Fairfax Stock this week

[Partner24]

"And with fund manager fees, you're looking at more than 40% to beat it... unless you are the fund manager"

 

Ericopoly, ahahaha  ;D I will not double check your math, but anyway I trust you. So, is there anybody who want to put some chips on the 5 or 10 years poker table to beat that?

 

Not me. If you want to play that game, I'm in the FFH side of the table ahahah  ;)

 

Cheers! 

 

[txlaw]

Very interesting thread.  A couple of questions seem to have emerged:

 

How much will an investment in FFH return in the long run at a price paid of $US 360?

 

Between 12% and 15%, according to Sanjeev.  That's actually where I would put it too. 

 

Sanjeev is obviously looking for returns greater than 15%, and he sees opportunities in the market to obtain these returns (without leverage, I'm assuming).  His investment partners should be very happy with that!

 

 

Given the above long term return, is it a good idea to buy FFH at current prices?

 

Yes, it would be very reasonable to purchase FFH at current prices if you are a long term buy and hold investor.

 

But you had better be prepared for the lumpy returns that Watsa talks about.  If the economy deteriorates (or fails to get any better) equity markets could trade flat or go down in the next 12 to 24 months.  In that case, you could see FFH trade flat or even be marked down by the market for that period of time.  That won't worry some FFH investors, but others will wish they had gone with companies that were more undervalued given the opportunities available.  It sounds like Sanjeev is saying that he'd rather go with deep value stocks he sees right now because they shouldn't be as severely affected by market fluctuations that may occur due to poor economic conditions.  That sounds like a reasonable position to me.

 

Also, it's unclear whether the hard market that people are yearning for will materialize any time soon.  It could be well after 2010 before this happens.  (I'd be interested to hear what the experienced insurance investors think about what pricing will be like next year.)  If that's the case, we might have several opportunities to buy FFH at a reasonable price.

 

One last thought.  If you know how to hedge your portfolio like Eric, Mungerville, and others (not me), you may be able to avoid the psychological pitfalls associated with market volatility.

 

 

Would it be wise to put a very large percentage of one's portfolio, say 40%, into FFH? 

 

Possibly.  But you better know FFH back and forwards given the complexity of the company and the complexity of the industry.  Some members of this board do know FFH this well and also know tons about the insurance industry.  They probably could do the analysis and be comfortable with FFH being such a high percentage of their portfolio. 

 

I'm not one of those people -- I have a lot to learn before I could even think about putting a high percentage of my portfolio into FFH.  I would think you would want to know enough to do the "try to kill the company" test before making FFH a large percentage of your portfolio.  A lot can go wrong for a pure insurance company. 

 

 

Would owning FFH at $360 be a good short term idea?

 

Okay, no one really asked this question outright.  But this was sort of implied by the thread about the upcoming earnings report. 

 

I think FFH is a good place to be for the short term.  Dazel makes a compelling argument that FFH is trading at a significant discount to current BV.  If the market acts somewhat rationally, FFH should at least trade at the new BV after earnings.

 

I own some FFH, but it is sort of like an arbitrage position for me.  I'm looking for a nice short term gain based on revaluation after the book value increase.  If I get that return, I will almost certainly sell out of FFH in my regular investment portfolio and increase my cash position to take advantage of a market correction.  If I don't get that return, no big deal since I own FFH at a price less than BV.

 

[ERICOPOLY]

One last thought.  If you know how to hedge your portfolio like Eric, Mungerville, and others (not me), you may be able to avoid the psychological pitfalls associated with market volatility.

 

I can't take credit for any hedging.  I was doubting it actually (before the crash).

 

I didn't do anything to hedge until FFH was already at $250, which is a little bit slow on the uptake really  :-\

[Viking]

Here is my very rough calculation of what FFH should earn going forward. Please correct me as you see fit.

 

1.) Underwriting income (CR = 99) = $40 mill

2.) Int / Div Income (Q2 $184.5x4) = $740

Operating Income = $780

3.) Net Gains on Invest (see below) = $960

4.) Interest Exp ($152 + 30 new debt + 14 pref) = $200

5.) Corporate Overhead = $100

Pre Tax Income = $1,440

6.) Inc Taxes (28%) = $400

Net Earnings = $1,040 = $51/share

 

Q2 BV = $315

BV Growth = $51 = 16%

 

Interesting that FFH has 15% target and if you simply drop in some basic assumptions you get 15% growth.

 

Where this gets a little more interesting is when you overlay what many have talked about previously.

- I am assuming CR = 99. This definitely should be beaten by FFH OpCo's over time.

