Fairfax 2023

[Viking]

1 hour ago, glider3834 said:

viking suggested I put up a post on this subject - buyout of 12% stake from Allied minority shareholders - I won't detail all the background here but just the key points - just to qualify I am not an expert on IFRS accounting, I have cobbled this info together from filings and we are missing shareholder agreement bw minority investors & Fairfax.

 

I guess the purpose of this post is to try and look at the mechanics of this deal and how future transactions with minority interests in Allied, Odyssey, Brit or other subs might look.

 

So here we go

 

1. What did Fairfax pay for the 12% stake in Allied?

 

Fairfax paid $650M cash to minority shareholders for their 12% stake in Allied in Sep-22, this is actually equal to the minority shareholders original investment in July 2017. 

 

 

Here is the calculation (12%/29.1%) x $1580M = $650M

 

So we could infer that its likely Fairfax will need to spend $930M to acquire the remaining 17.1% stake in Allied now held by minority shareholders.

 

Question: Can we also infer that  this is the buyout price template for Odyssey & Brit minority stakes as well?

 

2. What was Fairfax's equity financing cost for this deal? Minority shareholders received a priority, fixed 8% annual dividend (or $126.4M on $1580M investment) from Allied.

 

 

Putting 1. & 2. together - both the equity financing and buyout price are fixed. Fairfax benefit is that it retains all the upside from Allied's revenue, net income and shareholder equity growth.

 

3. What is the immediate cash benefit to Fairfax of this deal?

By my estimate = $22.7M per annum

Calculation

8% dividend paid on 12% stake = $52M less $29.3M (after-tax interest cost on senior notes used to fund deal ie $650M x 5.63% x (1-0.2) - lets assume a 20% tax rate

 

Any further upside that Fairfax receives from this acquired 12% share of Allied over & above $52M is gravy.

 

4. How is fair value of consideration (including accrued dividend)  of $733.5M calculated?

 

This is equal to $650M cash paid plus $38.5M accrued dividend paid (on 12% stake for 1 Jan to 27 Sep) plus (I am estimating) $45M fair value of call option exercised.

 

5. Does the 12% Allied buyout impact earnings or book value?

 

It increases Fairfax's share of Allied's operating earning & going forward EPS - common shares 

It reduced BVPS as the fair value of consideration (excluding accrued dividend paid) = $695M was more than $467M carrying value of 12% stake in Allied - so the difference is a $228M reduction in common shareholder equity (important point this impacts shareholders equity (specifically its a loss of retained earnings) and it doesn't run through the earnings statement).

 

I hope I haven't given anyone a headache! lol

 

@glider3834 that was very well explained. Thank you for taking the time to figure out all the different pieces to this deal. It will help us lots moving forward… my guess is Fairfax will buy back another chunk of Allied World this year.
 

It appears to me that the the real benefit to Fairfax is it cleans up their balance sheet. They no longer have to make the fixed payments. And if they fund future buy backs with cash then it can be viewed as deleveraging. Which given the amount of debt they currently have would be a good thing. 

[Xerxes]

They did float a bond some months ago. So they are just moving the liability (or however you want to describe it) at corporate level.  

[Thrifty3000]

10 hours ago, glider3834 said:

viking suggested I put up a post on this subject - buyout of 12% stake from Allied minority shareholders - I won't detail all the background here but just the key points - just to qualify I am not an expert on IFRS accounting, I have cobbled this info together from filings and we are missing shareholder agreement bw minority investors & Fairfax.

 

I guess the purpose of this post is to try and look at the mechanics of this deal and how future transactions with minority interests in Allied, Odyssey, Brit or other subs might look.

 

So here we go

 

1. What did Fairfax pay for the 12% stake in Allied?

 

Fairfax paid $650M cash to minority shareholders for their 12% stake in Allied in Sep-22, this is actually equal to the minority shareholders original investment in July 2017. 

 

 

Here is the calculation (12%/29.1%) x $1580M = $650M

 

So we could infer that its likely Fairfax will need to spend $930M to acquire the remaining 17.1% stake in Allied now held by minority shareholders.

 

Question: Can we also infer that  this is the buyout price template for Odyssey & Brit minority stakes as well?

 

2. What was Fairfax's equity financing cost for this deal? Minority shareholders received a priority, fixed 8% annual dividend (or $126.4M on $1580M investment) from Allied.

 

 

Putting 1. & 2. together - both the equity financing and buyout price are fixed. Fairfax benefit is that it retains all the upside from Allied's revenue, net income and shareholder equity growth.

 

3. What is the immediate cash benefit to Fairfax of this deal?

By my estimate = $22.7M per annum

Calculation

8% dividend paid on 12% stake = $52M less $29.3M (after-tax interest cost on senior notes used to fund deal ie $650M x 5.63% x (1-0.2) - lets assume a 20% tax rate

 

Any further upside that Fairfax receives from this acquired 12% share of Allied over & above $52M is gravy.

 

4. How is fair value of consideration (including accrued dividend)  of $733.5M calculated?

 

This is equal to $650M cash paid plus $38.5M accrued dividend paid (on 12% stake for 1 Jan to 27 Sep) plus (I am estimating) $45M fair value of call option exercised.

 

5. Does the 12% Allied buyout impact earnings or book value?

 

It increases Fairfax's share of Allied's operating earning & going forward EPS - common shares 

It reduced BVPS as the fair value of consideration (excluding accrued dividend paid) = $695M was more than $467M carrying value of 12% stake in Allied - so the difference is a $228M reduction in common shareholder equity (important point this impacts shareholders equity (specifically its a loss of retained earnings) and it doesn't run through the earnings statement).

 

I hope I haven't given anyone a headache! lol

 

 

 

 

 

 

 

 

 

 

 

 

I love the deep dive analysis! Thanks.

