Fairfax 2023

[Thrifty3000]

3 hours ago, Xerxes said:

thanks. I am looking forward to watch this movie 4x a year (through quarterly releases) for the next several years, watching it adapt and change. This almost beats reading Tolkien’ work. 
 

One thing that can be a bull case for artificially high ROE (in absence of external and internal opportunities), is a major return of capital that would drop equity, giving that ROE a low base to be computed from. 

 

YES. I was just about to say the same thing about return of capital. With so much cash flooding in the door it will be very interesting to watch where they park it. If the stock price continues hovering around book value then if they aren't using excess cash to buy back shares it means they must have REALLY juicy alternatives. I assume the only reason they would park excess cash into ultra-low yielding bonds rather than return capital would be if those bonds allowed them to underwrite additional insurance at extremely favorable rates.

Edited December 20, 2023 by Thrifty3000

[Hamburg Investor]

6 hours ago, SafetyinNumbers said:

It’s hard to argue it’s a big love in when the multiple is 1x BV and IFC and TSU trade closer to 2.5x BV. I appreciate it’s because their earnings have less variability and estimates show consistent growth which quants like. It doesn’t mean they will create more value over the next 5 years and certainly doesn’t guarantee they have better stock performance although anything is possible. 
 

I think a lot of FFH investors are scarred from the last decade and are very afraid of drawdowns. There is no consideration for what could go right despite a very strong set up. I think it’s greater than 50-50 odds that ROE is north of 15% for the next 3 years based on the current balance sheet. It could be materially north or it could be lower but ultimately I think the odds of a 20% ROE are higher than a 10% ROE over the next 3 years and thankfully my hurdle is 10% so I’m still happy to own it even if my lofty expectations aren’t met.

To me that seems a reasonable way to think about Fairfax. Heads you win a lot, tails it‘s ok. 
 

Again and again the discussion here touches interest rates. Where will they be in one year? In two year or three years? I don’t know. And I’m pretty sure the answer is: Nobody knows. Nobody has ever known. But the point is: it’s not important to know where interest will be in such a short timeframe, if you have lots of time to invest.
 

And what if we would think more about the question, if there is a “new normal” that is 0% or 2%? I think that is way more easy to answer for most of us. If you think there is a new normal, then Fairfax Financial (as well as every other insurance company, but Fairfax in particular) won’t prosper. If interest rates go back to zero and stay there for two decades, then there will be better buys than insurance companies. 
 

But I don’t think so. If anything history shows, that there has never been such a thing like “a normal interest rate.” There have been peaks and lows… but interest rates have never been staying at any level for long. 

 

Of course, others might disagree. There is always the possibility that “this time is different”. But I think there are a lot of cases in history, that show, that betting on “this time is different” normally isn’t a brilliant move. In fact going that way is really risky. 

 

So my thinking is more like: “If interest rates on average are at 2% or higher over longer timeframes then Fairfax has to do a lot of more dumb things then good things for not beating the S&P 500 buy a whole lot. 
 

And history. Again. How likely is it, that a company that has compounded within the top 1% (0.1%?) of stocks over 37 years is going to do so many more dumb things then good things? In fact you don’t find a lot of management teams, that have been working for one company for 37 years and being that good in the end. Buffett? Hasn’t reached 19% CAGR since 1986. Tom Gayner? I don’t think so, but I haven’t checked

 

Of course, people are free to believe that - again - “this time is different” with regards to the Fairfax management team. Maybe Prem and his team have lost all their skills in 2011 and 2021 to 2023/2025 is just a very short upswing episode in that downswing. Maybe.

 

But normally people that have done a very very good job over 25 years on average (1986 to 2011) don’t lose their skills overnight. 
 

A value investor having a CAGR of 19% of 37 years in his books at the end of a lost decade, which happened parallel to a zero interest rate episode, where growth has been beating value like never before, tells me another story.
 

The question is which perspective is right and which is wrong? 

[Hamburg Investor]

19 hours ago, Viking said:

In terms of return on their total investment portfolio, I have Fairfax tracking at 8.2% for 2023. And 7.2% for 2024 and 2025.
 

