Fairfax 2023

[SafetyinNumbers]

Value investors already own their shares and are likely the sellers near a $1000 because it’s a big figure and we are entering hurricane season. Investors are trying to avoid drawdowns but there seems to be decent demand keeping the stock close to all time highs. I think the buyers are the vast majority of closet indexers and index enhancers. That’s most of actively managed institutional capital benchmarked to the S&P/TSX Composite. The market cap of the benchmark is 3.1T but I’m not sure how much is benchmarked to it. Some estimates suggest 8% is owned directly by ETFs. For Fairfax, I think another 18% is owned between Prem and the TRS. I think FFH is pretty tightly held since the share turnover is relatively low vs the average stock but that could change if the stock gets closer to intrinsic value. 

 

I don’t have access to the data but I think this might have happened with FFH from 1995-1998. The stock went up 6x from C$98 to almost C$600 ending above 3x book at the end of 1998. The share count went up at the time and book value was growing fast at the time going from US$39 to US$112. The P/B multiple went up a lot too.

I think the current situation is an analog except, the starting valuation is incredibly low, it’s very cheap on earnings and while book value is growing quickly it’s not growing as quickly as 95-98. 

[Viking]

Is the stock priced properly?

 

Efficient market hypothesis: “The efficient market hypothesis (EMH) is a hypothesis that states that share prices reflect all information and consistent alpha generation is impossible. According to the EMH, stocks always trade at their fair value on exchanges, making it impossible for investors to purchase undervalued stocks or sell stocks for inflated prices…” Investopedia

 

A lot has happened at Fairfax over the past 30 months. Let’s do a quick review and see what we can learn. Most importantly, is the stock priced correctly, as the EMH would suggest?

 

How has Fairfax’s stock performed over the past 30 months?

 

First, let’s get some context. Fairfax has been one of the best performing stocks over the past 30 months both in absolute and relative terms. The outperformance has been remarkably consistent each year.

 

 

Fairfax’s stock has outperformed the S&P500 by 95% over the past 30 months. That outperformance must make Fairfax one of the top performing large cap (in Canada) stocks over the past 30 months.

 

Does this mean the stock is now expensive? The proverbial ‘big fish that got away’ from investors? Let’s find out. Let’s try and keep an open mind. What do the numbers tell us? And what about management? And future prospects?

 

Let’s start by looking at the traditional valuation tools:

 

Price to earnings ratio (PE)

 

My current estimate has Fairfax earning about $145/share in 2023 and $135 in both 2024 and 2025. I view this as a mildly conservative estimate for the next three years. I’ll provide more details in my 3-year earnings forecast for Fairfax - coming in the next week or so.

 

Importantly, the quality of the earnings being delivered by Fairfax are the highest in the company’s history; it is primarily being delivered by record operating earnings (underwriting profit + interest and dividend income + share of profit of associates). All three individually are at record levels.

 

 

We learn in the chart above that Fairfax is trading today at a forward PE multiple of 5.4 times. That is crazy cheap, especially given the quality and durability of earnings.

 

What is the PE multiple of the overall market?

 

The forward PE multiple of the S&P500 is 20. Fairfax’s stock is trading at a SIGNIFICANT discount to the S&P500. Fairfax’s stock price could double from here and it would still be trading at a 50% discount to the S&P500 multiple.

 

How about compared to some P&C insurance peers?

 

 

Looking at PE, Fairfax is trading at 48% (Chubb) to 70% (Markel) below peers. Fairfax’s stock looks dirt cheap. But let’s keep digging.

 

Price to book value multiple (P/BV) and return on equity (ROE)

 

Let’s now look at the price-to-book value (P/BV) and return-on-equity (ROE). These two are the preferred metrics used to value insurance companies. Let’s start with P/BV.

 

How does Fairfax stack up compared to peers?

 

 

Looking at P/BV, Fairfax is trading 36% (Markel) to 61% (WR Berkley) below peers. How about ROE?

 

 

Looking at ROE, Fairfax is poised to deliver an exceptional 16.8%, at the high end compared to peers.

 

What can we conclude after looking at the valuation metrics?

 

Looking at PE and P/BV, Fairfax’s stock is exceptionally cheap compared to the market and peers. At the same time Fairfax is delivering best-in-class ROE.

 

This makes no sense. Let’s keep digging.

 

What about management?

 

I recently did a long-form post where I reviewed capital allocation at Fairfax over the past 5 years. Bottom line, it can be argued that Fairfax currently has a best-in-class management team (compared to peers).

