Time to buy Fairfax again?

[ERICOPOLY]

Gio...possibly another way of thinking this through is to say that eric is doing an invested capital analysis to better understand the sources of returns, or, if you will economic goodwill.

 

Ok, thank you.

If I haven't overpaid for a business, why should I strip-out the goodwill on my balance sheet to compute what I truly own?

 

Gio

 

 

Because you are double counting.

 

You want a premium on top of the premium.

 

 

 

[ERICOPOLY]

They aren't paid?  I believe their pay is subtracted out of earnings, so we are paying for them.

 

;D ;D

 

Gio

 

 

The Dhandho pay model is better.  He gets paid for performance.

 

This idea of yours to pay HWIC via a huge premium is broken -- because when you pay a premium for the stock, it doesn't go into HWIC's pocket.  You are paying the wrong people.

 

Good management should be paid.

 

Mohnish isn't getting paid simply because he has a magic hat with a "seer stone" in it.  Sure he has one, but he'll be paid for the results it produces.  So he will be paid directly in line with the value he adds. 

 

[SharperDingaan]

Gio, keep in mind that business buyers have different time horizons than investors.

 

IV assumes a plan to hold forever; therefore intangibles are valid inclusions. If you have a shorter horizon, the carrying value of the intangibles as at the date you sell - has zero value as you no longer hold the coy (identical to what would occur if the coy was actually liquidated, & is no longer a going concern). Therefore, book value to the investor is total book value less intangibles. Divide current price by this adjusted book value, & you get a better picture as to the magnitude of the premium. Whether it goes higher or not is a judgement call.

 

SD

 

[ERICOPOLY]

but I agree with what I think Eric is getting at, which is that if an asset (e.g. Zenith) is on Fairfax's balance sheet at 1.3x already (tangible+goodwill) then you shouldn't pay 1.3x *that* number for Fairfax unless you think PW *underpaid* for Zenith.  In other words, you're in danger of paying 1.3*1.3=1.69x for Zenith. 

 

That's exactly right.

 

Double counting.

[arbcon]

Gio- I was actually trying to help you think through the economic goodwill calculation to help you frame out your investment in fairfax intellectually. Feel free to disregard my comments and no worries.

[petec]

Gio, keep in mind that business buyers have different time horizons than investors.

 

IV assumes a plan to hold forever; therefore intangibles are valid inclusions. If you have a shorter horizon, the carrying value of the intangibles as at the date you sell - has zero value as you no longer hold the coy (identical to what would occur if the coy was actually liquidated, & is no longer a going concern). Therefore, book value to the investor is total book value less intangibles. Divide current price by this adjusted book value, & you get a better picture as to the magnitude of the premium. Whether it goes higher or not is a judgement call.

 

SD

 

I'm not sure I understand this.  In the case of Zenith for example, I suspect PW could sell it for more than he paid so the intangibles have value to me under all scenarios and holding periods.  Or have I misunderstood?

[giofranchi]

but I agree with what I think Eric is getting at, which is that if an asset (e.g. Zenith) is on Fairfax's balance sheet at 1.3x already (tangible+goodwill) then you shouldn't pay 1.3x *that* number for Fairfax unless you think PW *underpaid* for Zenith.  In other words, you're in danger of paying 1.3*1.3=1.69x for Zenith. 

 

That's exactly right.

 

Double counting.

 

Ok, now I have understood what you mean.

But I am not trying to do what you suggest.

Instead, I am only trying to compute the true value of what I own today. In doing so I don’t see why I should strip-out goodwill, if PW hasn’t paid more than IV.

Then, I am trying to figure out the value of what I could be owning 30 years from now, if the value of what I own today compounds at 15% annual.

Then, I discount it back to the present.

That’s all I am doing. Where is the double counting?

 

Gio

 

[petec]

but I agree with what I think Eric is getting at, which is that if an asset (e.g. Zenith) is on Fairfax's balance sheet at 1.3x already (tangible+goodwill) then you shouldn't pay 1.3x *that* number for Fairfax unless you think PW *underpaid* for Zenith.  In other words, you're in danger of paying 1.3*1.3=1.69x for Zenith. 

 

That's exactly right.

 

Double counting.

 

Understood.

 

FWIW, I'd pay a significant premium to TBV for the assets PW has assembled.

[petec]

but I agree with what I think Eric is getting at, which is that if an asset (e.g. Zenith) is on Fairfax's balance sheet at 1.3x already (tangible+goodwill) then you shouldn't pay 1.3x *that* number for Fairfax unless you think PW *underpaid* for Zenith.  In other words, you're in danger of paying 1.3*1.3=1.69x for Zenith. 

 

That's exactly right.

 

Double counting.

 

Ok, now I have understood what you mean.

But I am not trying to do what you suggest.