 

Some back of the envelope analysis on Allied makes it look to me like FFH paid a very good price for the 12% stake...

 

A simple ROE analysis:

• Allied's book value = $4.6 billion
• A 15% ROE = $700 million of earnings power

A simple analysis of Allied's underwriting profitability and investment portfolio (to sanity check the ROE estimate):

• Allied's Net Premiums Written in 2022: $4.5 billion
• Allied's Average Combined Ratio since 2017: 94%
• Allied's Combined Ratio in 2022: 91%
• Allied's Underwriting Profit in 2022: $380 million
• Allied's Investment Portfolio: $11.5 billion

 

Conclusion, Allied's solid underwriting profitability and $11.5 billion investment portfolio appears to provide ample horsepower to deliver a 15% ROE. Add continued premium volume growth to the equation and it looks to me like FFH got a very good deal on its 12% purchase. And, I'm thrilled there's another 17% left for them to buy!

[This2ShallPass]

On 4/24/2023 at 8:27 AM, Viking said:

Fairfax Financial was the lone company among the top 10 that picked up market share in 2022, rising to 5.0% from 4.8%. The company also experienced a 26.6% surge in premiums.”

Why is Fairfax growing when Berkshire and Markel are being cautious? E&S is Markel's main line I think, so they have more expertise there than Fairfax.

 

We have all been ecstatic about their insane premium growth over the last few years, but is there a risk where they grew too fast? I assume not but this data point does concern me a bit..

[Munger_Disciple]

32 minutes ago, This2ShallPass said:

Why is Fairfax growing when Berkshire and Markel are being cautious? E&S is Markel's main line I think, so they have more expertise there than Fairfax.

 

We have all been ecstatic about their insane premium growth over the last few years, but is there a risk where they grew too fast? I assume not but this data point does concern me a bit..

 

+1

 

I had the same thoughts exactly. Wonder if there would be nasty u/w surprises at FFH.

[MMM20]

4.8% to 5.0% market share is statistical noise. A rounding error. Very different than a insurtech startup going from 0 to 10% in a few years and blowing up spectacularly. Worth monitoring with a Digit but I believe an unfair criticism of FFH as a whole… no new kid on the block. 

[This2ShallPass]

18 minutes ago, MMM20 said:

4.8% to 5.0% market share is statistical noise. A rounding error.

Going from 4.5% to 5% in 2 years is not noise. Markel went down from 5.8% to 5% in that period and most major insurers are also down..

[glider3834]

7 hours ago, This2ShallPass said:

Why is Fairfax growing when Berkshire and Markel are being cautious? E&S is Markel's main line I think, so they have more expertise there than Fairfax.

 

We have all been ecstatic about their insane premium growth over the last few years, but is there a risk where they grew too fast? I assume not but this data point does concern me a bit..

If you look at overall GPW growth rate for Fairfax at 17% in 2022 versus around 15% for Markel - not too different.

 

Fairfax is emphasising E&S with lines that have been in a hard market - if you listen to RB on WRB calls over course of 2022 he has been calling out the standard market while seeing more opportunities in E&S -so thats interesting - also if Fairfax were growing a lot in a soft market I would be  concerned.

 

IN recent quarters, Fairfax has been dialing down growth (& they talked about that at 2023 AGM) & that has been in line with moderating price increases - so appears to make sense. It does appear that property insurance is starting see more hardening conditions in recent months so that could open up more opportunity.

 

All of Fairfax's growth in 2022 is organic - so this is not acquisition led growth where they are buying new books

 

Berkshire grew DPW by 17.6% in E&S in 2022 - so looks more opportunistic than cautious to me and Fairfax was 26% but they are also coming off a smaller base.

 

 

 

 

 

 

 

 

 

 

 

 

Edited April 29, 2023 by glider3834

[MMM20]

7 hours ago, This2ShallPass said:

Going from 4.5% to 5% in 2 years is not noise.

We’ll have to agree to disagree!

 

Edited April 29, 2023 by MMM20

[Xerxes]

[Viking]

Is it time to sell Fairfax?

 

Fairfax’s stock has delivered a cumulative 105% return to investors over the past 28 months (since Dec 31, 2020). It has also paid three $10 dividends each year (all at once in January) so total returns have been even better.

 

 

How does this compare to the overall market? The S&P500 is up 11% over the past 28 months.

 

 

The performance of Fairfax’s share price the past 28 months has been breathtaking - both in absolute and relative terms. So what is a rational  investor to do with their shares? Why SELL of course. At least that is what I would have probably done in the past.

 

—————

Successful investors need to get two things right: when to buy AND when to sell. Over my investment career I have been much better at the ‘when to buy’ decision than the ‘when to sell’ decision. I have a history of selling my big winners way too early. An example? After a +100% gain over a couple of years, I sold most of my concentrated position in Apple in early 2016 - right around the time some guy names Warren Buffett started to buy. What was my mistake? My sell decision was primarily focussed on price - not fundamentals. Apple’s underlying business in 2014 and 2015 was getting better each year. After a +100% gain over 24 months the stock was still cheap when I sold it - and their future prospects never looked better. The crazy part is I knew all of this - I follow my largest positions very closely. So selling Apple in 2016 was a big mistake. Right? Not necessarily. One of the things I really like about investing is your mistakes can often lead to your greatest successes.

 

What was the lesson? Clearly, I needed to get better at the ‘when to sell’ part of investing. Here is what Peter Lynch has to say:

• The key to knowing when to sell, he says, is knowing "why you bought it in the first place." Lynch says investors should sell if: The story has played out as expected and this is reflected in the price.