 

The mystery deepens.

 

What about the future prospects of Fairfax?

 

Fairfax has three engines driving its business:

1. Insurance: Fairfax has grown net premiums written by 400% over the last 9 years. At a 95CR, underwriting profit is on track to be a record $1 billion in 2023.
2. Investments - fixed income: Fairfax has navigated the spike in interest rates masterfully in their $40 billion fixed income portfolio, moving to 1.2 years average duration in Dec 2021 and then pivoting and moving to 2.5 years average duration in Q1 2023, locking in higher yields. As a result interest and dividend income is expected to be a record +$1.5 billion for each of 2023, 2024 and 2025.
3. Investments - equities: Fairfax’s $16 billion equity holdings have been performing very well, lead by Eurobank and total return swaps on 1.96 million FFH shares.

Most importantly, all engines are performing very well at the same time, perhaps for the first time in the company’s history. Significant asset sales over the past 12 months have been icing on the cake: pet insurance ($1.4 billion), Resolute ($626 million+$183 million CVR), Ambridge Partners ($400 million).

 

In short, Fairfax’s prospects have never looked better.

 

What are external groups saying?

 

AM Best, the credit ratings agency who specializes in insurance companies, just upgraded Fairfax’s ratings (including those of its two largest subs - Odyssey and Allied) because of its much improved financial profile.

 

Most sell-side analysts have been warming to Fairfax over the past year, repeatedly increasing their estimates and target prices. Most have Fairfax as ‘outperform’ and a few have it as a ‘top pick’.

 

Conclusion

 

What did we learn about Fairfax?

• The stock price is unambiguously cheap in absolute terms and when compared to peers.
• The quality of the earnings are high and durable.
• The management team is best-in-class.
• Future prospects have never been better.
• Ratings agencies are drinking the Kool-Aid, with upgrades.
• Sell side analysts are drinking the Kool-Aid, with upgrades.

The cheap stock price stands out like a sore thumb.

 

How do we explain it?

 

The answer is simple: Mr. Market is wrong. Now I know, according to EMT, this is not supposed to happen. What we have today is a real life example of where the efficient market hypothesis is bullshit. At least in the short run.

 

We have situation where Mr. Market is grossly mis-pricing a stock. Now I do think the EMT is generally accurate over the medium to long term… the mis-pricing usually does not last for long.

 

The disconnect with Mr. Market is fundamentals. The fundamentals have been improving at Fairfax for the past couple of years but are just now showing up in earnings.

 

It’s like Mr. Market has been standing on the beach the last couple of years wondering why the water is running out to sea. The answer is we have a tsunami of earnings coming from Fairfax in the coming quarters and years. Mr. Market will figure it out. But in usual fashion, only when the wall of water comes crashing in (wiping out all the wrong-headed thinking on the company in the process). "What a shocker!" everyone will say. "Who could have known?" A similar thing happened to Fairfax in the 2006-2009 period.   

 

The coming spike in earnings is not a surprise to those who follow the company closely. So we are in this surreal environment where the future is kind of knowable (a spike in earnings leading to a spike in the share price).

 

What to do? Trust the analysis (be right). Get the correct position size. Have patience (sit tight).

—————

“And right here let me say one thing: after spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: it never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight! It is no trick at all to be right on the market. You always find lots of early bulls in bull markets and early bears in bear markets . I’ve known many men who were right at exactly the right time, and began buying and selling stocks when prices were at the very level which should show the greatest profit. And their experience invariably matched mine - that is, they made no real money out of it. Men who can both be right and sit tight are uncommon. I found it one of the hardest things to learn. But it is only after a stock operator has firmly grasped this that he can make big money. It is literally true that millions come easier to a trader after he knows how to trade than hundreds did in the days of his ignorance.” Reminiscences of a Stock Operator

Edited July 10, 2023 by Viking

[Luke]

If one wants to see why many could be hesitant about Fairfax and which past mistakes @Viking sometimes refers to, this looked like a decent write-up: 

 

http://azvalue.blogspot.com/2014/04/fairfax-and-their-bets-now-looking-in.html?m=1

[Luke]

The author of the article also did not include the dividends in the Berkshire Fairfax comparison, there was one comment about it: 

 

You exclude the nearly $125 in dividends paid by FFH over the past 13 years. Adjust the book value to account for the dividends and the returns are: 5 year = 8.1%, 10 year = 10.4%, 15 year = 9.7%, 20 year = 15.3%, 25 year = 17.4%. Now the comparison to BRK doesn't look quite as impressive. FFH outperforms BRK in all categories except the last 5 years.

