2018 shareholders letter

[petec]

There is nothing new....

Looking forward....I like where they sit....lots of options.

Time to perform that simple.

 

Dazel

 

Dazel you were bullish on the buyback - how do you feel about that now and in particular have you satisfied yourself about the options?

[Dazel]

 

Petec,

 

I get it...a good year is expensive in share dilution because of share based awards....but profits will go into more buybacks which will bring the share count down the next year... It’s incentive that is not being met which is why 89888 shares were issued the insurance companies that did well I am assuming.

So if Fairfax performs I can worry if not the buy back continues at a good clip unabated by share based awards.

Why not just pay cash bonuses from profits if it is a good year and take the share count down? Surely no one is begging for more shares the price has not moved in years!

 

[shalab]

This is also a year when the cash declined at the holding company and debt increased. As noted in page 19 of AR

Financial Position

The  following  table  shows  our  financial  position,  excluding  consolidated  non-insurance  companies,  at  the  endof 2018:

Holding company cash and investments (net of short sale and derivative obligations)1,550.6

Borrowings – holding company3,859.5

 

 

Petec,

 

I get it...a good year is expensive in share dilution because of share based awards....but profits will go into more buybacks which will bring the share count down the next year... It’s incentive that is not being met which is why 89888 shares were issued the insurance companies that did well I am assuming.

So if Fairfax performs I can worry if not the buy back continues at a good clip unabated by share based awards.

Why not just pay cash bonuses from profits if it is a good year and take the share count down? Surely no one is begging for more shares the price has not moved in years!

[Dazel]

 

I am not concerned with the drop in holdco cash vs debt....they bought back more of their subs and they had a miserable year investing not unlike everyone else this time. I have argued and continue to argue their massive cash position and treasury position puts them in position to outperform the Markel’s of the world who got caught in quarter four of 2018. This has allowed them to fund AGT, Seaspan, Greek eurobank-real Estate merger funding if needed and to give Blackberry the courage to make a game changing acquisition and most importantly to me...to give Brian Bradstreet the ability to print cash (I like the corporate bond position and hope that he went bigger in quarter one...it is likely up 10 to 15%=$700m to $1b from dec 31). Fairfax and Prem’s gift are operating companies not stock picking. They are vultures....it has cost them lately but that’s how they built Fairfax. Bradstreet and the insurance companies give me enough confidence that they will create very solid operating earnings...the investing side needs to do very little to create big numbers from the 2018 low.

 

In quiet year this year...Fairfax should make $3b pretax.

[ourkid8]

Dazel, $3B maybe too aggressive but let's use the numbers that Prem has provided to us in his annual letter as a starting point:

 

A 15% return on equity implies earnings of approximately $2 billion, so paying approximately $300 million in dividends would leave us with $1.7 billion for stock buybacks and tuck-in acquisitions.

 

In quiet year this year...Fairfax should make $3b pretax.

[Spekulatius]

 

I am not concerned with the drop in holdco cash vs debt....they bought back more of their subs and they had a miserable year investing not unlike everyone else this time. I have argued and continue to argue their massive cash position and treasury position puts them in position to outperform the Markel’s of the world who got caught in quarter four of 2018. This has allowed them to fund AGT, Seaspan, Greek eurobank-real Estate merger funding if needed and to give Blackberry the courage to make a game changing acquisition and most importantly to me...to give Brian Bradstreet the ability to print cash (I like the corporate bond position and hope that he went bigger in quarter one...it is likely up 10 to 15%=$700m to $1b from dec 31). Fairfax and Prem’s gift are operating companies not stock picking. They are vultures....it has cost them lately but that’s how they built Fairfax. Bradstreet and the insurance companies give me enough confidence that they will create very solid operating earnings...the investing side needs to do very little to create big numbers from the 2018 low.

 

In quiet year this year...Fairfax should make $3b pretax.

 

MKL isn’t really cash constrainted, imo. Rather than adding bonds, how about reducing debt and specifically the preferred?. They pay about $350M in interest annually. I doubt adding some bonds at prevailing interest rates is effective vs just reducing interested rate expense ciampreferred or bond buybacks.

[shalab]

1-2 Billion after-tax is difficult without gains from investments. (let alone 3B). I would take out income (net realized gain from investments) from equity/stock sales. Where will the money come from? It is one to dream big and another to make it happen.

 

Then you would have to assume that there won't be further dilution.

 

Overall, I don't see chances very bright to get 15% on equity on a continuous basis. It may happen one year because of gains in stocks or investment gains.

 

There are simpler and better opportunities out there.