For both 2024 and 2025 i am modelling nothing for large realized gains: items like selling pet insurance or Ambridge. Or revaluing of GIG (this should drop into 2023). I think it is highly likely Fairfax will do something meaningful to surface value in 2024 or 2025. So i think my 7.2% estimate is conservative. 
 

What about 2026? And further out? That is simply a bet on management. And their capital allocation skills. Fairfax has been putting on a clinic the past 5 years when it comes to capital allocation. Volatility is a tailwind for Fairfax - not a headwind. Why do people expect they are going to all of sudden get stupid? From my perspective that approach is not being conservative. 

 
I totally agree. And I asked myself this question again, and again.
 

Maybe it’s because: Prems results were always bumpy. Not like Berkshire or Markel or most of the other insurance companies. Maybe it’s harder for people to trust management with bumpy results, even if there is a clear pattern over 37 years? A pattern with absolute returns that are way better than the smooth results of the competitors fishing in the same lake? Don’t get me wrong. Berkshire and Markel are opposition two and three in my investment portfolio. But Fairfax is on position one.
 

@Viking As you are discussing this historical chart, I look at again and again. But I don’t get the point of that chart.

 

All I can read is that the returns of the investment portfolio more or less define the end results in conpounding.
 

But even there are exceptions. And I can’t read anything out of the combined ratio. There’s just no relationship getting visable with regards to the compounding. Of course there is a relationship, I know. But this historical chart doesn’t help to understand that. and normally you show chart because you want the reader to understand an inner structure. 
 

So is the cr just included to point out to shareholders that Prem is aware that the combined ratio is important? Sometimes I ask myself if Prem thinks that in the future, the relationship will be getting more and more visible and I would agree on that point. 
 

What is he trying to show to us? What do you read in it?

[Viking]

2 hours ago, Hamburg Investor said:

 
I totally agree. And I asked myself this question again, and again.
 

Maybe it’s because: Prems results were always bumpy. Not like Berkshire or Markel or most of the other insurance companies. Maybe it’s harder for people to trust management with bumpy results, even if there is a clear pattern over 37 years? A pattern with absolute returns that are way better than the smooth results of the competitors fishing in the same lake? Don’t get me wrong. Berkshire and Markel are opposition two and three in my investment portfolio. But Fairfax is on position one.
 

@Viking As you are discussing this historical chart, I look at again and again. But I don’t get the point of that chart.

 

All I can read is that the returns of the investment portfolio more or less define the end results in conpounding.
 

But even there are exceptions. And I can’t read anything out of the combined ratio. There’s just no relationship getting visable with regards to the compounding. Of course there is a relationship, I know. But this historical chart doesn’t help to understand that. and normally you show chart because you want the reader to understand an inner structure. 
 

So is the cr just included to point out to shareholders that Prem is aware that the combined ratio is important? Sometimes I ask myself if Prem thinks that in the future, the relationship will be getting more and more visible and I would agree on that point. 
 

What is he trying to show to us? What do you read in it?

@Hamburg Investor if i understand your question correctly, i think Prem is trying to provide a shorthand way to value Fairfax (this is just a guess): CR + Total return on investment portfolio = possible ROE = way to value Fairfax.

 

Here is a link to an old writeup on Fairfax from 2019 that discusses this relationship. 
- https://www.woodlockhousefamilycapital.com/post/the-horse-story

 

“Moreover, I think the assets collectively could generate a ~10%-type ROE. Watsa has made a public goal of hitting 15%. (FFH’s ROE was 15% in the second quarter, thanks to investment gains). He says a 95% combined ratio and a 7% return on FFH’s investments gets to a 15% ROE.

 

“But in a low-interest rate environment, and given a large bond portfolio, a 7% return seems unlikely. But possible. Sustaining a double-digit ROE is key. (FFH can reach 10% by following a number of roads. For example, one road requires a ~95% combined ratio and ~5% return on its portfolio. That seems do-able.)

 

“Anyway, a consistent 10% would grow book value at a decent clip and then you’d likely get an additional lift from the valuation even if the stock moved just to 1.2x book. As RayJay reports, a comparable set of North American insurers with an 11% ROE trades for 1.7x book value per share.”

Edited December 20, 2023 by Viking

[gfp]

3 minutes ago, Viking said:

Here is a link to an old writeup on Fairfax from 1999 that discusses this relationship. 