—————

Let’s get back to Fairfax. What’s happened with the fundamentals at Fairfax over the past 28 months? We don’t have Q1 results yet so let's just look at the 24 months from Dec 31, 2020 to Dec 31, 2022.

 

1.) insurance: we have been in a hard market the past 2 years.

• net written premiums were up 50% over the two years from 2020 to 2022. CR has been improving. Underwriting profit has increased a whopping 260% from $308 million in 2020 to $$1.1 billion in 2022.
• Digit: we also learned Fairfax owns a large chunk of a start-up insurance company in India that is growing like a weed...

2.) investments - fixed income: we have shifted from QE to QT over the past 2 years.

• at the end of 2020 interest rates were very low with central banks saying they would remain very low for years. Interest income at Fairfax was falling like a stone. 2020 = $717 million. 2021 = $568 million.
• 2 short years later, at the end of 2022, interest rates had spiked. Interest income has now spiked higher. 2022 = $874 million.
• more importantly, the guide from Fairfax is for interest income to come in around $1.4 billion for 2023, 2024 and 2025.

3.) investments - equities: stock picking and active management is back.

• over the last 2 years Fairfax’s various equity holdings have spike higher. Fairfax’s style of investing (active management, value, commodities, energy) appears ideally suited for the current environment.
• new investment: TRS of FFH shares, a position initiated late 2020 and early 2021, was up $500 million pre-tax in 2 years ($700 million the past 28 months).
• share of profit of associates has ballooned from -$113 million in 2020 to $1.1 billion in 2022. This should come in around $900 million per year moving forward.

4.) investments - realized gains: chug, chug, chug...

• pet insurance was sold in 2022 for $1 billion after tax gain = $40/share. This was like found money.
• Resolute Forest Products was sold at the top of the lumber cycle for $625 million plus $180 million CVR. Resolute had a carrying value of $134 million at Dec 31, 2020. This was a significant increase in value for shareholders.

5.) shares outstanding: has come down 11% from 26.2 million on Dec 31, 2020 to 23.3 million on Dec 31, 2022.

• in late 2021 Fairfax repurchased 2 million shares at $500/share. 

 

----------

OK, let’s summarize things from a fundamental perspective. Over the past two years, Fairfax has delivered:

1.) record underwriting profit

2.) record interest and dividend income

3.) record share of profit of associates

4.) more than $2.5 billion in asset monetizations

5.) double digit decline in share count

 

So we have that interesting situation where Fairfax’s intrinsic value has been growing at 20-25% per year (2021 and 2022). Yes, the stock went up 21% in 2022 but my guess is intrinsic value in 2022 went up much more than that. So even after a 21% increase, the stock was likely cheaper at Dec 31, 2022 ($594) than it was on Dec 31, 2021 ($492).

 

How do Fairfax’s future prospects look? The three engines of their business (insurance, investments - fixed income and investments - equities) all look very well positioned in the current environment. For the first time in Fairfax’s history they are all performing well at the same time. And this set-up is expected to continue in the coming years. That suggests profitability at Fairfax should remain robust.

 

How do the usual valuation metrics look?

• P/E multiple: stock is trading at < 6 times 2023 earnings (est $120)
• P/BV multiple: stock is trading at about 1.06 x Dec 31 BV or 1 x est March 31 BV.
• ROE = 18% ($120 / $658)
• note: i did not use IFRS 17 BV = + $94/share at Dec 31, 2022. Using that measure just makes Fairfax stock look even cheaper.

Across all three metrics, Fairfax still looks cheap to dirt cheap. Less than 6 times earnings? An 18% ROE grower trading at 1 times BV?

 

So what is a rational investor to do after a 105% return in 28 months? What would Peter Lynch do? I think Peter Lynch would stick with this winning stock.

 

PS: The management team at Fairfax has been executing exceptionally well since about 2018. The fundamentals have been improving every year since then.

 

—————

The Peter Lynch Approach to Investing in "Understandable" Stocks

- https://home.csulb.edu/~pammerma/fin382/screener/lynch.htm

 

Lynch is an advocate of maintaining a long-term commitment to the stock market. He does not favor market timing, and indeed feels that it is impossible to do so. But that doesn’t necessarily mean investors should hold onto a single stock forever. Instead, Lynch says investors should review their holdings every few months, rechecking the company "story" to see if anything has changed either with the unfolding of the story or with the share price. The key to knowing when to sell, he says, is knowing "why you bought it in the first place." Lynch says investors should sell if:

• The story has played out as expected and this is reflected in the price; for instance, the price of a stalwart has gone up as much as could be expected.
• Something in the story fails to unfold as expected or the story changes, or fundamentals deteriorate; for instance, a cyclical’s inventories start to build, or a smaller firm enters a new growth stage.

For Lynch, a price drop is an opportunity to buy more of a good prospect at cheaper prices. It is much harder, he says, to stick with a winning stock once the price goes up, particularly with fast-growers where the tendency is to sell too soon rather than too late. With these firms, he suggests holding on until it is clear the firm is entering a different growth stage.

 

Rather than simply selling a stock, Lynch suggests "rotation"--selling the company and replacing it with another company with a similar story, but better prospects. The rotation approach maintains the investor’s long-term commitment to the stock market, and keeps the focus on fundamental value.

 

Edited April 30, 2023 by Viking

[This2ShallPass]

On 4/28/2023 at 4:57 PM, glider3834 said:

If you look at overall GPW growth rate for Fairfax at 17% in 2022 versus around 15% for Markel - not too different.

 

I tried looking at the last 8 years as that seemed like the inflection point. Fairfax is higher but not by much and maybe there's some international new business / inorganic growth there as well..

 

Gross premiums

 

Markel (2015-22) = $4.63B to $13.2b  (185% growth)

 

Fairfax (2015-2022) = $8B to $25B (212%. 2022- Page 11 of shareholder letter without Allied, I assume this is at Fairfax share of GPW)

 

 

[Dipesh Patel]

 

Here...comes...INDIA!!!