 

 

 

I am not concerned with the drop in holdco cash vs debt....they bought back more of their subs and they had a miserable year investing not unlike everyone else this time. I have argued and continue to argue their massive cash position and treasury position puts them in position to outperform the Markel’s of the world who got caught in quarter four of 2018. This has allowed them to fund AGT, Seaspan, Greek eurobank-real Estate merger funding if needed and to give Blackberry the courage to make a game changing acquisition and most importantly to me...to give Brian Bradstreet the ability to print cash (I like the corporate bond position and hope that he went bigger in quarter one...it is likely up 10 to 15%=$700m to $1b from dec 31). Fairfax and Prem’s gift are operating companies not stock picking. They are vultures....it has cost them lately but that’s how they built Fairfax. Bradstreet and the insurance companies give me enough confidence that they will create very solid operating earnings...the investing side needs to do very little to create big numbers from the 2018 low.

 

In quiet year this year...Fairfax should make $3b pretax.

[Dazel]

 

 

I am okay with $3b pretax probably $1.3b first quarter...will go from there.

I don’t agree with the crowd normally and have been wrong here before but not often...I am happy to be against the crowd.

 

Good luck to all!

[Dazel]

 

 

I am aware it is a bold call and certainly would not bet the house on it...but Fairfax is coming from a very low level on Dec 31 2018...why not have 2019 be a big year for Fairfax...they are certainly due.

[Spekulatius]

Pretty good commentary from the shareholder meeting

https://www.woodlockhousefamilycapital.com/blog/notes-from-toronto

[shalab]

Parsad said this in the other thread. I think that discussion belongs here.

 

FFH is definitely a viable business and is in a different league compared to BH or PGNT (ethics). Prem has achieved a lot and he doesn't need to compare himself to anyone. He and his family is set for generations as they virtually control FFH. However, FFH as an investment is a different story for folks trying to increase their own wealth by investing their hard earned dollars. I don't think there is a need to say they aim for 15% return or that they will emulate Singleton. One of the legacies of Singleton is that his family is one of the largest land owners in America. May be that is what Prem is alluding to when he says he will emulate Singleton - his family will be one of the richest in Canada for generations. These claims are misleading and unnecessary. If anything, it tarnishes his legacy.

 

He has been the chancellor of university of waterloo, has given money to charity (Dakshana foundation) etc. He can do more of these and his legacy will be safe.

 

There are many honest, capable managers in corporate america - one can invest in one or many of these companies or the entire group through an index. Over a lifetime, one can get very good results through the index, especially with dividend reinvestment.

 

Feel free to throw me and everyone else under the bus, but you jackasses should probably remove FFH from that list...Prem's given you nearly 35 years of outperformance.

 

Yeah there have been periods where he has under performed...even long stretches...but he's walked the walk and talked the talk better than anyone else other than Buffett.  Even Buffett had a tough time the last few years, and he's as close to perfect in the industry as anyone has ever seen!

 

So if your bar is Buffett and only Buffett, then that is a statistical population of one!  If your bar is ethical, honest investment company CEO's that you can trust your money with and have a good chance of outperforming for the long-term with interest aligned, it may be nominally higher and Prem would be in that group.  Cheers!

 

Thanks for posting.

 

Pretty good commentary from the shareholder meeting

https://www.woodlockhousefamilycapital.com/blog/notes-from-toronto

[Jurgis]

Pretty good commentary from the shareholder meeting

https://www.woodlockhousefamilycapital.com/blog/notes-from-toronto

 

Not bad. But I think there's a lot of anchoring to Watsa's 15% return goal.

[coc]

It doesn't strike anyone as strange that the company states a 15% IRR goal (over and over, year after year) when it hasn't achieved that in the last 5, 10, 15, 20, or 25 year periods?

 

It's one thing to call it "aspirational" but one could interpret that as "deeply misleading".

[petec]

It doesn't strike anyone as strange that the company states a 15% IRR goal (over and over, year after year) when it hasn't achieved that in the last 5, 10, 15, 20, or 25 year periods?

 

It's one thing to call it "aspirational" but one could interpret that as "deeply misleading".

 

This is a personal view, but the 15% is now being expressed as 95% CR and 7% return on investments. I see no issue in targeting those metrics over the long term. What they've achieved in the past doesn't have to be a guide to what they aspire to in the future, especially when they've sworn not to repeat the biggest mistake of all (the huge naked hedge).

 

That said, I couldn't care less that they target 15% and I find it surprising that people on here focus so hard on it. That's not a criticism, it's just that I have never had the sense that they manage towards the 15% goal in a bad way. Their mistakes are plenty, but they are so long term in approach that personally I don't think the mistakes stem from stretching to get to 15% - and that's the main negative of having a public goal. So I just ignore it, and focus on whether I think 95% and 7% are achievable (probably and probably not, respectively) and whether I'd be happy owning Fairfax at the current price if the ROE was say 10% over the long haul (yes with bells on).