Oh man I really thought that was going to be a 1999 research piece but I guess you meant 2019.  

[Hamburg Investor]

17 minutes ago, Viking said:

@Hamburg Investor if i understand your question correctly, i think Prem is trying to provide a shorthand way to value Fairfax (this is just a guess): CR + Total return on investment portfolio = possible ROE = way to value Fairfax.

 

Here is a link to an old writeup on Fairfax from 1999 that discusses this relationship. 
- https://www.woodlockhousefamilycapital.com/post/the-horse-story

 

“Moreover, I think the assets collectively could generate a ~10%-type ROE. Watsa has made a public goal of hitting 15%. (FFH’s ROE was 15% in the second quarter, thanks to investment gains). He says a 95% combined ratio and a 7% return on FFH’s investments gets to a 15% ROE.

 

“But in a low-interest rate environment, and given a large bond portfolio, a 7% return seems unlikely. But possible. Sustaining a double-digit ROE is key. (FFH can reach 10% by following a number of roads. For example, one road requires a ~95% combined ratio and ~5% return on its portfolio. That seems do-able.)

 

“Anyway, a consistent 10% would grow book value at a decent clip and then you’d likely get an additional lift from the valuation even if the stock moved just to 1.2x book. As RayJay reports, a comparable set of North American insurers with an 11% ROE trades for 1.7x book value per share.”

I know the discussion and the theoretical frameset. I like that persoective.
 

But how do you get those numbers together?

 

- 1986 to 1990: cagr of 57.7%, a combined ratio of 106.7 and an average total return on the investment portfolio of 10.4%.

- From 2001 to 2005 the investment returns were 8.6%, the cr was 105.4%, but the cagr was minus 0.9 per cent.

 

So both the insurance businesses as well as the investment returns are relatively similar in both timeframes; but the cagr couldn’t differ more. 58 per cent plus to minus 1 per cent. So the relationship between the numbers shown doesn‘t get visible. 

Or look at the timeframe 1996 to 2000. Investment returns were equal, but the cr was way more bad. Still the cagr was 31 per cent better then in the years with the worse cr.

 

At least we’d need to know how big the investment portfolio was and the premiums and the equity. But he hasn’t added that. Why not? Without that context and other contexts (like the macro bet) that are important in some of the timeframes, I can‘t read the relationship out of the numbers.  
 

That would be a great framework and one would understand a lot. What does the chart alone show to you intuitively?

 

As he hasn’t added those numbers, I wonder why? How does the chart help without that? The numbers shown alone to me seem totally random, one (at least me) isn’t able to get to any conclusion by looking at the numbers shown about any relationship between those. There’s just nothing to understand intuitively by looking at the chart for me - so I guess, there’s something I miss.  (There are other tables and charts like e. g. the table with the insurance companies results or the table with the tech stocks, that are easy to understand).

[Viking]

1 hour ago, gfp said:

Oh man I really thought that was going to be a 1999 research piece but I guess you meant 2019.  

 My mistake - edit has been made  

[StubbleJumper]

28 minutes ago, Hamburg Investor said:

But how do you get those numbers together?

 

- 1986 to 1990: cagr of 57.7%, a combined ratio of 106.7 and an average total return on the investment portfolio of 10.4%.

- From 2001 to 2005 the investment returns were 8.6%, the cr was 105.4%, but the cagr was minus 0.9 per cent.

 

 

There's a relationship there, but it's not perfectly clean.  That table is intended to convey the financing differential for the insurance companies.  So, the short form of that is, in approximate terms, (portfolio return% - cost (benefit) of float%)  x premiums to surplus ratio = ROE for the insurance sub.  But it's not really that clean because the cost of float is calculated on a calendar year basis rather than an accident year basis, so the skeletons in the closet appear from previous years and advance forward to future years.  What is more, for most of those years, unrealised gains did not appear in the investment returns, so much of the value that was created didn't show up until assets were disposed (sometimes 3 or 4 years later).  But, the thought process is very much the driver of value creation in an insurance sub even if the accounting metrics are imperfect.