The world has a new largest country, and it's on the move.

https://www.noahpinion.blog/p/herecomesindia

 

 

 

[MMM20]

21 hours ago, Viking said:

Is it time to sell Fairfax?

 

Fairfax’s stock has delivered a cumulative 105% return to investors over the past 28 months (since Dec 31, 2020). It has also paid three $10 dividends each year (all at once in January) so total returns have been even better.

 

 

How does this compare to the overall market? The S&P500 is up 11% over the past 28 months.

 

 

The performance of Fairfax’s share price the past 28 months has been breathtaking - both in absolute and relative terms. So what is a rational  investor to do with their shares? Why SELL of course. At least that is what I would have probably done in the past.

 

—————

Successful investors need to get two things right: when to buy AND when to sell. Over my investment career I have been much better at the ‘when to buy’ decision than the ‘when to sell’ decision. I have a history of selling my big winners way too early. An example? After a +100% gain over a couple of years, I sold most of my concentrated position in Apple in early 2016 - right around the time some guy names Warren Buffett started to buy. What was my mistake? My sell decision was primarily focussed on price - not fundamentals. Apple’s underlying business in 2014 and 2015 was getting better each year. After a +100% gain over 24 months the stock was still cheap when I sold it - and their future prospects never looked better. The crazy part is I knew all of this - I follow my largest positions very closely. So selling Apple in 2016 was a big mistake. Right? Not necessarily. One of the things I really like about investing is your mistakes can often lead to your greatest successes.

 

What was the lesson? Clearly, I needed to get better at the ‘when to sell’ part of investing. Here is what Peter Lynch has to say:

• The key to knowing when to sell, he says, is knowing "why you bought it in the first place." Lynch says investors should sell if: The story has played out as expected and this is reflected in the price.

—————

Let’s get back to Fairfax. What’s happened with the fundamentals at Fairfax over the past 28 months? We don’t have Q1 results yet so let's just look at the 24 months from Dec 31, 2020 to Dec 31, 2022.

 

1.) insurance: we have been in a hard market the past 2 years.

• net written premiums were up 50% over the two years from 2020 to 2022. CR has been improving. Underwriting profit has increased a whopping 260% from $308 million in 2020 to $$1.1 billion in 2022.
• Digit: we also learned Fairfax owns a large chunk of a start-up insurance company in India that is growing like a weed...

2.) investments - fixed income: we have shifted from QE to QT over the past 2 years.

• at the end of 2020 interest rates were very low with central banks saying they would remain very low for years. Interest income at Fairfax was falling like a stone. 2020 = $717 million. 2021 = $568 million.
• 2 short years later, at the end of 2022, interest rates had spiked. Interest income has now spiked higher. 2022 = $874 million.
• more importantly, the guide from Fairfax is for interest income to come in around $1.4 billion for 2023, 2024 and 2025.

3.) investments - equities: stock picking and active management is back.

• over the last 2 years Fairfax’s various equity holdings have spike higher. Fairfax’s style of investing (active management, value, commodities, energy) appears ideally suited for the current environment.
• new investment: TRS of FFH shares, a position initiated late 2020 and early 2021, was up $500 million pre-tax in 2 years ($700 million the past 28 months).
• share of profit of associates has ballooned from -$113 million in 2020 to $1.1 billion in 2022. This should come in around $900 million per year moving forward.

4.) investments - realized gains: chug, chug, chug...

• pet insurance was sold in 2022 for $1 billion after tax gain = $40/share. This was like found money.
• Resolute Forest Products was sold at the top of the lumber cycle for $625 million plus $180 million CVR. Resolute had a carrying value of $134 million at Dec 31, 2020. This was a significant increase in value for shareholders.

5.) shares outstanding: has come down 11% from 26.2 million on Dec 31, 2020 to 23.3 million on Dec 31, 2022.

• in late 2021 Fairfax repurchased 2 million shares at $500/share. 

 

----------

OK, let’s summarize things from a fundamental perspective. Over the past two years, Fairfax has delivered:

1.) record underwriting profit

2.) record interest and dividend income

3.) record share of profit of associates

4.) more than $2.5 billion in asset monetizations

5.) double digit decline in share count

 

So we have that interesting situation where Fairfax’s intrinsic value has been growing at 20-25% per year (2021 and 2022). Yes, the stock went up 21% in 2022 but my guess is intrinsic value in 2022 went up much more than that. So even after a 21% increase, the stock was likely cheaper at Dec 31, 2022 ($594) than it was on Dec 31, 2021 ($492).

 

How do Fairfax’s future prospects look? The three engines of their business (insurance, investments - fixed income and investments - equities) all look very well positioned in the current environment. For the first time in Fairfax’s history they are all performing well at the same time. And this set-up is expected to continue in the coming years. That suggests profitability at Fairfax should remain robust.

 

How do the usual valuation metrics look?

• P/E multiple: stock is trading at < 6 times 2023 earnings (est $120)
• P/BV multiple: stock is trading at about 1.06 x Dec 31 BV or 1 x est March 31 BV.
• ROE = 18% ($120 / $658)
• note: i did not use IFRS 17 BV = + $94/share at Dec 31, 2022. Using that measure just makes Fairfax stock look even cheaper.

Across all three metrics, Fairfax still looks cheap to dirt cheap. Less than 6 times earnings? An 18% ROE grower trading at 1 times BV?

 

So what is a rational investor to do after a 105% return in 28 months? What would Peter Lynch do? I think Peter Lynch would stick with this winning stock.

 

PS: The management team at Fairfax has been executing exceptionally well since about 2018. The fundamentals have been improving every year since then.