- 9% return on investments may also be lite as the current market (lots of volatility) is in Hamblin Watsa sweet spot as they tend to trade and not simply buy and hold.

- I also expect that will all subs under one umbrella there will be some restructuring that will improve results to the bottom line (over time).

- insurance hard market? When is happens this could really juice FFH BV growth.

- and lastly... what rabbits will Prem and team pull out of their hats next (they are there!)?

- weave it all together... Q3 BV = Q2 BV $315 + $60 (my est for Q3) = $375

- cost today $355 for 15% grower with nice upside potential... pretty good buy.

- and, yes, fasten your seat belts; as we learned in Q1, the ride will not be for the faint hearted! 

__________________________________________

Net Gains on Investment

- total portfolio investments = $18,887 (p9 of Q2) = $924/share

- 10 yr avg return = 9% x $18,887 = $1,770

- Net Gains = I/Div Income $740 - $1,700 = $960

 

Shares Outstanding = 17,564 + 2,882 = 20,446

[ECCO]

I considered myself lucky being able to read and participate to that board. There are guys here from all over the world, some are 20 and begins investing, others are retired, that makes this board so interresting. At the end, we are all investors and share the same passion. Thanks Sanjeev for taking care of this board.    

 

Many of you guys are very good when come time to evaluate FFH book value. It surprised me that nobody had refer to that citation on page 17 of Odyssey Re solicitation document:

 

the fact that the offer price represents a 1.25x multiple to OdysseyRe's book value per share of common stock as of june 30, 2009 and a 1.11x multiple to OdysseyRe's estimated book value as of September 30, 2009, based on management estimates...

 

So if 65$ is 1.11x book value, that mean ORH book value should be at 58.56$ as of September 30. ORH book value was 51.90 as of june 30, then there is a 12.8% appreciation in ORH book value from june to september. Over the last quarters, ORH growth in book value was higher than FFH, so is it reasonnable to expect more than 12% growth in FFH book value this quarter?

 

ECCO

 

N.B. As you might have noticed, english is not my first language, feel free to ask me what I mean if what i write dont make sense ;).

 

 

 

[ERICOPOLY]

Over the last quarters, ORH growth in book value was higher than FFH, so is it reasonnable to expect more than 12% growth in FFH book value this quarter?

 

I think FFH actually grew book faster than ORH over the last quarters.  FFH went into this quarter with a higher percentage of book allocated to equities, and that brings more punch to the party.

 

Perhaps though they sold investments early and that's one thing that would lead to exagerrated expectations, just like Q4 last year with the long bonds.

 

[Viking]

ECCO, thanks for sharing the numbers provided by FFH for ORH; 12.8% increase for one quarter is excellent!

 

So far this year FFH earnings have been much more volatile than ORH (underperforming on the downside and outperforming on the upside). My guess is this is because they hold more risky assets at FFH and ORH has a relatively speaking more conservative holdings. Based on recent history I would expect FFH to outperform ORH in Q3.

 

Looking at Q2, FFH BV increased 24% while ORH increased 18.5%.

If ORH grew BV 12.8% in Q3 perhaps FFH increase 16% = $50

 

Bottom line, with all the moving parts, it is impossible to precisely caclulate the change in BV. From where I sit, my best guess is FFH BV has increased $40 to $60. Not too shabby...

 

BV                ORH          FFH

Dec 31        $45.37      $278.28

March 31    $43.80      $254.95

June 30      $51.90      $315.91

Sept 30      $58.56 est    ????

 

The BULL case for buying FFH today (at roughly BV):

1.) they are very conservatively reserved (minimal PY reserve releases)

2.) underwriting is OK (one area for improvement)

3.) interest & dividend income now is VERY healthy

4.) operating earning should be solid

5.) gains on investments will continue to outperform peer group (total portfolio return of 9%)

6.) hard market is coming in next year or two (FFH will grow its top line business dramatically)

7.) market will fall in love with insurers/re-insurers

 

We will get higher BV at the same time Mr. Market attaches a higher multiple to those earnings. My experience is those are the situations you see only rarely and are VERY profitable.

 

And what is the BEAR case?

Easy... Markets tank 30 to 40%... FFH will get punished. (Should this happen I will bet that FFH then begins a massive share buy back). 