 

 

SJ

[Hamburg Investor]

18 minutes ago, StubbleJumper said:

 

There's a relationship there, but it's not perfectly clean.  That table is intended to convey the financing differential for the insurance companies.  So, the short form of that is, in approximate terms, (portfolio return% - cost (benefit) of float%)  x premiums to surplus ratio = ROE for the insurance sub.  But it's not really that clean because the cost of float is calculated on a calendar year basis rather than an accident year basis, so the skeletons in the closet appear from previous years and advance forward to future years.  What is more, for most of those years, unrealised gains did not appear in the investment returns, so much of the value that was created didn't show up until assets were disposed (sometimes 3 or 4 years later).  But, the thought process is very much the driver of value creation in an insurance sub even if the accounting metrics are imperfect.

 

 

SJ

ThNk tou for tour answer. What do you mean with „That table is intended to convey the financing differential for the insurance companies.“? Sorry for not getting that point. 

 

And isn‘t the formular more like portfolio return x portfolio assets + profit (loss) ratio of insurance x premiums to surplus ratio etc.?
 

The Portfolio returns are on all assets (so e. g. including equity and float), while the combined ratio is only linked to the premiums. Or am I wrong here?

[Thrifty3000]

2 hours ago, Hamburg Investor said:

I know the discussion and the theoretical frameset. I like that persoective.
 

But how do you get those numbers together?

 

- 1986 to 1990: cagr of 57.7%, a combined ratio of 106.7 and an average total return on the investment portfolio of 10.4%.

- From 2001 to 2005 the investment returns were 8.6%, the cr was 105.4%, but the cagr was minus 0.9 per cent.

 

So both the insurance businesses as well as the investment returns are relatively similar in both timeframes; but the cagr couldn’t differ more. 58 per cent plus to minus 1 per cent. So the relationship between the numbers shown doesn‘t get visible. 

Or look at the timeframe 1996 to 2000. Investment returns were equal, but the cr was way more bad. Still the cagr was 31 per cent better then in the years with the worse cr.

 

At least we’d need to know how big the investment portfolio was and the premiums and the equity. But he hasn’t added that. Why not? Without that context and other contexts (like the macro bet) that are important in some of the timeframes, I can‘t read the relationship out of the numbers.  
 

That would be a great framework and one would understand a lot. What does the chart alone show to you intuitively?

 

As he hasn’t added those numbers, I wonder why? How does the chart help without that? The numbers shown alone to me seem totally random, one (at least me) isn’t able to get to any conclusion by looking at the numbers shown about any relationship between those. There’s just nothing to understand intuitively by looking at the chart for me - so I guess, there’s something I miss.  (There are other tables and charts like e. g. the table with the insurance companies results or the table with the tech stocks, that are easy to understand).

You would have to chart a few more things to be able to answer your questions.

 

Just looking at per share BV growth, CR and Portfolio return doesn’t tell you enough. 
 

For example, you would need to know the share count at the beginning and end of the period. During some periods FFH issues lots of new shares, while other times FFH buys back shares. This impacts per share BV growth. 
 

Additionally you would need to chart the premiums written per share and the value of the portfolio per share. 
 

The amount of premiums written per share fluctuates widely depending on the underwriting environment. During soft markets FFH will reduce premium volumes to 1x BV or less. But, during hard markets FFH ramps up premium volume to 1.5x BV. So, CR needs to be viewed in relation to the amount of premiums per share during a given time period. 

Edited December 21, 2023 by Thrifty3000

[vinod1]

I analyzed historical Fairfax investment returns and compared to what their return would have been if they invested in index funds both with CDS gains and excluding CDS gains. This is way back in 2015 and I posted this on my blog but when I moved my website to another provider, I did not move the blog and dont have it online.

 

I was doing this because I wanted to see if I should get back in FFH after selling it off in 2011.

 

Vinod

Fairfax Expected Returns Year End 2014.pdf

[StubbleJumper]

2 hours ago, Hamburg Investor said:

ThNk tou for tour answer. What do you mean with „That table is intended to convey the financing differential for the insurance companies.“? Sorry for not getting that point. 

 

And isn‘t the formular more like portfolio return x portfolio assets + profit (loss) ratio of insurance x premiums to surplus ratio etc.?
 

The Portfolio returns are on all assets (so e. g. including equity and float), while the combined ratio is only linked to the premiums. Or am I wrong here?

