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Market Disconnect is One of the Craziest I've Seen in 23 Years!


Parsad
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The market disconnect presently is the craziest I've seen since the 1999 bubble, which ended badly by March of 2000.  I remember when Berkshire was selling at 0.75 of book value, while internet stocks were ridiculously priced.

 

Today, we have Fairfax trading at 0.75 of book value in solid shape with insurance churning out cash, while meme stocks like AMC with a business being disrupted by streaming, will lose close to $1.5-2B this year, and carrying enormous debt being valued at $20B market cap...down from $35B recently.  

 

Just plain silly!  Cheers!

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What I can’t fathom Sanjeev is who’s selling at these prices. I can’t imagine that real/knowledgeable investors would do this so you’ve got to wonder if it’s a short attack reprise, and to what end?

D

Edited by Daphne
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54 minutes ago, Daphne said:

What I can’t fathom Sanjeev is who’s selling at these prices. I can’t imagine that real/knowledgeable investors would do this so you’ve got to wonder if it’s a short attack reprise, and to what end?

D

 

No idea!  I just keep adding and adding. 

 

Unlike the past, I don't think there is anything nefarious going on.  If anything, I think institutions don't want to be on the wrong side of the trade, and are selling value stocks to add more and more high-flying stocks.  

 

As well, you have a ETF's pumping and buying more and more of the stocks in their indices.  They have to allocate the huge influx of capital into ETF's and it's a self-propagating cycle pushing up prices in those stocks.  

 

Finally, you have millennials and their supporters pushing up heavily shorted stocks with poor fundamentals and high-flying stocks like Tesla, Amazon, Google, Facebook, etc.  

 

It's just a wacky irrational market right now!  Cheers!

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Perhaps, if the intent is to close up the discount, and if the value is real there, than a NY-based listing would provide a boost in that price discovery.

Surely, the NY-based bears have moved on, and FFH today is not FFH of then. 

 

Large pension and/or sovereign fund have a problem these days: low interest rate. That problem is pushing them deeper and deeper into the world alternatives into the arms of Blackstone and Brookfield. FFH (for that matter other insurances) have the same issue as pension and/or sovereign fund, albeit at a smaller scale. Difference is that they cannot push deeper and deeper into alternatives, because they need to keep them into T-bill and bonds for regulatory reasons.

 

Now doesn't that deserve a broad industry discount to intrinsic value (given the very low yield on that bond portfolio).

 

Add to it, FFH-specific opaqueness compared to other insurers.

 

Now doesn't that deserve a FFH-specific discount to book value.

 

 

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It appears we have a supply / demand imbalance 🙂 More sellers than buyers. I am not trying to insult anyones intelligence but i think this best explains why we are seeing with the shares slowly selling off before what should be a good to very good earnings report. Lately, more investors are thinking selling shares is a better decision than buying more shares.
 

Insurance stocks in general are weak right now and have been for months (due to low bond yields and concerns hard market price increases have peaked). Cyclical stocks have also been weak for months; and Fairfax is loaded with cyclicals (look at how Atlas has been trading the past few months). So perhaps investors are looking at Fairfax and they see headwinds on both the insurance and investing buckets and therefore want to sell the shares (perhaps locking in big gains from the past year). And with Fairfax releasing earnings in a few days (Thursday after markets close) perhaps large investors want to see actual results before committing new money. 
 

The important thing to me right now are the Q2 results of the company. In aggregate, my view is the Fairfax ‘story’ continues to get better. Hopefully, this is confirmed on Thursday. This should help stoke demand (although posting very good results did not help WRB’s share price). However, it would not surprise me to see shares trade in the current range over the next few months given what we are seeing in the overall market.
 

The biggest near term catalyst might be stock buybacks by Fairfax. If earnings are solid perhaps Fairfax will have the cash to do a sizeable buyback. And with the stock trading at such a cheap valuation perhaps Fairfax will be more motivated to buy back shares. It will not take much of an increase in demand for shares for the price to pop. But if Fairfax is not interested/ or able buy back shares in a meaningful quantity i am not sure what the near term catalyst will be (given the current weakness in insurance and cyclical stocks). 
 

PS: Xerxes, makes sense a US listing would result in higher demand for shares 🙂 

Edited by Viking
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Because I always have to be that guy here....