[nwoodman]

Financial DD underway for IDBI bank

 

“Kotak Mahindra Bank and Canadian billionaire Prem Watsa-led Fairfax India Holdings have shown interest in acquiring majority stake in IDBI bank. The other bidders are said to be Sumitomo Mitsui Financial Group and Emirates NBD.”

 

“The process is expected to conclude by September and the final bids may be in by December.”

 

“The government is keen to wrap up the transaction by March 2024, according to sources.”

 

https://www.thehindubusinessline.com/money-and-banking/financial-due-diligence-underway-at-idbi-bank/article67059941.ece/amp/

[Haryana]

1 hour ago, Luca said:

The author of the article also did not include the dividends in the Berkshire Fairfax comparison, there was one comment about it: 

 

You exclude the nearly $125 in dividends paid by FFH over the past 13 years. Adjust the book value to account for the dividends and the returns are: 5 year = 8.1%, 10 year = 10.4%, 15 year = 9.7%, 20 year = 15.3%, 25 year = 17.4%. Now the comparison to BRK doesn't look quite as impressive. FFH outperforms BRK in all categories except the last 5 years.

 

Most self-acclaimed investment experts fail to include dividends in return calculations.
Dividends make an unexpectedly extraordinary difference to total return due to compounding.
Since Berkshire never paid a dividend, those making these comparisons get yet more Buffett brainwash.

 

Prem had to write the following in 2022 letter (page 31) to remind us for our own benefit:
"Don’t forget the dividends in your return calculation!"

[MMM20]

On 7/9/2023 at 2:56 PM, Thrifty3000 said:

Ha, what happens when the population of potential buyers of an asset consists only of value investors that will never pay full price?

With a high earnings yield, a stable/growing stream of earnings, and reasonable capital allocation, you get a compounder… a real compounder, not just a stock that went from 15x to 50x P/E as interest rates went to 0...

 

Edited July 12, 2023 by MMM20

[SafetyinNumbers]

3 hours ago, Haryana said:

 

Most self-acclaimed investment experts fail to include dividends in return calculations.
Dividends make an unexpectedly extraordinary difference to total return due to compounding.
Since Berkshire never paid a dividend, those making these comparisons get yet more Buffett brainwash.

 

Prem had to write the following in 2022 letter (page 31) to remind us for our own benefit:
"Don’t forget the dividends in your return calculation!"

I did the math to solve for the DRIP and the multiple expansion for BRK and contraction for FFH. The spread narrows quite a bit. That’s what I call margin of safety.

 

 

[Thrifty3000]

3 hours ago, MMM20 said:

With a stable/growing stream of earnings and reasonable capital allocation you get a compounder… a real life compounder, not just a stock that went from 15x to 50x earnings as interest rates went to 0...

 

Yes! The asset price will correlate with intrinsic value long term. Multiple expansion is not guaranteed, but it’s a nice bonus that’s likely to happen.

[MMM20]

On 7/10/2023 at 10:44 AM, Thrifty3000 said:

Yes! The asset price will correlate with intrinsic value long term. Multiple expansion is not guaranteed, but it’s a nice bonus that’s likely to happen.

If earnings roughly match free cash flow and are at least stable for the next 3 years (as @Viking and others here have argued is a reasonable assumption) then they’ll retain earnings of about 60% of the current market cap depending on the dividend and incremental ROIC (and assuming no buybacks).
 

If they agree the stock is too cheap and keep buying it back, that’s theoretically ~US$10B of buybacks using free cash flow alone over the next few years. If at an average cost of ~US$1000/share that’s ~10M shares.  
 

Then even if earnings are flattish vs current as we exit year 3, ok, that’s ~$3.5B / ~12M shares = ~$300 EPS.
 

Even at still just a ~5-6x multiple, that’s a ~$1500+ stock or a ~2x+ from here even with flat earnings. 
 

That gets at the power of FFH's now structurally higher earnings yield and good capital allocation. 

 

Edited July 12, 2023 by MMM20

[John Hjorth]

8 minutes ago, MMM20 said:

If earnings roughly match free cash flow and are at least stable for the next 3 years ...

 

@MMM20,

 

I think, you'd better be careful such presumptions about the implications of such assumptions for an insurer - not much is static in that space of business for such a period. That does not change the fact that FFH looks really compellng right now.

[keegomaster]

13 hours ago, Viking said:

Is the stock priced properly?