 

 

Yes, but the mental framework dates back to when sovereign debt rates were higher, so insurance companies routinely lost money on underwriting.  So, there was an investment return and a cost of float (because the CR was more than 100).  The cost of float was the cost of financing (ie, the amount you paid to use someone else's money for a year).  If your investment return exceed your cost of financing you made money, at least before admin costs.  Over the long term, your financing differential has been 4-4.5%.  This year it's been 6-ish% (94 CR) plus 5-ish% from treasury bonds, for a total of 11-ish percent....

 

 

SJ

[petec]

On 12/20/2023 at 1:35 PM, SafetyinNumbers said:

It’s hard to argue it’s a big love in when the multiple is 1x BV and IFC and TSU trade closer to 2.5x BV. 

 

I'm certainly not suggesting FFH is overvalued. More just saying that it isn't the layup that it was, and wondering about my position size.

 

On 12/20/2023 at 1:35 PM, SafetyinNumbers said:

I think a lot of FFH investors are scarred from the last decade and are very afraid of drawdowns. There is no consideration for what could go right despite a very strong set up.

 

I spent most of 2010-2020 thinking exclusively about what could go right! Now that they are, it is time to start thinking about what might go wrong.

 

On 12/20/2023 at 1:35 PM, SafetyinNumbers said:

I think the odds of a 20% ROE are higher than a 10% ROE over the next 3 years and thankfully my hurdle is 10% so I’m still happy to own it even if my lofty expectations aren’t met.

 

I think this is an excellent framework.

 

Worst case for me is BV $1300 in 3 years and stock at 0.8x on low rates. Not a terrible outcome.

[Ross812]

27 minutes ago, petec said:

 

I'm certainly not suggesting FFH is overvalued. More just saying that it isn't the layup that it was, and wondering about my position size.

 

 

I spent most of 2010-2020 thinking exclusively about what could go right! Now that they are, it is time to start thinking about what might go wrong.

 

 

I think this is an excellent framework.

 

Worst case for me is BV $1300 in 3 years and stock at 0.8x on low rates. Not a terrible outcome.

 

I think worst case is a super cat year comes along in the next few years and this ends up even money to down slightly if they sit at 0.8 to 1 x BV.  The bear case is 0 to 5% CAGR over 3 years - the bull case is 1.3x on a 2026 BV of $1300 - that's a CAGR of 23% over 3 years. My position size in Fairfax is 25% and I haven't sold a share yet. 

[Viking]

Operating income at Fairfax averaged around $40/share from 2015-2018. During this time, Fairfax was experiencing big losses from equity hedges and its new equity purchases were pretty terrible (APR, Farmers Edge, Fairfax Africa, AGT, Exco bankruptcy etc). Insurance was a tough business. Interest rates were low. Over this same timeframe, Fairfax’s stock price averaged around $525. That is what investors felt all the above was ‘worth.’ 

 

In 2024, operating income at Fairfax could come in around $200/share. This number is sustainable. That is 5 times higher. That is a massive increase in quality earnings. Capital allocation has been MUCH better from 2018-2023. Actually, it has been exceptional. Interest rates are much higher (even at current levels). Insurance has been in a 4 year hard market - and the business is now twice the size. Fairfax’s stock price today is $890, up a ‘whopping’ 70% from its average 2015-2018. 
 

Do people seriously think Fairfax is close to being fully valued today at $890? 
 

It appears we are at the ‘wall of worry’ phase with Fairfax. All the hand wringing on this board is probably a pretty bullish set up for the stock.
 

I keep coming back to this… the key is earnings. And what a ‘normalized’ level is for Fairfax. There is no consensus on what this number is today. IF the number is (as i suspect) $150/share then Fairfax is still crazy cheap. If correct, Fairfax should be able to grow this by 8-10% per year over the next couple of years (with volatility). And with this, we should see modest multiple expansion. With very modest assumptions it is fairly easy to get a double in Fairfax’s stock price over the next 3 to 3.5 years. How? 
 

1.) 2023YE BV = $925

2.) modest earnings growth each year

- 2024 = $165 (lets be conservative here).

- 2025 = $175

- 2026 = $185

3.) 2026BV = $1,450 (ignore dividends)

4.) modest multiple expansion to 1.2 x BV = $1,740 = double from current stock price. 
 

That would be a CAGR of 25%. Pretty good. 
 