 

theres lots, and has been lots of easy money out there folks. And over and over we keep hearing the same drum beat about FFH "eventually" catching fire....is there a need to be the one who finally gets blood from a stone? In other words, are you averse to just taking the easy route or something? We're well into a market where insurance is on fire, FFH equities have gone nuts, Watsa hasn't done anything crazy in a while....isnt it shit or get off the pot soon time? As they say...SHOW ME THE FUCKIN MONEY!

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🙂

The F'ING MONEY IS THERE, (i.e. Stelco is on fire today) ... but we keep getting 80 cents on every dollar that we put in.

Need 20 cents more to make us whole.

 

Edited by Xerxes
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Greg, Fairfax HAS caught fire over the past 9 months. It was trading at US $270 last October. And $340 Dec 31. So trading at even $413 today lots of investors have done very well with Fairfax over the past 9 months or so. 
 

Yes, the stock price has gone side ways for the last 5 months. And during that time its insurance operations and investments have done very well. So i think we can comfortably say the company is worth much more today than it was in Feb. We will find out more on Thursday. 
 

My guess is we will see another pop in the share price this year (assuming Fairfax continues to deliver solid results). At some point Mr Market will connect the dots and pick up the $20 bill lying on the ground 🙂

 

As Buffett says, time is the friend of the wonderful business. Given what is going on under the hood right now at Fairfax i think investors can be patient. And to be able to say that about Fairfax in 2021 puts a smile on my face 🙂 (However, i will be keeping an open mind on this topic.)

Edited by Viking
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2 hours ago, Viking said:

Greg, Fairfax HAS caught fire over the past 9 months. It was trading at US $270 last October. And $340 Dec 31. So trading at even $413 today lots of investors have done very well with Fairfax over the past 9 months or so. 
 

Yes, the stock price has gone side ways for the last 5 months. And during that time its insurance operations and investments have done very well. So i think we can comfortably say the company is worth much more today than it was in Feb. We will find out more on Thursday. 
 

My guess is we will see another pop in the share price this year (assuming Fairfax continues to deliver solid results). At some point Mr Market will connect the dots and pick up the $20 bill lying on the ground 🙂

 

As Buffett says, time is the friend of the wonderful business. Given what is going on under the hood right now at Fairfax i think investors can be patient. And to be able to say that about Fairfax in 2021 puts a smile on my face 🙂 (However, i will be keeping an open mind on this topic.)

 

The pop will come approximately 2 days after they announce phenomenal earnings - as it has the last few times they've had great earnings. 

 

Has been shocking how predictably it has repeated this behavior. 

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5 hours ago, Gregmal said:

Because I always have to be that guy here....

 

theres lots, and has been lots of easy money out there folks. And over and over we keep hearing the same drum beat about FFH "eventually" catching fire....is there a need to be the one who finally gets blood from a stone? In other words, are you averse to just taking the easy route or something? We're well into a market where insurance is on fire, FFH equities have gone nuts, Watsa hasn't done anything crazy in a while....isnt it shit or get off the pot soon time? As they say...SHOW ME THE FUCKIN MONEY!

 

Just goes completely against the grain with me.  I'm ok with easy money, if it is fundamentally easy money...buying in March of 2020...buying in late 2008/early 2009...buying value stocks in late 1999...buying Overstock at 0.1 of sales...buying WFC because everyone hates it at 0.6 times tangible book...buying JEF at 0.5 times tangible book...and buying FFH at 0.6 times book.  But the other easy money today...other than buying a ton of puts on AMC at $67...or a certain Greek bank at 0.2 times book (no, not Eurobank)...not the type of stuff I can hold any conviction for.  Cheers!

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Hopefully Fairfax the business is on track and the stock is now poised to outperform, but I don't think that you can deny that the stock price has been terrible for the last decade.

 

The stock has been an underperformer for almost any time period.  1, 2, 3, 5 10 years - all bad outperformance.  Probably most of last year is behind the indexes.  In the last 10 years, it looks to me that as of today the only outperforming timeframe to present is from a short period last fall.  If someone had the foresight to buy in October last year, then they are reasonably ahead of the S&P 500 today, but that is a super-cherry-picked timeframe.  A purchase at almost any other time is behind, and often very significantly so.