 

[SharperDingaan]

 

You might want to step back a bit:

 

Agreed Q3 is probably a good quarter, but lets be a little more conservative & assume a BV increase of only $40 (ORH offer costs, FX, surprizes, etc). 09/30 BV is 355 (315 Q2 + 40) which equals the present price of 355; ie. price/book multiple of 1.00

 

To make a quick gain here we really need the multiple to expand, but the headline news is going to be year-over-year comparisom - & unless these numbers are much better than last year; there will be little reason to increase the multiple. The brilliant quarter with lots of 'sexy' gains may well give us a higher BV, but don't count on price/BV expansion.

 

Assume 15% P(x) we get $60, BV of $375, P/B of 1.1. Price is 412.5, 'gain' is 57

Assume 60% P(x) we get $40, BV of $355, P/B of 1.0. Price is 355.0, 'gain' is 0

 

Last years CDS gains could haunt us.

 

SD 

[oldye]

I know you are well intentioned Sanjeev,  

 

But if you think they grow BV at 15% a year for the next 5 years...using 400 as a base you get aprox. 2x or 800$ book.  If you think that the market assigns no multiple like that analysis they used to take ORH private, you would be right...but thats one possible outcome and I don't think its very likely.  

Frankly I don't think its a fair way to deal with shareholders, they took all the potential downside that came with owning the stock.  Telling them that they're earning an adequate return based on projections that are conservative (they assumed 12% growth for ORH) x 1x multiple.

 

If you think of you shareholders as business owners than shouldn't you at least present 1 argument as to why a business owner should want to even bother selling their stake during the tail end of a soft market.

Anyway, I don't want to start another debate.

 

 

All I'm saying its a steal at 360 because its selling for less than half of what it should reasonably be selling for in private transaction today.  We all know you can do better Sanjeev, I just don't think I can do better than having HW manage my money.  

 

 

P.S Viking, I think your math is slightly off because you don't include the increase in investments from the acquisition from ORH.  Investments per share should be north of 1000$. 

[goldfinger]

Ericopoly said it well indirectly: we may not have the same perspective as individual investors as fund managers do. There are a bunch of fees I don't have to make up for and besides I am not as good as Sanjeev: it is his job and I am not as smart. Finding exceptionally talented investors to take care of my money at no fees at a decently discounted price to current value is a big feat for me (with no tax for a while). I was in Wells Fargo sub 10$, or AXP sub 12.5$, I sold close to the 30$ each and redeployed into FFH, SSN or BRK at close to book for assets worth much more under the right management. I am OK with that, especially long term. I did some of the "freaky" stuff he said we were not doing recently, but during more "normal" times I do not have the ability to do that much better. If I had a fund, I would probably think differently as I would have to think about my partners and volatility, fees and comparative performance, and I would spend all of my time in it...

[niels12think]

it can be very misleading to look merely at reported P/B;

the Buffet concept of "look through" apply not only to earnings, but also to both book value and growth and intrinsic value.

 

example:

one stock, A trades at P/B of 0.5  with P/E of 8 and annual growth of 10% and 5% dividend yield

another stock, B trades at P/B of 1.0 with P/E of 16 and annual growth of 7.5% and no dividend yield

And there is similar underlying risk in the two stocks.

 

you might think the first stock is the better buy?

 

now, suppose that the assets of the second company consist of a million shares in the first company.

 

For the second stock,

look through P/B is 0.5

look through P/E is 8

look through growth is eg. 13.2% (dividend is used to buy up own stock, thereby boosting look through growth, but assuming no tax)

 

Fairly obvious if there is only one underlying stock, but also applicable to a company with a portfolio of stocks and bonds.

 

And though at first sight, it appear that A is the best buy due to reported lower P/B, lower P/E, higher annual growth and higher dividend yield,

then in fact it is the second company, which in this case is just as good or better (ignoring taxes).

 

On top of this, if B is an insurance company then also the insurance operations should add to the value in the form of extra earnings due to CR below 100 and interest income from the float, although this comes with some additional risk from the insurance operations.

Neither future value of CR below 100 nor future income from the float is part of the book (except for goodwill).

 

In this situation, it seems much preferable to buy B at P/B of 1.0 instead of the many stocks and other stuff that the insurer owned.

This is true even if the reported valuation ratios of those other stocks and stuff were seemingly more favorable.

 

Indeed, you would have to be *a lot* better at managing investments than the investment managers of the insurance company, in order for you to earn more by investing directly in other companies and stuff, than in the insurance company.

 

Knowing how cleaver the team at Fairfax has been at managing investments, then it seems that an investment in Fairfax at 1.0 of book would be *very* hard to beat, at least without taking extraordinary risks.

And if anyone could invest so much better, then that guy might belong on the HWIC...

 

And let's not forget that book value might have increased further during October.

 

Btw, I think the P/B ratio should expand over time in order to lessen or remove the above inefficiency.