What if earnings increase at more than $10/year? Likely in my view.
What if the multiple goes to more than 1.2 x BV? Also likely. 
 

Well, your 25% CAGR gets even better. 
 

What are board members currently getting most wrong about Fairfax? 
1.) what baseline earnings are today

2.) how good Fairfax is at capital allocation

3.) the impact record earnings and the magic of compounding will have on the trajectory of earnings over the next couple of years.

Edited December 21, 2023 by Viking

[Haryana]

On 12/20/2023 at 3:46 AM, petec said:

 

I preferred this investment when one didn't have to count on such things - they were available for less than free.

 

FFH is still my biggest position by far (17%) but I am wondering how long I should keep it there.

 

I am counting on them to make well timed trades to take advantage of volatility and doing so only because they are likely and only to upgrade 200/year or 1000 over 4 to 5 years. Otherwise, you may still get about 160 per year without them.

 

I like to know what will you buy instead if you sell FFH. I cannot see any better alternative in the whole market other than a more conservative Berkshire hold.

 

When you got in before the recent surge, you actually did that based on a lot of optimism and that appears good in the rear view mirror. You nailed the timing. However, to buy now is more rational than it was then due to better visibility.

 

The biggest risk I see is regulatory if they come to squeeze the whole sector.

 

[steph]

@Vikingthe only thing that will certainly happen in the coming years, but we don't know when, is a high catastrophe year with very bad combined ratios.   Business as usual, but it will impact your 25% compound. 

[petec]

14 hours ago, Viking said:

around $200/share. This number is sustainable

 

For three years, or long term? If you mean long term, what interest rates and CR do you need to get there? Genuinely interested and you're much closer to the numbers and modelling than anyone else, so value your view.

 

8 hours ago, Haryana said:

However, to buy now is more rational than it was then due to better visibility.

 

We will have to disagree on that. One of the structural underpinnings of my investment philosophy is that the market overpays for visibility. I therefore spend my time trying to find things where things could go very right, but not very wrong, at the going-in price. That kind of optionality is often underpriced, and it strikes me as highly rational to take those bets.  

[StubbleJumper]

16 hours ago, Viking said:

1.) 2023YE BV = $925

2.) modest earnings growth each year

- 2024 = $165 (lets be conservative here).

- 2025 = $175

- 2026 = $185

3.) 2026BV = $1,450 (ignore dividends)

4.) modest multiple expansion to 1.2 x BV = $1,740 = double from current stock price. 
 

That would be a CAGR of 25%. Pretty good. 
 

What if earnings increase at more than $10/year? Likely in my view.
What if the multiple goes to more than 1.2 x BV? Also likely. 
 

Well, your 25% CAGR gets even better. 

 

That's a good framework for thinking about this.  My preference is to think about the pessimistic scenario (but not the catastrophic one), and then to happily accept any outcome that ends up being better than that.  I tend to give a haircut to

2025 and 2026 out of an abundance of caution, and I don't tend to get too enthusiastic about the P/BV expansion because historically the market has been reticent to grant FFH much of a premium.  What that gives me is a reasonable floor of perhaps BV of $1,300 at Christmas 2026, and no growth in valuation.  So, ignoring the divvies, that pessimistic case is ~40%+ growth in the share price over three years, which would be a perfectly acceptable return.

 

The moons and stars might remained aligned for the next three years to enable FFH to continue to get strong underwriting profit, the economy might not slide into a recession which will enable the operating companies to continue to get strong operating results, and the market might take a more favourable view of FFH and award it a higher P/BV as it has done occasionally in the past.  If those things happen, I'll be a happy guy.  But, I have a large enough portfolio allocation to FFH that I am unwilling to assume that current favourable conditions will persist.  At some point, I will need to be rational and trim my position, and that needs to be informed by the pessimistic scenario.

 

 

16 hours ago, Viking said:

What are board members currently getting most wrong about Fairfax? 
1.) what baseline earnings are today

2.) how good Fairfax is at capital allocation

3.) the impact record earnings and the magic of compounding will have on the trajectory of earnings over the next couple of years.