 

Share price has stunk.  No point denying it.  In fact, that's one of the reasons it might be a good opportunity today.

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I recently bought some, however if you take the devils advocacy you can empathize with Mr Market's lack of enthusiasm for the following reasons:

 

1.  The Magic Hat. No premium above mark-to-market valuation should be given to their equity portfolio.  It is also tax inefficient for many investors rather than holding these stocks directly in their tax-deferred accounts.

2.  Interest rates.  I'm not expecting Mr Market to assign much value to float that generates so little to show for the added risk.

3.  Growth in premiums.  Refer back to 2.  More low interest rate float that carries added risk.

4. Underwriting profit.  Looking back 10 years, it has value and came at no cost but how much did they actually rake in and what could have gone wrong instead?

5.  Swearing they'll never short again.  Do you remember when they had "learned" to invest in quality companies for the long term and bought JNJ, WFC, and KFT to prove their commitment to this revelation?  For how long did they own those stocks?

 

 

 

 

Edited by ERICOPOLY
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Although I own FFH and want the stock to go up, I can understand where the skeptics are coming from.  The way I see things, Prem says "Don't judge me on quarterly results or yearly results.  Instead, judge me on 5 year, 10 year, 20 year averages"

 

So now the market says, "ok Mr. Watsa, we can accept your terms of having the occasional bad quarter or bad year, but as long as we hit 13-15% return on book over a 5 or 10 year period, we'll be happy"  

 

Unfortunately, all during the 2010s this has not been the case.  In my simplified and crude calculations, FFH's rolling 5 year percentage return of book value since 2013 has been subpar.

 

Having said that, as many on the board have mentioned in the last 6 months - year, there is a lot to be optimistic about going forward.

Rolling 5 year book value average.xlsx

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https://s1.q4cdn.com/579586326/files/doc_financials/AR2000.pdf

https://s1.q4cdn.com/579586326/files/doc_financials/2020/q4/WEBSITE-Fairfax-Financial's-2020-Annual-Report.pdf

 

So, I'll argue the con argument here.  Sometimes addition by subtraction gets a better result.  Let's say you bought in 1999 at ~$200 at a nice discount to book value of $231.98 at year end which Sanjeev and I both did.  Fast forward 22 years, there are now twice as many shares 26.4M vs 13.1M and book value has grown to a whopping $661.7/share or 2.86 times or 4.9% annualized in 22 years and it's still at a discount to book.  Has anything really changed?  Is it really going to start compounding at 15% annually?

 

A different strategy would be to sell the Fairfax shares, patiently hold large sums of cash and deploy the cash during a market or company-specific downturn into a basket of actual long-term 15-20% compounders that are selling at a then market discount.

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10 minutes ago, omagh said:

https://s1.q4cdn.com/579586326/files/doc_financials/AR2000.pdf

https://s1.q4cdn.com/579586326/files/doc_financials/2020/q4/WEBSITE-Fairfax-Financial's-2020-Annual-Report.pdf

 

So, I'll argue the con argument here.  Sometimes addition by subtraction gets a better result.  Let's say you bought in 1999 at ~$200 at a nice discount to book value of $231.98 at year end which Sanjeev and I both did.  Fast forward 22 years, there are now twice as many shares 26.4M vs 13.1M and book value has grown to a whopping $661.7/share or 2.86 times or 4.9% annualized in 22 years and it's still at a discount to book.  Has anything really changed?  Is it really going to start compounding at 15% annually?

 

A different strategy would be to sell the Fairfax shares, patiently hold large sums of cash and deploy the cash during a market or company-specific downturn into a basket of actual long-term 15-20% compounders that are selling at a then market discount.

 

Three important things here:

 

- The insurance subsidiaries and operations between 2000 and 2010 were subpar to the likes of WTM, BRK, MKL, WRB, etc.  Different story today.

- Fairfax spent too much time on macro issues...made them money in 2009/2010, but cost them even more between 2012-2019.  Different story today.

- One of the most studied periods by Fairfax's team was Japan circa 1980-2000.  They've seen what happens to insurers in low interest rate environments.  I think they will do better in this environment than most of their peers.