 

—————

The Peter Lynch Approach to Investing in "Understandable" Stocks

- https://home.csulb.edu/~pammerma/fin382/screener/lynch.htm

 

Lynch is an advocate of maintaining a long-term commitment to the stock market. He does not favor market timing, and indeed feels that it is impossible to do so. But that doesn’t necessarily mean investors should hold onto a single stock forever. Instead, Lynch says investors should review their holdings every few months, rechecking the company "story" to see if anything has changed either with the unfolding of the story or with the share price. The key to knowing when to sell, he says, is knowing "why you bought it in the first place." Lynch says investors should sell if:

• The story has played out as expected and this is reflected in the price; for instance, the price of a stalwart has gone up as much as could be expected.
• Something in the story fails to unfold as expected or the story changes, or fundamentals deteriorate; for instance, a cyclical’s inventories start to build, or a smaller firm enters a new growth stage.

For Lynch, a price drop is an opportunity to buy more of a good prospect at cheaper prices. It is much harder, he says, to stick with a winning stock once the price goes up, particularly with fast-growers where the tendency is to sell too soon rather than too late. With these firms, he suggests holding on until it is clear the firm is entering a different growth stage.

 

Rather than simply selling a stock, Lynch suggests "rotation"--selling the company and replacing it with another company with a similar story, but better prospects. The rotation approach maintains the investor’s long-term commitment to the stock market, and keeps the focus on fundamental value.

 

I would say “submit this to VIC” but I’m happy to let FFH take out as many shares as they can at 6x earnings.

[Thrifty3000]

On 4/30/2023 at 11:45 AM, Viking said:

Is it time to sell Fairfax?

 

Fairfax’s stock has delivered a cumulative 105% return to investors over the past 28 months (since Dec 31, 2020). It has also paid three $10 dividends each year (all at once in January) so total returns have been even better.

 

 

How does this compare to the overall market? The S&P500 is up 11% over the past 28 months.

 

 

The performance of Fairfax’s share price the past 28 months has been breathtaking - both in absolute and relative terms. So what is a rational  investor to do with their shares? Why SELL of course. At least that is what I would have probably done in the past.

 

—————

Successful investors need to get two things right: when to buy AND when to sell. Over my investment career I have been much better at the ‘when to buy’ decision than the ‘when to sell’ decision. I have a history of selling my big winners way too early. An example? After a +100% gain over a couple of years, I sold most of my concentrated position in Apple in early 2016 - right around the time some guy names Warren Buffett started to buy. What was my mistake? My sell decision was primarily focussed on price - not fundamentals. Apple’s underlying business in 2014 and 2015 was getting better each year. After a +100% gain over 24 months the stock was still cheap when I sold it - and their future prospects never looked better. The crazy part is I knew all of this - I follow my largest positions very closely. So selling Apple in 2016 was a big mistake. Right? Not necessarily. One of the things I really like about investing is your mistakes can often lead to your greatest successes.

 

What was the lesson? Clearly, I needed to get better at the ‘when to sell’ part of investing. Here is what Peter Lynch has to say:

• The key to knowing when to sell, he says, is knowing "why you bought it in the first place." Lynch says investors should sell if: The story has played out as expected and this is reflected in the price.

—————

Let’s get back to Fairfax. What’s happened with the fundamentals at Fairfax over the past 28 months? We don’t have Q1 results yet so let's just look at the 24 months from Dec 31, 2020 to Dec 31, 2022.

 

1.) insurance: we have been in a hard market the past 2 years.

• net written premiums were up 50% over the two years from 2020 to 2022. CR has been improving. Underwriting profit has increased a whopping 260% from $308 million in 2020 to $$1.1 billion in 2022.
• Digit: we also learned Fairfax owns a large chunk of a start-up insurance company in India that is growing like a weed...

2.) investments - fixed income: we have shifted from QE to QT over the past 2 years.

• at the end of 2020 interest rates were very low with central banks saying they would remain very low for years. Interest income at Fairfax was falling like a stone. 2020 = $717 million. 2021 = $568 million.
• 2 short years later, at the end of 2022, interest rates had spiked. Interest income has now spiked higher. 2022 = $874 million.
• more importantly, the guide from Fairfax is for interest income to come in around $1.4 billion for 2023, 2024 and 2025.

3.) investments - equities: stock picking and active management is back.

• over the last 2 years Fairfax’s various equity holdings have spike higher. Fairfax’s style of investing (active management, value, commodities, energy) appears ideally suited for the current environment.
• new investment: TRS of FFH shares, a position initiated late 2020 and early 2021, was up $500 million pre-tax in 2 years ($700 million the past 28 months).
• share of profit of associates has ballooned from -$113 million in 2020 to $1.1 billion in 2022. This should come in around $900 million per year moving forward.

4.) investments - realized gains: chug, chug, chug...

• pet insurance was sold in 2022 for $1 billion after tax gain = $40/share. This was like found money.
• Resolute Forest Products was sold at the top of the lumber cycle for $625 million plus $180 million CVR. Resolute had a carrying value of $134 million at Dec 31, 2020. This was a significant increase in value for shareholders.

5.) shares outstanding: has come down 11% from 26.2 million on Dec 31, 2020 to 23.3 million on Dec 31, 2022.

• in late 2021 Fairfax repurchased 2 million shares at $500/share. 

 

----------

OK, let’s summarize things from a fundamental perspective. Over the past two years, Fairfax has delivered:

1.) record underwriting profit

2.) record interest and dividend income

3.) record share of profit of associates

4.) more than $2.5 billion in asset monetizations

5.) double digit decline in share count

 

So we have that interesting situation where Fairfax’s intrinsic value has been growing at 20-25% per year (2021 and 2022). Yes, the stock went up 21% in 2022 but my guess is intrinsic value in 2022 went up much more than that. So even after a 21% increase, the stock was likely cheaper at Dec 31, 2022 ($594) than it was on Dec 31, 2021 ($492).