 

 

Cheers

[SharperDingaan]

 

Agreed re P/B & 'look through' earnings, but keep in mind that it's the long term buy & hold view. As 'Mr Markets' view is typically very short term, the prudent thing is to expect some dissappointment.

 

Nothing to prevent one from taking advantage of the poor fellow though  ;)

 

SD

[Estimated Profit]

 

As the reporting of the third quarter approaches speculation as to whether or not to buy into earnings is rampant.

 

My short answer is maybe.  All things being equal Q3 should have attractive earnings should HW have kept their portfolio constant. However, we don't know what they are holding as we have more or less in the past as far as Q2 EPS was concerned or the CDS portfolio last year.

 

I am in the camp of Value Buff with his 40% of a position thesis.  FFH is one of those companies like MVL that one needs to hold on to, because though very volatile, you really do want to hold it for the long term.

 

Sharper Dingan though has a thought that I hadn't considered until now which is the headline risk. Competing with last year's returns offer the headline: FFH profit down 80% on Investment Earnings.... or somethingto that effect.To say again however, people just don't realize how cheap this company can get and in all likelihood, we will see .6x book many times before we see 1.4x book.  For anyone with a full position here at BV they will in all likelihood see good "crunchy" returns over the next 5 to ten years. But they will in all likelihood miss out on the next 5 to 10 .6x book to book market mispricings and repricings that will happen along the way.

 

But, once more, maybe the shorts are tired of getting their a$$es handed to them by HWIC. Maybe they have moved on. But being a non household name, with low trading volumes, this will in all likelihood, attact those looking to make a quick buck via market manipulation.

 

Sorry for the long post. If you are going to speculate going into these earnings, count the amount of maybe's in your investment thesis and recognize speculation for what it is and don't fool yourself into believing that you have a large margin of safety for your capital here.

 

(Disclosure... I am speculating going into earnings. I'm not all in, but I have replaced 50% of the positions that I sold after Q2s revaluation to book as I believe we are at a discount now.... I do know that I'm rolling the dice however, looking for a short term gain.)  ;D

[Guest misterstockwell]

 

Sharper Dingan though has a thought that I hadn't considered until now which is the headline risk. Competing with last year's returns offer the headline: FFH profit down 80% on Investment Earnings.... or somethingto that effect.To say again however, people just don't realize how cheap this company can get and in all likelihood, we will see .6x book many times before we see 1.4x book.  For anyone with a full position here at BV they will in all likelihood see good "crunchy" returns over the next 5 to ten years. But they will in all likelihood miss out on the next 5 to 10 .6x book to book market mispricings and repricings that will happen along the way.

 

Wow---I think many here would be giddy to be able to buy this at .6X book. Perhaps that was the pattern in the past, but this is a different company now(as long as they dont make any stupid acquisitions). A valuation of .6X book only comes out during times of serious stress. If you look at quality insurers in the last year(i.e. HCC, WRB, MKL, BRK), none got even close to .6X book. I'll take the other side of your bet.

[SharperDingaan]

 

Even we don't think we'll see .6x BV, but we see the argument.

 

Keep in mind that trading the changes in BV multiple became a lot more dangerous when ORH came back into the fold. With 4 strong coys (FFH, NB, ORH, C&F) now all on the same consolidated Balance Sheet, the elimination of cross-holding committments, & European regulators starting to break up a number of players (ie: ING), there is now a quiet upward bias. One announcement, could well add an instant .3x to the multiple.

 

We covered our synthetic short just after FFH went to market, & are back to our core long position.

 

SD

   

[Estimated Profit]

How quickly we forget how volatile the markets can be.

 

We haven't had a nasty cat for some time but domestic terrorist attack, earthquake, hurricane and all of a sudden we see .6 book in short order.

 

Also, a general panic in the markets and a broad based sell off in financials will take this company down with all the rest regardless of whether or not it deserves it... but then again when was the last time that happened?  ???

[ERICOPOLY]

0.6x US GAAP book has only happened once, in 2003.

 

Some people think there was a huge book value discount in 2006 but much of that was due to differences in how Canadian GAAP valued those finite re arrangements.

 

[oldye]

It was at .67 at some point in 2006

[ERICOPOLY]

That's pretty close to what I get (I get about 0.72x using $125 US GAAP figure and stock at $90 in June 2006).

 

An assertion was made that a terror attack or a hurricane would knock down the valuation to 0.6x book...

 

Let's look at what happened to ORH after the 9/11 attack:  the stock was driven down to $11.29, but ORH had a book value of about $13.50 at the time (not the exact figure, I'm working from memory).   So that was roughly .8x book.