 

I'm not going to lie to you.  Other than my taxable account, I've never held Fairfax from 2000-2020.  I've never held Berkshire consistently during that period.  I don't fall in love with stocks, no matter how much I admire the operations or manager...I put focus on the value of my portfolio...there is no forever hold stock for me.  But the periods when I've held these stocks, I've done very well and I believe we're in for another period where Fairfax will eventually be priced 1.15-1.25 times book.  Cheers!

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I would just add to Sanjeev's points that changes in the market values of Fairfax's non-insurance investments in associates & consolidated subs are not being captured by book value, so book value needs to be adjusted IMO if you want to measure Fairfax's intrinsic value. In Q1 2021, the mark to market movement of these non-insurance investments increased by $1.1 bil. 

 

Some of these significant non-insurance investments have been directly affected by Covid-19 & re-opening restrictions - Bangalore Airport, Thomas Cook India, Recipe etc - so operating earnings should improve as vaccination drive heats up.

 

 

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I might not explain this thought very well… but here goes.

 

Looking at past results can be useful when looking at a company as an input to better estimate future performance / expected returns for shareholders. When not much changes at the company (business, business strategy, management, industry etc). Berkshire is perhaps a good example. 
 

There are other times when looking at past results completely messes investors up. A good example here are the big US banks around 2016-2017. Many investors looked at their performance over the previous 10 years (terrible results) and concluded they were dogs with fleas. Management teams were also a bunch of crooks (Goldman were vampire squid). The REALITY of the situation in 2016-17 was the banks were completely different animals: well capitalized, profitable, well managed. Over relying/weighting on past results caused most investors to completely miss the opportunity staring them in the face. 
 

What matters? The logic. Why did a company perform a certain way 5 years ago? Or last year? And are the 2 comparable? When a company has changed overweighting past results will lead investors to mis-forecast future results.

 

A great example is Fairfax in 2008. They nailed CDS and made billions. This was not a repeatable event. But it resulted in investors being too optimistic about future results. 
 

And worse for investors Fairfax then got extremely bearish and proceeded to lose billions on short positions from 2013-2020. 
 

What does this ‘history’ tell us about future returns for Fairfax? On its own, way, way less than most investors might think.  
 

For me the key lesson of Fairfax’s historical returns (going back decades) is pretty simple: when they get the investing bucket right future returns for investors can be exceptionally good. When they get the investing bucket wrong future returns for investors can be terrible. There is also a second lesson for me: their insurance underwriting has improved (from weakness to mild strength). And a third lesson: this is NOT a buy and forget type stock (like Berkshire).
 

Logic and being rational and open minded is key. 

Edited by Viking
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17 hours ago, Thrifty3000 said:

Parsad! Shhhhh, you're spoiling the fun!

 

Buy 'em back, Prem!

 

This is key.  From the 2018 AR

 

"I mentioned to you last year that we are focused on buying back our shares over the next ten years as and when we get the opportunity to do so at attractive prices. Henry Singleton from Teledyne was our hero as he reduced shares outstanding from approximately 88 million to 12 million over about 15 years. We began that process by buying back 1.1 million shares since we began in the fourth quarter of 2017 up until early 2019 – about half for cancellation and half for various long term incentive plans we have across our company. This was after we increased our ownership of Brit to 89% from 73% while having the funds ready to increase our ownership of Eurolife from 50% to 80% in August 2019"

 

The next couple of quarters will be key in terms of whether this is just more platitudes.  All things considered, I cannot think of when Fairfax's share price has been more attractive.  Sure last year was cheaper on a P/B basis but on a relative basis compared to other opportunities it was cheapish.  Now compared to other opportunities I think it is a screaming buy.

 

Viking's comments are spot on, "You can't see the future through a rearview mirror".  However, managements actions, given the circumstances, will be key for me.  Given they were hamstrung last year,  the TRS play was a very good start

Edited by nwoodman
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When we say things like "this should trade above book value", what we are implicitly claiming is that Goodwill is understated on the balance sheet.

 

1.  We are left with $140.1m of pre-tax earnings for FFH in Q1 2021 after stripping out the "gains on investments".  

2.  If you annualize those earnings, you come to $560.4m and I'm currently noticing that the $6.3b of Goodwill on the balance sheet is 11x that figure.  The actual PE is higher because remember those are pre-tax earnings.