 

How do Fairfax’s future prospects look? The three engines of their business (insurance, investments - fixed income and investments - equities) all look very well positioned in the current environment. For the first time in Fairfax’s history they are all performing well at the same time. And this set-up is expected to continue in the coming years. That suggests profitability at Fairfax should remain robust.

 

How do the usual valuation metrics look?

• P/E multiple: stock is trading at < 6 times 2023 earnings (est $120)
• P/BV multiple: stock is trading at about 1.06 x Dec 31 BV or 1 x est March 31 BV.
• ROE = 18% ($120 / $658)
• note: i did not use IFRS 17 BV = + $94/share at Dec 31, 2022. Using that measure just makes Fairfax stock look even cheaper.

Across all three metrics, Fairfax still looks cheap to dirt cheap. Less than 6 times earnings? An 18% ROE grower trading at 1 times BV?

 

So what is a rational investor to do after a 105% return in 28 months? What would Peter Lynch do? I think Peter Lynch would stick with this winning stock.

 

PS: The management team at Fairfax has been executing exceptionally well since about 2018. The fundamentals have been improving every year since then.

 

—————

The Peter Lynch Approach to Investing in "Understandable" Stocks

- https://home.csulb.edu/~pammerma/fin382/screener/lynch.htm

 

Lynch is an advocate of maintaining a long-term commitment to the stock market. He does not favor market timing, and indeed feels that it is impossible to do so. But that doesn’t necessarily mean investors should hold onto a single stock forever. Instead, Lynch says investors should review their holdings every few months, rechecking the company "story" to see if anything has changed either with the unfolding of the story or with the share price. The key to knowing when to sell, he says, is knowing "why you bought it in the first place." Lynch says investors should sell if:

• The story has played out as expected and this is reflected in the price; for instance, the price of a stalwart has gone up as much as could be expected.
• Something in the story fails to unfold as expected or the story changes, or fundamentals deteriorate; for instance, a cyclical’s inventories start to build, or a smaller firm enters a new growth stage.

For Lynch, a price drop is an opportunity to buy more of a good prospect at cheaper prices. It is much harder, he says, to stick with a winning stock once the price goes up, particularly with fast-growers where the tendency is to sell too soon rather than too late. With these firms, he suggests holding on until it is clear the firm is entering a different growth stage.

 

Rather than simply selling a stock, Lynch suggests "rotation"--selling the company and replacing it with another company with a similar story, but better prospects. The rotation approach maintains the investor’s long-term commitment to the stock market, and keeps the focus on fundamental value.

 

 

I can see EPS of $100 per share being the new lower bound for FFH. And, the share price obviously doesn't reflect that. However, I'm not sure I can confidently forecast when we might hit a normalized EPS beyond $150, so for now I'll be inclined to reduce my stake as Fairfax approaches my estimation of fair value on a modestly growing $100 per share earnings stream. Let's call it somewhere between $1,200 and $1,500 USD per share as of today.

 

Fairfax is experiencing some incredible tailwinds right now. But, the following headwinds 3 years from now aren't unthinkable:

 

- much softer insurance market

- much lower interest rates

- fairly valued share price (no more buybacks)

 

Each of those headwinds could act as gravity on the current $100 EPS, which means any new earnings from the invested free cash may only supplant rather than enhance EPS in the future.

 

I'm not suggesting another 7 year famine as much as I'm saying it's in the realm of possibility that normal earnings could be hovering somewhere below $150 per share in 3 years, and we could be staring at a sub $1,500 share price.

 

Don't get me wrong, when it comes to FFH I'm still jacked to the tits!

 

 

 

 

Edited May 1, 2023 by Thrifty3000

[jfan]

An aside to this topic of FFH still being cheap despite the run up in pricing and the question of what to do at this point. 

 

I think the concept of economic elasticity might be helpful:

ie:

- Thinking on the margins instead of absolutes

- What is the return/risk on the next marginal dollar?

- Anchoring bias on the prior absolute purchase price vs what the purchase price today means relative to its fundamentals

 

My normalized EPS is ~ $110 USD or $140 CAD. Even if I'm wrong, and EPS is really 1/2 of this, at these current prices, the earning's yield is 7.8%. Compared to the S&P 500 historical return of 7-8%, my general feel of the risk of margin compression, top-line growth deceleration, persistent share count dilution, probability of reinvestment success, etc between these 2 options, FFH seems better positioned.

 

The question for me is: "what is the rational thing to do with my future savings"?

 

I posted before that I would probably continue to hold my position, but the more I think about it, perhaps the rational thing to do is buy more given the opportunity set I have in front of me. 

 

 

[Viking]

1 hour ago, Thrifty3000 said:

 

I can see EPS of $100 per share being the new lower bound for FFH. And, the share price obviously doesn't reflect that. However, I'm not sure I can confidently forecast when we might hit a normalized EPS beyond $150, so for now I'll be inclined to reduce my stake as Fairfax approaches my estimation of fair value on a modestly growing $100 per share earnings stream. Let's call it somewhere between $1,200 and $1,500 USD per share as of today.

 

Fairfax is experiencing some incredible tailwinds right now. But, the following headwinds 3 years from now aren't unthinkable:

 

- much softer insurance market

- much lower interest rates

- fairly valued share price (no more buybacks)

 

Each of those headwinds could act as gravity on the current $100 EPS, which means any new earnings from the invested free cash may only supplant rather than enhance EPS in the future.