[Viking]

Pretty good commentary from the shareholder meeting

https://www.woodlockhousefamilycapital.com/blog/notes-from-toronto

 

Thanks for posting. The author has other interesting posts :-)

[Spekulatius]

It doesn't strike anyone as strange that the company states a 15% IRR goal (over and over, year after year) when it hasn't achieved that in the last 5, 10, 15, 20, or 25 year periods?

 

It's one thing to call it "aspirational" but one could interpret that as "deeply misleading".

 

This is a personal view, but the 15% is now being expressed as 95% CR and 7% return on investments. I see no issue in targeting those metrics over the long term. What they've achieved in the past doesn't have to be a guide to what they aspire to in the future, especially when they've sworn not to repeat the biggest mistake of all (the huge naked hedge).

 

That said, I couldn't care less that they target 15% and I find it surprising that people on here focus so hard on it. That's not a criticism, it's just that I have never had the sense that they manage towards the 15% goal in a bad way. Their mistakes are plenty, but they are so long term in approach that personally I don't think the mistakes stem from stretching to get to 15% - and that's the main negative of having a public goal. So I just ignore it, and focus on whether I think 95% and 7% are achievable (probably and probably not, respectively) and whether I'd be happy owning Fairfax at the current price if the ROE was say 10% over the long haul (yes with bells on).

 

I regard the 15% ROE as an aspirational goal at this point. What irks me more than FFH not even close to reaching this goal is the increasing share count (by 2.4M shares last year) that shalab pointed out. It’s even more irritating with all the talk about Singleton and quite frankly, it looks like he is talking one thing and doing just the opposite. Did someone ask a question regarding the share dilution and how it squares with the talk about buybacks? There might be a good explanation for this, but it’s odd that it’s not addressed in the annual report or in the shareholders meeting.

[Gregmal]

It doesn't strike anyone as strange that the company states a 15% IRR goal (over and over, year after year) when it hasn't achieved that in the last 5, 10, 15, 20, or 25 year periods?

 

It's one thing to call it "aspirational" but one could interpret that as "deeply misleading".

 

This is a personal view, but the 15% is now being expressed as 95% CR and 7% return on investments. I see no issue in targeting those metrics over the long term. What they've achieved in the past doesn't have to be a guide to what they aspire to in the future, especially when they've sworn not to repeat the biggest mistake of all (the huge naked hedge).

 

That said, I couldn't care less that they target 15% and I find it surprising that people on here focus so hard on it. That's not a criticism, it's just that I have never had the sense that they manage towards the 15% goal in a bad way. Their mistakes are plenty, but they are so long term in approach that personally I don't think the mistakes stem from stretching to get to 15% - and that's the main negative of having a public goal. So I just ignore it, and focus on whether I think 95% and 7% are achievable (probably and probably not, respectively) and whether I'd be happy owning Fairfax at the current price if the ROE was say 10% over the long haul (yes with bells on).

 

I regard the 15% ROE as an aspirational goal at this point. What irks me more than FFH not even close to reaching this goal is the increasing share count (by 2.4M shares last year) that shalab pointed out. It’s even more irritating with all the talk about Singleton and quite frankly, it looks like he is talking one thing and doing just the opposite. Did someone ask a question regarding the share dilution and how it squares with the talk about buybacks? There might be a good explanation for this, but it’s odd that it’s not addressed in the annual report or in the shareholders meeting.

 

There is a certain personality/salesmanship type that follows the below playbook;

 

Tout positive events

Spin mid spectrum events in your favor

Ignore bad events

 

There is an even more unique type that can take that last one and without guilt say it is actually something different and wholly positive.

 

There is no tolerance it seems, from many when a certain businessman, now politician does this sort of mind trickery, but it appears there is still tolerance for it on the investment front.

 

It is my belief that no profitable business trading below IV should ever be issuing shares. Period. Maybe, and only maybe in very minimal amounts, to certain key employees, but thats it. There is no excuse here.

[petec]

@Spek my understanding is that the share issuances relate to the management restructuring - as you know there's been a huge shift in who manages what and in effect they wanted the new movers and shakers to have more equity. What annoys me is that they haven't given any detail around whether this might continue, whether there was a performance-based element, whether those employees have committed to buying shares in the market with salary, etc. Actually it doesn't just annoy me, it staggers me.