3.  Prem's comment in this years letter claims that a share price of $1,000 would cure the problem of the stock being undervalued.

 

Challenge question:

At what PE is Prem assigning to this annualized $560m figure in order to generate a goodwill asset so large as to push the stock price to $1,000?

 

And how does that compare to the 40x P/E that he is ragging on for MSFT?

Edited by ERICOPOLY
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It is likely that FFH is selling off due to lower interest rates, similar to other of the insurance peers. I don’t think there is anything special going on suppressing FFH in particular.

 

A comparison with Teledyne / Singleton was always nonsense. Teledyne is an industrial and can be run without notional equity. FFH is a financial and need regulatory capital to run their insurance subs. They are already leveraged with some debt at the holding level and that‘s pretty much all there is possible.

 

The other reason why FFH is trading at a discount is because their results are too inconsistent, compared to  comps like BRK. I think they have the wrong structure, stuff like  ATCO or Stelco really shouldn’t be held in an insurance umbrella. Those business are just too volatile for this. BRK hold quasi regulated equities like  BHE Energy and their railroad subs which are really equity bonds. Those are keeping regulators happy as they deliver predictable results.

Edited by Spekulatius
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I am with spekulatius on this. The timing of the ffh sell off seems to coincide with the plunge in yields.  I just assumed investors are concerned as ffh holds large amounts of bonds. 

 

Concerns about the long term capital allocation performance of ffh have always been present so not sure that is a factor to recent weakness. 

 

I agree too that ffh needs to ramp up buybacks or else accept a low multiple.  I would greatly prefer they cancel the dividend and apply that and all other excess capital to share buybacks. 

Edited by no_free_lunch
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5 hours ago, no_free_lunch said:

I am with spekulatius on this. The timing of the ffh sell off seems to coincide with the plunge in yields.  I just assumed investors are concerned as ffh holds large amounts of bonds. 

 

Concerns about the long term capital allocation performance of ffh have always been present so not sure that is a factor to recent weakness. 

 

I agree too that ffh needs to ramp up buybacks or else accept a low multiple.  I would greatly prefer they cancel the dividend and apply that and all other excess capital to share buybacks. 

 

I tend to agree with this too. Market is indiscriminately selling them because the biggest piece of the earnings pie (interest on their float) is constrained in a low rate environment. 

 

This whole "well, the market is justified in hating Prem" explanation would make A LOT more sense if it had traded for a discount to book for the last 5-years. But it hasn't. It traded at a reasonable premium to book in 2018/2019 with the same Prem, the same hindsight, and the same mistakes. I pointed out at that time that the math was hard to make sense of unless if you had unrealistic projections of the returns they'd earn on their equities and debt investments. 

 

Here we are 3-years later. Book value has caught up to the excitement that was priced in back in 2018/2019. We've had a free look at the growth of Digit and the other Indian investments which are doing phenomenally. Insurance subs are improving and Fairfax owns more of them today setting up a long-term sustained improvement in earnings power. And while I don't believe rates are about to sky rocket, I think the likelihood of treasury rates heading higher from 1.2% is quite a bit higher than it was at 3.25% back in 2018. And on top of that, instead of paying 1.2-1.3x book value (IIRC), you get it all for 0.6 - 0.8x book value if you've been acquiring for the last 12-18 months. 

 

Seems to me it's not Prem that the market is discounting. Mr. Market just gets too excited, or too dejected, on interest rates at exactly the wrong times. 

 

On 7/27/2021 at 4:59 PM, Parsad said:

 

- One of the most studied periods by Fairfax's team was Japan circa 1980-2000.  They've seen what happens to insurers in low interest rate environments.  I think they will do better in this environment than most of their peers.

 

I would hope this would be the case, but then remember that they closed out their duration bet in 2016 thinking Donald Trump would lead growth massively higher. They don't have much life left on the deflation swaps and they've sworn off shorting meaning if it's a deflationary bust they likely won't benefit much at all. 

 

Beyond their superb bond management in general, I don't think there is much else to hang our hat on here for them to outperform in deflationary and/or low rate environment unless if they were to do another immediate about face with there investment policies. 

 

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