 

Oh, I don't think board members are generally myopic about any of that.  We know very well that FFH has remarkable earnings capacity and has had a good investment track record.  In fact, Prem published a table depicting historical outcome of this on page 20 of his letter last year, and has publicly set a goal of achieving 15% annual growth in BV on a going-forward basis.  The challenge for a long-term investor in FFH is to reflect a little about that table on page 20 and Prem's stated goal.  If you believe that FFH will routinely clear that 15% hurdle on a long-term basis, you would happily accumulate shares up to a price of perhaps 1.3x or 1.4x BV (ie, 15% growth in BV priced at 1.4x gives you a PE a shade over 9).  But, if you are like me, when you look at that table on page 20 and you squint a little, maybe what you see is something considerably lower than 15% annual growth in BV.  The long-term results could be different on a going-forward basis, but investors would be well-advised to be mindful of the long-term past results.

 

 

SJ

 

 

[Viking]

13 hours ago, steph said:

@Vikingthe only thing that will certainly happen in the coming years, but we don't know when, is a high catastrophe year with very bad combined ratios.   Business as usual, but it will impact your 25% compound. 

@steph there are lots of things that could happen that would impact my earnings estimates. Some are bad. Some are good. Time frame also matters: short term or long term - some things will be short term negative and long term positive (and the opposite).
 

A really bad year for catastrophe losses in 2024 would likely extend the current hard market - so it might be a positive looking out 2 or 3 years. If Fairfax’s stock sold off aggressively this would give the company the opportunity to buyback a meaningful amount of shares on the cheap - which would be a big positive looking out 2 or 3 years. 
 

Bottom line, we know all of my estimates will be wrong. What we don’t know is if they will be too high or too low - and by how much. Especially over a couple of years. And that is the fun/interesting part of investing.

Edited December 22, 2023 by Viking

[Viking]

13 hours ago, petec said:

 

Viking: 

In 2024, operating income at Fairfax could come in around $200/share. This number is sustainable.

 

Petec: For three years, or long term? If you mean long term, what interest rates and CR do you need to get there? Genuinely interested and you're much closer to the numbers and modelling than anyone else, so value your view.

@petec i build my forecasts from the bottom up. You can see all my assumptions for 2024 and 2025. After 2025? Looking out 3 years or more i do not have any hard numbers. But for operating income, $200/share looks to me like a reasonable baseline to use. There will be lots of important puts and takes:
 

- share count: will likely come down, perhaps meaningfully (i think 2% per year is meaningful if sustained over many years)

- minority interest: Fairfax will likely continue to take minority partners out

- leverage: Fairfax will likely continue to use leverage. The GIG acquisition includes a sizeable ‘promissory note’

 

All three of these things will meaningfully impact the $200/share number looking out 5 years (and how much accrues to Fairfax shareholders). 
 

- net written premiums: my guess is this will continue to grow. Even if hard market ends? Yes. How? No idea, but GIG acquisition might provide a clue.

- size of fixed income portfolio: i expect this to continue to grow. $55 billion is not a crazy number looking out 5 years (it is $41 billion today).

- dividends: Eurobank could increase this by 50% in 2024. This bucket should grow nicely each year moving forward.

- share of profit of associates: Stelco is delivering close to zero today. Guess what it will deliver in the next steel up-cycle? Earnings at Poseidon/Atlas have been a mild headwind (underperforming); my guess is this will flip to a tailwind. More holdings will likely be coming into this bucket which would be another tailwind. The Hellenic Bank acquisition should be a big tailwind for Eurobank.

 

Now you asked about interest rate and CR. I don’t have a strong opinion about either. Perhaps rates move lower looking out 3 years. Or perhaps interest rates move higher again (perhaps we get a resurgence in inflation in 2H 2024 or 2025), which gives Fairfax the opportunity to lock in high rates for longer in another year or two. Or perhaps we get an event that causes credit spreads to blow out (like what happened to the regional banks but on a larger scale), and Fairfax flips to higher yielding corporates.

 

Perhaps the hard market continues to chug along. When the hard market ends perhaps it just goes sideways for 4 or 5 years (which i think is what usually happens). Perhaps Fairfax takes a bunch of the excess capital and buys back a bunch of stock and takes out some minority partners. 
 

Crisis and opportunity are different sides of the same coin. And Fairfax has excelled since 2018 at exploiting this relationship. I expect this to continue… i just can’t provide any details today of what they are going to do in 3 or 4 years time. 
 