 

[MarioP]

It doesn't strike anyone as strange that the company states a 15% IRR goal (over and over, year after year) when it hasn't achieved that in the last 5, 10, 15, 20, or 25 year periods?

 

It's one thing to call it "aspirational" but one could interpret that as "deeply misleading".

So I just ignore it, and focus on whether I think 95% and 7% are achievable (probably and probably not, respectively) and whether I'd be happy owning Fairfax at the current price if the ROE was say 10% over the long haul (yes with bells on).

 

Pete I’m really surprise that you  think FFH will probably not achieve 7% investment returns. Long term it’s less than a S&P500 index. I’m more septic about 95% CR when the loss from catastrophes are include

[petec]

It doesn't strike anyone as strange that the company states a 15% IRR goal (over and over, year after year) when it hasn't achieved that in the last 5, 10, 15, 20, or 25 year periods?

 

It's one thing to call it "aspirational" but one could interpret that as "deeply misleading".

So I just ignore it, and focus on whether I think 95% and 7% are achievable (probably and probably not, respectively) and whether I'd be happy owning Fairfax at the current price if the ROE was say 10% over the long haul (yes with bells on).

 

Pete I’m really surprise that you  think FFH will probably not achieve 7% investment returns. Long term it’s less than a S&P500 index. I’m more septic about 95% CR when the loss from catastrophes are include

 

That's 7% across the whole portfolio, ~70% of which has to be invested in fixed income for regulatory reasons (quite rightly). 7% was very doable when treasuries yielded 5%. Much harder now - the extra work the equities have to do is far greater.

[Parsad]

It doesn't strike anyone as strange that the company states a 15% IRR goal (over and over, year after year) when it hasn't achieved that in the last 5, 10, 15, 20, or 25 year periods?

 

It's one thing to call it "aspirational" but one could interpret that as "deeply misleading".

So I just ignore it, and focus on whether I think 95% and 7% are achievable (probably and probably not, respectively) and whether I'd be happy owning Fairfax at the current price if the ROE was say 10% over the long haul (yes with bells on).

 

Pete I’m really surprise that you  think FFH will probably not achieve 7% investment returns. Long term it’s less than a S&P500 index. I’m more septic about 95% CR when the loss from catastrophes are include

 

That's 7% across the whole portfolio, ~70% of which has to be invested in fixed income for regulatory reasons (quite rightly). 7% was very doable when treasuries yielded 5%. Much harder now - the extra work the equities have to do is far greater.

 

As far as I know, they aren't required to have 70% in fixed income for regulatory reasons...where did you get that from? 

 

I think they could do 7% no problem long-term, as long as Brian Bradstreet is also there.  They will have to find someone as gifted as Brian to join Hamblin-Watsa.  I don't think they can rely on the young guys they have there already, because it's not something you just can learn...like picking equities, there is an art to fixed income as well. 

 

Brian is one of the best...Francis is damn good...but I don't know how much depth there is at Hamblin-Watsa on the fixed income side.  It's a project they need to work on over the next 2-3 years.  Find that guy!  Cheers!

[petec]

It doesn't strike anyone as strange that the company states a 15% IRR goal (over and over, year after year) when it hasn't achieved that in the last 5, 10, 15, 20, or 25 year periods?

 

It's one thing to call it "aspirational" but one could interpret that as "deeply misleading".

So I just ignore it, and focus on whether I think 95% and 7% are achievable (probably and probably not, respectively) and whether I'd be happy owning Fairfax at the current price if the ROE was say 10% over the long haul (yes with bells on).

 

Pete I’m really surprise that you  think FFH will probably not achieve 7% investment returns. Long term it’s less than a S&P500 index. I’m more septic about 95% CR when the loss from catastrophes are include

 

That's 7% across the whole portfolio, ~70% of which has to be invested in fixed income for regulatory reasons (quite rightly). 7% was very doable when treasuries yielded 5%. Much harder now - the extra work the equities have to do is far greater.

 

As far as I know, they aren't required to have 70% in fixed income for regulatory reasons...where did you get that from? 

 

I think they could do 7% no problem long-term, as long as Brian Bradstreet is also there.  They will have to find someone as gifted as Brian to join Hamblin-Watsa.  I don't think they can rely on the young guys they have there already, because it's not something you just can learn...like picking equities, there is an art to fixed income as well. 

 

Brian is one of the best...Francis is damn good...but I don't know how much depth there is at Hamblin-Watsa on the fixed income side.  It's a project they need to work on over the next 2-3 years.  Find that guy!  Cheers!