 

I'm not suggesting another 7 year famine as much as I'm saying it's in the realm of possibility that normal earnings could be hovering somewhere below $150 per share in 3 years, and we could be staring at a sub $1,500 share price.

 

Don't get me wrong, when it comes to FFH I'm still jacked to the tits!

@Thrifty3000 my crystal ball only looks out about 2 years. I continue to estimate earnings of US$120 for both 2023 and 2024. Looking further out to 2025 and 2026, yes, lots of things could change. The key driver of earnings looking out a couple of years could well be capital allocation. Fairfax’s capital allocation track record since 2018 has been very good.

 

Over 4 years, 2022 to 2025, i think Fairfax might generate more than $8 billion in free cash flow ($2 billion per year). If they invest this $8 billion wisely they could earn 10% per year (10% is a modest estimate). By the beginning of year 5 (2026) that would result in an incremental $800 million in earnings/increase in intrinsic value. That would be about $40/share pre-tax (my guess is share count will be close to 21 million in 4 years). 

Fairfax today has no pot holes left to fill. No annual cash burn of $500 million from equity hedges. No annual cash burn of $200-$250 million from fixing broken equity holdings. Moving forward, pretty much all of the free cash flow will be invested into assets that will generate a future return for shareholders. That is a big, big deal for shareholders. The turn started in 2018. But it often takes years for good capital allocation decisions to flow through to reported results. We have seen much improved results at Fairfax in 2021 and 2022 (when you net out the loss from fixed income). The outlook for 2023 and 2024 is even better. 
 

My guess is another tailwind is coming for Fairfax… and it is the fruits of years of good capital allocation decisions combined with the magic of compounding. 

Edited May 1, 2023 by Viking

[Viking]

56 minutes ago, jfan said:

An aside to this topic of FFH still being cheap despite the run up in pricing and the question of what to do at this point. 

 

I think the concept of economic elasticity might be helpful:

ie:

- Thinking on the margins instead of absolutes

- What is the return/risk on the next marginal dollar?

- Anchoring bias on the prior absolute purchase price vs what the purchase price today means relative to its fundamentals

 

My normalized EPS is ~ $110 USD or $140 CAD. Even if I'm wrong, and EPS is really 1/2 of this, at these current prices, the earning's yield is 7.8%. Compared to the S&P 500 historical return of 7-8%, my general feel of the risk of margin compression, top-line growth deceleration, persistent share count dilution, probability of reinvestment success, etc between these 2 options, FFH seems better positioned.

 

The question for me is: "what is the rational thing to do with my future savings"?

 

I posted before that I would probably continue to hold my position, but the more I think about it, perhaps the rational thing to do is buy more given the opportunity set I have in front of me. 

@jfan the thing i struggle with the most when valuing a company like Fairfax is what multiple to attach. My miss with Apple in 2016 was mostly multiple related, which increased from something like 10 x earnings to 30 x earnings over the next 5 years. Mr Market went from hating the stock to loving it. 
 

So what multiple should Fairfax trade at given its execution the past couple of years, current situation and near term prospects? 1.2 x BV seems low but reasonable as a next step. My guess is BV will come in around US$690 when Q1 is reported (i am ignoring IFRS 17 until after Fairfax reports). So this suggests to me a low fair price for Fairfax today is around $830. With shares trading today at $690 this suggests Fairfax is 20% undervalued. This seems too low to me, given the current set up for the company.

 

How has the mood of Mr Market changed with Fairfax?

- 2020: extreme pessimism

- 2021: pessimism

- 2022: neutral

- 2023/2024: slow shift to mild optimism? 
 

If Fairfax delivers $120/share in earnings in 2023 and again in 2024 then i think we will see Mr Market shift to mild optimism… and this should lead to multiple expansion. Perhaps we get to a conservative multiple of 1.2 x earnings by the end of 2024:
- BV at end of 2024 = $880/share ($660+$120+$120-$10-$10). 

- 1.2 x BV = $1,050/share

- stock price today = $690 = 50% return over next 7 quarters.

 

Impossible to know. But is is important to think/model how things might play out.

Edited May 1, 2023 by Viking

[glider3834]

https://www.businesswire.com/news/home/20230503005889/en/AM-Best-Upgrades-Issuer-Credit-Ratings-of-Fairfax-Financial-Holdings-Limited-Its-Subsidiaries-and-Allied-World-Assurance-Company-Holdings-Ltd.

[Viking]

I have spilt lots of ink writing what I like about Fairfax. Does that mean i am ignoring the risks? No, of course not. So let’s flip the script today and write about a few of the risks of investing in Fairfax. What am i missing?

 

For starters, there are the usual run-of-the-mill risks:

1.) Will this be another bad year for catastrophes? 

2.) Is the hard market over?

3.) Is a severe recession coming?

 

These risks are important but out of Fairfax’s control. With this post, I want to discuss the risks that are more specific to Fairfax - and firmly in their control. 

 

What are the risks of investing in Fairfax? 

 

1.) Can management be trusted? 2010-2020 was a lost decade for Fairfax shareholders.

 

Buffett says "It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you'll do things differently." Well, Fairfax shredded their reputation not in 5 minutes but over a 10 years period.

 

What happened? Bad decisions. Poor communication. Terrible business results. Not a great combination. Long term shareholders capitulated in May of 2020, and the stock dropped to US$230. Yes covid was partly to blame. But only partly.

 

The interesting thing is things actually started improving at Fairfax in about 2018. For the past 5 years we have seen much better decisions. Better communication. Very good business results. Record high stock price. 

 

Does that mean we are the clear? No. Trust can only be re-built with time. So we will see. 

 

PS: Trust is the core building block of strong relationships. If Fairfax wants long term shareholders they need to be a trustworthy partner. 

 

The next two risks fall under the ‘capital allocation’ bucket:

 

2.) Do they make another ‘equity hedge’ type decision? This is the big one for me. 