 

Efficient market hypothesis: “The efficient market hypothesis (EMH) is a hypothesis that states that share prices reflect all information and consistent alpha generation is impossible. According to the EMH, stocks always trade at their fair value on exchanges, making it impossible for investors to purchase undervalued stocks or sell stocks for inflated prices…” Investopedia

 

A lot has happened at Fairfax over the past 30 months. Let’s do a quick review and see what we can learn. Most importantly, is the stock priced correctly, as the EMH would suggest?

 

How has Fairfax’s stock performed over the past 30 months?

 

First, let’s get some context. Fairfax has been one of the best performing stocks over the past 30 months both in absolute and relative terms. The outperformance has been remarkably consistent each year.

 

 

Fairfax’s stock has outperformed the S&P500 by 95% over the past 30 months. That outperformance must make Fairfax one of the top performing large cap (in Canada) stocks over the past 30 months.

 

Does this mean the stock is now expensive? The proverbial ‘big fish that got away’ from investors? Let’s find out. Let’s try and keep an open mind. What do the numbers tell us? And what about management? And future prospects?

 

Let’s start by looking at the traditional valuation tools:

 

Price to earnings ratio (PE)

 

My current estimate has Fairfax earning about $145/share in 2023 and $135 in both 2024 and 2025. I view this as a mildly conservative estimate for the next three years. I’ll provide more details in my 3-year earnings forecast for Fairfax - coming in the next week or so.

 

Importantly, the quality of the earnings being delivered by Fairfax are the highest in the company’s history; it is primarily being delivered by record operating earnings (underwriting profit + interest and dividend income + share of profit of associates). All three individually are at record levels.

 

 

We learn in the chart above that Fairfax is trading today at a forward PE multiple of 5.4 times. That is crazy cheap, especially given the quality and durability of earnings.

 

What is the PE multiple of the overall market?

 

The forward PE multiple of the S&P500 is 20. Fairfax’s stock is trading at a SIGNIFICANT discount to the S&P500. Fairfax’s stock price could double from here and it would still be trading at a 50% discount to the S&P500 multiple.

 

How about compared to some P&C insurance peers?

 

 

Looking at PE, Fairfax is trading at 48% (Chubb) to 70% (Markel) below peers. Fairfax’s stock looks dirt cheap. But let’s keep digging.

 

Price to book value multiple (P/BV) and return on equity (ROE)

 

Let’s now look at the price-to-book value (P/BV) and return-on-equity (ROE). These two are the preferred metrics used to value insurance companies. Let’s start with P/BV.

 

How does Fairfax stack up compared to peers?

 

 

Looking at P/BV, Fairfax is trading 36% (Markel) to 61% (WR Berkley) below peers. How about ROE?

 

 

Looking at ROE, Fairfax is poised to deliver an exceptional 16.8%, at the high end compared to peers.

 

What can we conclude after looking at the valuation metrics?

 

Looking at PE and P/BV, Fairfax’s stock is exceptionally cheap compared to the market and peers. At the same time Fairfax is delivering best-in-class ROE.

 

This makes no sense. Let’s keep digging.

 

What about management?

 

I recently did a long-form post where I reviewed capital allocation at Fairfax over the past 5 years. Bottom line, it can be argued that Fairfax currently has a best-in-class management team (compared to peers).

 

The mystery deepens.

 

What about the future prospects of Fairfax?

 

Fairfax has three engines driving its business:

1. Insurance: Fairfax has grown net premiums written by 400% over the last 9 years. At a 95CR, underwriting profit is on track to be a record $1 billion in 2023.
2. Investments - fixed income: Fairfax has navigated the spike in interest rates masterfully in their $40 billion fixed income portfolio, moving to 1.2 years average duration in Dec 2021 and then pivoting and moving to 2.5 years average duration in Q1 2023, locking in higher yields. As a result interest and dividend income is expected to be a record +$1.5 billion for each of 2023, 2024 and 2025.
3. Investments - equities: Fairfax’s $16 billion equity holdings have been performing very well, lead by Eurobank and total return swaps on 1.96 million FFH shares.

Most importantly, all engines are performing very well at the same time, perhaps for the first time in the company’s history. Significant asset sales over the past 12 months have been icing on the cake: pet insurance ($1.4 billion), Resolute ($626 million+$183 million CVR), Ambridge Partners ($400 million).

 

In short, Fairfax’s prospects have never looked better.

 

What are external groups saying?

 

AM Best, the credit ratings agency who specializes in insurance companies, just upgraded Fairfax’s ratings (including those of its two largest subs - Odyssey and Allied) because of its much improved financial profile.

