[thepupil]

i know this has been discussed ad nauseum but...

 

I've never looked at fairfax in depth but here is the composition of the $24B investment portfolio. Is it not ludicrous to expect 6% returns (much less 9%) from a portfolio that is 70% cash and bonds? And isn't the common stock portion hedged?

 

So you expect Prem to crank out 6% from a portfolio that is 40% bonds (double barclay's agg which yields 2.4%), 30% cash (yields a big fat gooseegg), 16% a market neutral hedge fund (0% expected return assuming no outperformance, obviously he'll likely do much better than 0 but you're starting at 0 when you hedge out all the market risk/reward).

 

it seems unrealistic given the asset mix.

 

 

40% bonds

31% cash

16% common stocks

2.6% preferred

6% investment in associates