Instead, I am only trying to compute the true value of what I own today. In doing so I don’t see why I should strip-out goodwill, if PW hasn’t paid more than IV.

Then, I am trying to figure out the value of what I could be owning 30 years from now, if the value of what I own today compounds at 15% annual.

Then, I discount it back to the present.

That’s all I am doing. Where is the double counting?

 

Gio

 

I think you have to justify why the goodwill will compound at 15%.

 

*Or* you actually have to do a DCF and value it as P/PV, but not P/BV.

[Rabbitisrich]

 

I think you have to justify why the goodwill will compound at 15%.

 

*Or* you actually have to do a DCF and value it as P/PV, but not P/BV.

 

But a P/DCF is simultaneously a P/BV. You just divide DCF/BV.

[giofranchi]

I think you have to justify why the goodwill will compound at 15%.

 

If PW thinks Zenith IV is 1.3 x BV0, with BV0 = BV today, and Zenith BV compounds at 15% annual, and the business prospects for Zenith don’t change, won’t PW still think that Zenith IV would be 1.3 x BV30, with BV30 = BV 30 years from now?

 

Gio

[Rabbitisrich]

but I agree with what I think Eric is getting at, which is that if an asset (e.g. Zenith) is on Fairfax's balance sheet at 1.3x already (tangible+goodwill) then you shouldn't pay 1.3x *that* number for Fairfax unless you think PW *underpaid* for Zenith.  In other words, you're in danger of paying 1.3*1.3=1.69x for Zenith. 

 

That's exactly right.

 

Double counting.

 

Understood.

 

FWIW, I'd pay a significant premium to TBV for the assets PW has assembled.

 

I don't really follow this argument, and it seems like you [Petec] aren't committed to it either in that last comment. Why is it a matter of direct interest what is the liquidation value, or the snapshot value of assets, unless you are planning to immediately liquidate or sell the company? If the business is a going concern, then the snapshot value is the material for managerial discretion. I might decide to pay no more than book value, but that is due to my expectations about the use of assets. There is no room for a passive regard of management.

[Gopinath]

Well, i think these posts are not at all talking about the economic goodwill after the businesses have been acquired and put it on the balance sheet(with accounting goodwill). Take a look at the company like Odyssey Re, they must have bought it for some $X, now the business must have been grown and streamlined & made it better.. this will not show up in the accounting goodwill..

 

Buffett made an analogy about Geico valuation through accounting goodwill versus, valuation through economic good will.. Based on the book value, it may look like $2 billion(including accounting goodwill) or so.. but the business have grown so much which produces premiums/underwriting profits almost or more than Progressive which is worth about $15 Billion.. If you valued that based on profits, likelyhood of staying power, the business value is so much more than stated book value.. Book value may not be a true representation of value whether including acc goodwill or not! Just my 2 cents!

[SharperDingaan]

I'm not sure I understand this.  In the case of Zenith for example, I suspect PW could sell it for more than he paid so the intangibles have value to me under all scenarios and holding periods. 

 

IFRS defines goodwill (intangible) as whatever was paid above market for the asset, less all FMV adjustments to the assets & liabilities of that asset at date of acquisition. That goodwill is then amortized forward by means testing every year, & the difference in values is amortization.

 

For you to benefit as an investor, Zenith had to be on the books as an asset available for sale, with quarterly FMV. If it is not available for sale, the best you will see is time of purchase goodwill at FMV (means test of identified CF). An estimate, of no real value, unless Zenith is actually sold.

 

SD

[Fat Pitch]

Does anyone know what’s the maximum dollar amount Fairfax can lose in any given year from their insurance exposure?

[ERICOPOLY]

Fairfax is one of those stocks that makes me think of the Buffett comment about making sure you are buying a business that even an idiot could run. 

 

My point in saying that is the HWIC portion is clearly not of the "idiot proof" type.  It does not have lasting "special" value beyond the current management.

 

So it is not to be valued accordingly.  In other words, not at it's intrinsic value.

 

The "magic hat" is not where the value is, the value is in the seer.  You can't purchase a person, but you can pay them for their services.

 

Pay for the seer, not the magic hat.

 

The seer is not a perpetuity.

 

Think of the employees of a company -- any company.  They are paid for their labor, and hopefully paid fairly.  They are not purchased at a capitalized DCF premium to the expected value of all their future labor.

[ERICOPOLY]

That’s all I am doing. Where is the double counting?

 

Gio

 

The double counting is when you are fixated at the low P/B...  yet the "low" P/B isn't that low at all.

 

So by looking at something that makes the premium invisible, your mind is being tricked by an optical illusion.  You are then trying to put a premium on something that has already had a premium put on it... without regard for measuring the premium that is already there (that's the double counting).