 

I phrased that badly. What I meant was: they have to have a lot in fixed income for regulatory reasons and generally the weighting has been around 70%. In fact I think it's probably more like 75% on average - off the top of my head I can't recall a time when they had >30% in equities although I may be wrong. I don't ever expect them to have much more than their own book value invested in equities and I don't get the impression they feel they can add much equity exposure from today's starting point. I draw that assumption from various sources.

 

Anyway the core point is that the S&P is not a fair benchmark for the entire portfolio, as was implied by the post I was replying to. I think they might do 7%, but with fixed income priced where it is I'm happier with an assumption of 5% or 6%. However the float leverage means that even with the portfolio performing below the S&P, BV growth could beat it. And I think the debt+warrant deals are a very smart way to juice returns in a low rates environment - I hope to see more of them.

 

Totally agree that the fixed income bench is opaque and replacing Bradstreet is a huge project. Frankly it worries me if you don't know who's behind him in the queue - I thought you knew everything ;)

[Cigarbutt]

The historical return on bonds has been exceptional, explains a lot of the "excess" return earned over the years and, looking at a table that has been included up to the 2017 annual report and at other disclosures, FFH bond returns over 10 to 15 yr periods have mostly beat the return on the S&P, by a wide margin in some periods. This will be very hard to repeat.

 

From a long-term perspective, in the last 10 years, bond exposure has been 2-3x common stock exposure. The proportional exposure was 4-5x in the 2003-7 period and about 10x in the 1999-2001 period. So the times, they are changin'.

 

Whatever regulatory or risk management reasons and similar to Berkshire Hathaway, the cash and fixed income portion of the portfolio has remained quite constant in comparison to liability reserves. Using: (cash + cash equivalents + bonds + preferred) / (Insurance contract liabilities minus recoverable from reinsurers) as a relatively crude but quite accurate measure, the ratio has been 1.06 +/- 0.06 over the last 10 years and 1.03 +/- 0.03 over the last 8 years.

 

At this point, for better or for worse, the 7% pre-tax expected return on the 1425.97 USD investments per share has a lot to do with the net exposure to equity investments in the portfolio.

 

[coc]

There is no specific regulatory requirement, but Fairfax could never put so much in equities that a major drop (of 50% type magnitude or more) would impair their claims-paying ability or their solvency as an insurer. Rather than look at it as “does fixed income cover claims?”, you might want to see it in reverse “does my capital cover my equity portfolio?”

 

At the end of the day, the claims are a revolving door. In any one period, Fairfax does not need access to most of its investments. But it does need to be (comfortably) solvent at all times.

 

Even Berkshire, with all of its earnings sources, has rarely had its equity portfolio greater than its actual shareholders’ equity (in other words, a leveraged equity portfolio).

 

Imagine for a second that Fairfax put 150% of its capital in equities — so call it $16 billion — which then fell 50% in a market rout. With $3 billion of capital left, they would be in very, very dire straits as an insurance company - the regulators could force them to raise capital, stop underwriting, dilute, etc.

 

So there are limits - but not hard limits. This is my understanding.

[TwoCitiesCapital]

It doesn't strike anyone as strange that the company states a 15% IRR goal (over and over, year after year) when it hasn't achieved that in the last 5, 10, 15, 20, or 25 year periods?

 

It's one thing to call it "aspirational" but one could interpret that as "deeply misleading".

So I just ignore it, and focus on whether I think 95% and 7% are achievable (probably and probably not, respectively) and whether I'd be happy owning Fairfax at the current price if the ROE was say 10% over the long haul (yes with bells on).

 

Pete I’m really surprise that you  think FFH will probably not achieve 7% investment returns. Long term it’s less than a S&P500 index. I’m more septic about 95% CR when the loss from catastrophes are include

 

That's 7% across the whole portfolio, ~70% of which has to be invested in fixed income for regulatory reasons (quite rightly). 7% was very doable when treasuries yielded 5%. Much harder now - the extra work the equities have to do is far greater.

 

Agreed here. 7% is going to be very difficult in an environment where 10-year Treasuries yield 2.5%.

 

Bradstreet has been amazing in bonds, and the return has been exceptional - but that all occurred primarily in an environment where yields were falling (i.e. bonds purchased gaining value).

 

Starting from yields of 2.5% with the bulk of the portfolio in short-term debt, we don't have that tailwind. Brian may make some very prescient moves (a la selling portfolio following Trump's election), but that primarily results in losses avoided - not gains to the bottom line that count towards that 7%. That will generally be the case if we're in an extended period of rising rates like Prem believes.

 

Until interest rates are significantly higher, and the portfolio deployed into longer-term debt collecting the higher rates, a consistent 7% hurdle/average is going to be very difficult on the investment side.