You said in an earlier post that you felt the increase in interest rates was the primary driver of the increase in earnings at Fairfax. I couldn’t disagree more. My view is the biggest driver of earnings at Fairfax today are the collective decisions being made by the management team at Fairfax. Their many capital allocation decisions, some going back all the way to 2014.

 

Fairfax’s future results (including where operating income/share goes) depends primarily on the decisions the management team has made and will make moving forward. External factors (the path of interest rates and the insurance cycle) matter, but much less. This is where Fairfax differs from most other P/C insurers.

Edited December 23, 2023 by Viking

[Spekulatius]

On 12/19/2023 at 10:12 PM, Tommm50 said:

 

I don't believe lower CR's are driven by higher interest rates, if fact, the opposite. If an insurance company is not making income on the investment side it is forced to try to make it on the underwriting side i.e. lower CR's. I'm not sure the relationship to growth but growth is not as important as profit.

Yes all else being equal, higher interest rates should lead to higher CR because earnings from float should increase and that can compensate for higher CR’s.

 

Right now insurers have tailwind from both the hard market and higher investment income due to higher interest rates and I don’t think both will persist forever.

[Gregmal]

20 minutes ago, Spekulatius said:

Right now insurers have tailwind from both the hard market and higher investment income due to higher interest rates and I don’t think both will persist forever.

I don’t think you need it to because if it does, at 5x you get rich really quick.

[Viking]

3 hours ago, Spekulatius said:

Yes all else being equal, higher interest rates should lead to higher CR because earnings from float should increase and that can compensate for higher CR’s.

 

Right now insurers have tailwind from both the hard market and higher investment income due to higher interest rates and I don’t think both will persist forever.

@Spekulatius i agree that we will see some tailwinds turn into headwinds in the coming years. At the same time we will see some headwinds turn into tailwinds. Insurers are in the capital management business - and the well run companies will make adjustments. Fairfax likely has more options than any other P/C insurer.
 

I think the relationship between CR and interest rates is way more complicated than people think. Why?

1.) there is no insurance market. There are many insurance markets. Workers comp is still in a soft market - its hard market is likely coming. Personal (auto) has been a terrible business in recent years - and it is a very large market. Reinsurance (property cat) looks to be in a hard market. This is just for the US. Each region of the world also has its own unique characteristics. All these lines and regions have their own unique insurance cycle. Sometimes they line up and other times (like now) they do not. WR Berkley talked about this on one of their conference calls this year.

2.) interest rates are not having a significant impact on investment portfolios today. The Swiss Re Institute released a comprehensive study recently and they are projecting portfolio returns to tick modestly higher in both 2023 and 2024. Most P/C insurers were not positioned like Fairfax was in 2021 - so they are not seeing a spike in interest income. If interest rates go lower in 2H 2024 most insurers will likely have missed the big move higher.

I also think the whole CR/interest rate discussion matters way less for Fairfax compared to traditional P/C insurers.

3.) For Fairfax, today only 20% of their various income streams comes from underwriting profit and 80% comes from other sources (40% from interest and dividends, 20% from share of profit of associates and 20% from mark to market equities and investment gains). Underwriting profit is a much more important income stream for traditional P/C insurers. So even if the CR at Fairfax declines slightly in the coming years (this is not a given), given its small relative size, it will likely have a small impact on Fairfax’s total earnings - the total $ decline will likely easily be absorbed by another income stream. 
4.) everyone is laser focussed on interest income today. Guess what rarely gets discussed? Equities/non-interest bearing investments. Even at Fairfax. Why? Equities have been in a bear market - pretty much everything ex the magnificent seven. This will reverse. And when it does Fairfax will likely see some big gains from its equity portfolio - likely +$2 billion in one year.

 

And to really blow your mind (love the Matrix movie), try and forecast these individual buckets with precision looking out 3 or 4 years. 

Edited December 25, 2023 by Viking

[Hoodlum]

In the official press release from today, Fairfax plans to buy the remaining 10% of GIG in Q1. 
 

https://www.fairfax.ca/press-releases/fairfax-successfully-completes-acquisition-of-additional-46-32-interest-in-gulf-insurance-group-from-kipco-2023-12-26/