 

[ERICOPOLY]

Well, i think these posts are not at all talking about the economic goodwill after the businesses have been acquired and put it on the balance sheet(with accounting goodwill). Take a look at the company like Odyssey Re, they must have bought it for some $X, now the business must have been grown and streamlined & made it better.. this will not show up in the accounting goodwill..

 

Buffett made an analogy about Geico valuation through accounting goodwill versus, valuation through economic good will.. Based on the book value, it may look like $2 billion(including accounting goodwill) or so.. but the business have grown so much which produces premiums/underwriting profits almost or more than Progressive which is worth about $15 Billion.. If you valued that based on profits, likelyhood of staying power, the business value is so much more than stated book value.. Book value may not be a true representation of value whether including acc goodwill or not! Just my 2 cents!

 

You are dead right.

 

Just toss out the accounting goodwill.

 

Recreate the "true" goodwill by looking at the size of the float, the anticipated rate of increase of the float, and the underwriting profit.  That's all worth a premium for sure and it's economic goodwill.

 

The accounting goodwill is just a subset of the economic goodwill.  Nothing gets missed by tossing out the accounting goodwill -- it all gets recaptured when looking at economic goodwill.

 

[ERICOPOLY]

Why is it a matter of direct interest what is the liquidation value, or the snapshot value of assets, unless you are planning to immediately liquidate or sell the company?

 

It's the way of determining what economic goodwill the market is currently assigning to FFH.  Current market cap is a reflection of that economic goodwill.

 

Has nothing to do with liquidation value -- I have no interest in valuing a company on it's liquidation value.

 

[Munger_Disciple]

This is my first post in this thread.

 

The problem with FFH is that it is highly levered relative to Berkshire. Because of the excess leverage, FFH is always forced to play defense, and hence all these hedges. This is very much unlike Berkshire, which is swimming in cash ($55B at the end of Q2-2014) and very under-levered relative to their capital. In effect FFH is similar to a highly levered hedge fund, so it does not deserve much of a premium over book.

[ERICOPOLY]

I mean... paying a discounted present value for the future excessive gains that are to be reaped from HWIC's abilities to see a future that nobody else sees.

 

That truly is seer-stone stuff (in the eyes of most people).

 

Are you really surprised that the market isn't going to value the magic hat for a premium?

[beerbaron]

I mean... paying a discounted present value for the future excessive gains that are to be reaped from HWIC's abilities to see a future that nobody else sees.

 

That truly is seer-stone stuff (in the eyes of most people).

 

Are you really surprised that the market isn't going to value the magic hat for a premium?

 

The market values the insurance business on their UW and investments at par. I think the market has it roughly right. FFH should be great at UW and great at investing. ..the later coming as a bonus.

 

BeerBaron

[RichardGibbons]

Was done with this discussion, but I thought of an example that amuses me.

 

Company A: Puts all of its $100M in assets in an index, and waits.

 

Company B: Its management has stated that its strategy will be as follows. It will holds $100M cash, except every week, 2 minutes before the SPY options are about to expire, it puts 50% of its portfolio into purchasing the farthest out of the money options that are available.  These options will almost certainly expire worthless, so its value falls 50% every week.

 

Per Ericopoly's valuation methodology, these two companies have the same value.  (In fact, I imagine he'd be eager to purchase company B, since it would likely be trading at, like, 1% of Ericopoly's fair value. A huge bargain!)

 

[ERICOPOLY]

Was done with this discussion, but I thought of an example that amuses me.

 

Company A: Puts all of its $100M in assets in an index, and waits.

 

Company B: Its management has stated that its strategy will be as follows. It will holds $100M cash, except every week, 2 minutes before the SPY options are about to expire, it puts 50% of its portfolio into purchasing the farthest out of the money options that are available.  These options will almost certainly expire worthless, so its value falls 50% every week.

 

Per Ericopoly's valuation methodology, these two companies have the same value.  (In fact, I imagine he'd be eager to purchase company B, since it would likely be trading at, like, 1% of Ericopoly's fair value. A huge bargain!)

 

Put them on Fairfax's balance sheet and suddenly you are overbidding what Black Scholes dictates.

 

Because of the magic hat, Black Scholes is wrong and you confidently bid it higher.

 

A good example (on topic of derivatives) is the deflation hedges.  They were purchased out of the money.  You are overbidding the market because they have the magic hat.

[ERICOPOLY]

You invest with a manager that you trust and you like his process.  You pay him for managing the money.  Perhaps you pay a fee as percentage of assets.  Perhaps you pay a salary. Perhaps you pay him a percentage of gains as they come in after a hurdle rate is met.

 

Richard pays them upfront for the future gains, discounted to the present.  He even knows how to discount this properly because he knows their future gains.  Maybe Richard has the magic hat too!

 

We all have our favorite ways of paying people.  I have mine, he has his.