 

Then there was Katrina/Rita/Wilma -- it drove ORH P/B down to about 1.0x.  But it was already trading near book in the first place.  I mean, the stock actually was higher in November than in July!

 

So today FFH is trading at book value... will KRW repeat, and if it does, will FFH follow ORH and actually go UP?

 

 

[oldye]

That's pretty close to what I get (I get about 0.72x using $125 US GAAP figure and stock at $90 in June 2006).

 

An assertion was made that a terror attack or a hurricane would knock down the valuation to 0.6x book...

 

Let's look at what happened to ORH after the 9/11 attack:  the stock was driven down to $11.29, but ORH had a book value of about $13.50 at the time (not the exact figure, I'm working from memory).   So that was roughly .8x book.

 

Then there was Katrina/Rita/Wilma -- it drove ORH P/B down to about 1.0x.  But it was already trading near book in the first place.  I mean, the stock actually was higher in November than in July!

 

So today FFH is trading at book value... will KRW repeat, and if it does, will FFH follow ORH and actually go UP?

 

 

 

A strong insurable event would lead to a hard market and lots and lots of profitable float which could quickly bring intrinsic value up by a 8-10 billion dollars.  Thats why using BV as a wading wand for intrinsic value ain't the smartest thing in the world...but I understand why many chose to do it,  anchoring. 

The gap between IV and BV will only increase when they start do more business.

[benhacker]

I will bet a lot of money with anyone who thinks <0.6x will happen before 1.4x.  Seriously guys, this is a total lack of clear thinking about history if anyone thinks that's going to happen <with any meaningful probability>.  At 0.7x or 0.8x, I think I *still* might take the bet.

 

That is not to say that FFH is a no-brainer, just to keep in perspective how different things are now vs. 2003 (or even 2006).

 

Thanks,

 

Ben

[oec2000]

Even if we accept 0.6x book as a possibility (which I think we should), we should at the same time factor in the probability of it happening. Someone who worried about the possibility of 0.6x book in non-probabilistic terms would have reached the same conclusion all through 2007,8 & 9 and missed the opportunity of taking a full position in FFH.

 

If you believe that FFH can grow book by 15% p.a. over the long run, you are fighting gravity by waiting for the 0.6x book event. If you think it is a high probability event, you would be prudent to wait. But, if you think it is a low probability event, waiting could cause you to lose out. E.g. If the 0.6x event only happens 3 years out when book had compounded to 1.52x of current book, the 0.6x event would bring you back to only 0.9x current book.

[ERICOPOLY]

That's pretty close to what I get (I get about 0.72x using $125 US GAAP figure and stock at $90 in June 2006).

 

An assertion was made that a terror attack or a hurricane would knock down the valuation to 0.6x book...

 

Let's look at what happened to ORH after the 9/11 attack:  the stock was driven down to $11.29, but ORH had a book value of about $13.50 at the time (not the exact figure, I'm working from memory).   So that was roughly .8x book.

 

Then there was Katrina/Rita/Wilma -- it drove ORH P/B down to about 1.0x.  But it was already trading near book in the first place.  I mean, the stock actually was higher in November than in July!

 

So today FFH is trading at book value... will KRW repeat, and if it does, will FFH follow ORH and actually go UP?

 

 

 

A strong insurable event would lead to a hard market and lots and lots of profitable float which could quickly bring intrinsic value up by a 8-10 billion dollars.  Thats why using BV as a wading wand for intrinsic value ain't the smartest thing in the world...but I understand why many chose to do it,  anchoring. 

The gap between IV and BV will only increase when they start do more business.

 

 

The key phrase is "when they do more business".  Sanjeev pointed out recently that soft markets can last more than a decade.

 

 

 

[Alekbaylee]

The key phrase is "when they do more business".  Sanjeev pointed out recently that soft markets can last more than a decade.

 

 

Well the hard market seems here, at least for me. Got my car insurance renewal in the mail this week and it was up nearly 20%. Called them but, unlike in the past, they were firm and say 95% of their clients this year will see their premium go up. I've been with the same company (Eastern Canada) for the last 12 years (car+residential insurance) and have the cleanest record (no accident or claim whatsoever).

Called another broker to see if I could get a better cotation, but they couldn't offer any better deal.

 

 

[oldye]

The average insurance cycle lasts about 7 years so no doubt it can go longer than 7 years but a long soft market ain't bad at all for Fairfax...they have the flexibility to put capital to work in a wide variety of ways other than insurance.