 

This one decision cost Fairfax shareholders a total of $5.4 billion from 2010 to 2020 (an average loss of $494 million for 11 straight years). Most of the losses happened from 2010-2016. However, in one last slap in the face of investors, Fairfax delivered one final $529 million loss in 2020. (Yes, how could an ‘equity hedge’ lose that much money in the bear market of 2020?)

 

Fairfax has said many times over the past few years that the ‘equity hedge’ position was a mistake. Further, they have said they will no longer short individual stocks or market indices. This was THE key driver of underperformance at Fairfax from 2010-2020. So we know this specific mistake will not be repeated in the future.

 

But does Fairfax make another big bet that sets them back +5 years? I don’t see one today. But my eyes are wide open.

 

3.) Do they make a string of bad equity purchases in the near future?

 

Fairfax’s equity picks from 2014-2017 were mostly terrible. By my count Fairfax made 10 different purchases during this period that performed poorly and resulted in the company booking various losses of about $1.5 billion ($200 million on average per year) over the past 8 years. 

 

The good news? It looks to me like something changed in about 2018. Fairfax’s equity purchases from 2018 to today have been very good. As well, the equities purchased from 2014-2017 that were under-performing have largely been fixed. 

 

So I am not concerned today. But I do monitor each of their equity purchases. 

 

4.) financial leverage: increase in net debt

 

Fairfax is comfortable using leverage to boost shareholder returns. Over the past 5 years net debt at Fairfax has increased 80%. Over the same time period common shareholders equity has increased 23%.

 

 

I don’t see Fairfax’s current net debt level as a problem. However, for the next year or two, it would be nice to see net debt remain at this level (or even go a little lower). I expect earnings to be very good over the next few years and this should increase shareholders equity meaningfully. Net debt is something to monitor.  

 

5.) corporate governance

 

Fairfax is a family controlled company (not unlike other founder led companies). Prem has a 10% economic interest and a 43.9% voting interest. Two of Prem’s kids currently serve as directors: Christine McLean and Ben Watsa. 

 

When a company is performing well, the issue of family control tends not to matter. However, when the company is not performing well, the issue of family control can become a big issue. Minority shareholders have little recourse should they be unhappy with the decisions management is making. 

 

This is what it is. 

Edited May 4, 2023 by Viking

[Xerxes]

The positiveness of “Family control” goes both ways. 
 

Ex: only a company controlled by the family (I.e. Bombardier) would be bold enough to embark on the C-Series, and “have capacity to suffer” through it. And suffer they did. 
 

However in that case, it just didn’t pan out. It was/is an incredible product but it ruined the whole company. The incumbents reacted fast. With hindsight we can write a nice essay why Bombardier didn’t deliver. That is hindsight. Point is, they took a shot and didn’t pan out. 

[Viking]

5 hours ago, glider3834 said:

https://www.businesswire.com/news/home/20230503005889/en/AM-Best-Upgrades-Issuer-Credit-Ratings-of-Fairfax-Financial-Holdings-Limited-Its-Subsidiaries-and-Allied-World-Assurance-Company-Holdings-Ltd.

 

@glider3834 Looks like the ratings agencies are giving Fairfax credit for the positioning of their fixed income portfolio and the much higher operating income that will be coming in 2023 and future years. Well done! Just another indication that the worm has turned. 

----------

"The Long-Term ICR upgrade for Fairfax reflects its ability to limit investment volatility through year-end 2022, and the prospective earnings outlook from deploying substantial cash into higher yielding debt instruments. Fairfax has benefited from solid underlying returns among its core operating subsidiaries in recent years, despite elevated catastrophic losses in the North American market. Furthermore, due to its relatively low duration and strong cash position at year-end 2021, Fairfax’s unrealized losses from the market turmoil in 2022 were materially less than peer averages. The upgrade also considers that Fairfax’s financial leverage has improved materially compared with historically higher levels and has been consistently maintained at levels largely in line with comparably rated peers in recent years. AM Best expects that Fairfax will continue to maintain financial leverage at or near current levels going forward. The group’s capital position should continue to improve over time, as it benefits from higher levels of dividend and interest incomes, which should further reduce the group’s reliance on external debt."

Edited May 4, 2023 by Viking

[glider3834]

2 hours ago, Viking said:

 

@glider3834 Looks like the ratings agencies are giving Fairfax credit for the positioning of their fixed income portfolio and the much higher operating income that will be coming in 2023 and future years. Well done! Just another indication that the worm has turned. 

----------

"The Long-Term ICR upgrade for Fairfax reflects its ability to limit investment volatility through year-end 2022, and the prospective earnings outlook from deploying substantial cash into higher yielding debt instruments. Fairfax has benefited from solid underlying returns among its core operating subsidiaries in recent years, despite elevated catastrophic losses in the North American market. Furthermore, due to its relatively low duration and strong cash position at year-end 2021, Fairfax’s unrealized losses from the market turmoil in 2022 were materially less than peer averages. The upgrade also considers that Fairfax’s financial leverage has improved materially compared with historically higher levels and has been consistently maintained at levels largely in line with comparably rated peers in recent years. AM Best expects that Fairfax will continue to maintain financial leverage at or near current levels going forward. The group’s capital position should continue to improve over time, as it benefits from higher levels of dividend and interest incomes, which should further reduce the group’s reliance on external debt."

Now for Moodys & S&P -  Lets wait & see 

 

 

[Tommm50]

When do they announce 1st quarter?

[gfp]

16 minutes ago, Tommm50 said:

When do they announce 1st quarter?

" The finalized information will be presented in the Company’s 2023 first quarter unaudited financial results, which will be released after the close of markets on Thursday, May 11."