 

Most sell-side analysts have been warming to Fairfax over the past year, repeatedly increasing their estimates and target prices. Most have Fairfax as ‘outperform’ and a few have it as a ‘top pick’.

 

Conclusion

 

What did we learn about Fairfax?

• The stock price is unambiguously cheap in absolute terms and when compared to peers.
• The quality of the earnings are high and durable.
• The management team is best-in-class.
• Future prospects have never been better.
• Ratings agencies are drinking the Kool-Aid, with upgrades.
• Sell side analysts are drinking the Kool-Aid, with upgrades.

The cheap stock price stands out like a sore thumb.

 

How do we explain it?

 

The answer is simple: Mr. Market is wrong. Now I know, according to EMT, this is not supposed to happen. What we have today is a real life example of where the efficient market hypothesis is bullshit. At least in the short run.

 

We have situation where Mr. Market is grossly mis-pricing a stock. Now I do think the EMT is generally accurate over the medium to long term… the mis-pricing usually does not last for long.

 

The disconnect with Mr. Market is fundamentals. The fundamentals have been improving at Fairfax for the past couple of years but are just now showing up in earnings.

 

It’s like Mr. Market has been standing on the beach the last couple of years wondering why the water is running out to sea. The answer is we have a tsunami of earnings coming from Fairfax in the coming quarters and years. Mr. Market will figure it out. But in usual fashion, only when the wall of water comes crashing in (wiping out all the wrong-headed thinking on the company in the process). "What a shocker!" everyone will say. "Who could have known?" A similar thing happened to Fairfax in the 2006-2009 period.   

 

The coming spike in earnings is not a surprise to those who follow the company closely. So we are in this surreal environment where the future is kind of knowable (a spike in earnings leading to a spike in the share price).

 

What to do? Trust the analysis (be right). Get the correct position size. Have patience (sit tight).

—————

“And right here let me say one thing: after spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: it never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight! It is no trick at all to be right on the market. You always find lots of early bulls in bull markets and early bears in bear markets . I’ve known many men who were right at exactly the right time, and began buying and selling stocks when prices were at the very level which should show the greatest profit. And their experience invariably matched mine - that is, they made no real money out of it. Men who can both be right and sit tight are uncommon. I found it one of the hardest things to learn. But it is only after a stock operator has firmly grasped this that he can make big money. It is literally true that millions come easier to a trader after he knows how to trade than hundreds did in the days of his ignorance.” Reminiscences of a Stock Operator

After seeing the comparison of P/E and P/B of FFH against the other competitors...I wouldn't be surprised if at some point in the future Berkshire makes a bid for Fairfax (similar to what they did with Alleghany). 

[SafetyinNumbers]

5 minutes ago, keegomaster said:

After seeing the comparison of P/E and P/B of FFH against the other competitors...I wouldn't be surprised if at some point in the future Berkshire makes a bid for Fairfax (similar to what they did with Alleghany). 

I don’t think Prem is a seller, thankfully.

[gfp]

"As I have mentioned many times in the last 37 years, you, our shareholders, suffer a major negative as our company is not for sale at any price."

 

- Prem, most recent annual letter to shareholders.

[MMM20]

On 7/10/2023 at 12:12 PM, John Hjorth said:

 

@MMM20,

 

I think, you'd better be careful such presumptions about the implications of such assumptions for an insurer - not much is static in that space of business for such a period. That does not change the fact that FFH looks really compellng right now.

What I’m trying to do is think through this off of normalized earnings looking forward… maybe helpful, maybe not, fair enough. There will of course be extreme volatility around that core structural earnings power and risk of various 100 year floods. But there is also some chance that the outcome is much better
 

Edited July 12, 2023 by MMM20

[Munger_Disciple]

16 hours ago, Viking said:

Is the stock priced properly?

 

Efficient market hypothesis: “The efficient market hypothesis (EMH) is a hypothesis that states that share prices reflect all information and consistent alpha generation is impossible. According to the EMH, stocks always trade at their fair value on exchanges, making it impossible for investors to purchase undervalued stocks or sell stocks for inflated prices…” Investopedia

 

A lot has happened at Fairfax over the past 30 months. Let’s do a quick review and see what we can learn. Most importantly, is the stock priced correctly, as the EMH would suggest?

 

How has Fairfax’s stock performed over the past 30 months?

 

First, let’s get some context. Fairfax has been one of the best performing stocks over the past 30 months both in absolute and relative terms. The outperformance has been remarkably consistent each year.

 

 

Fairfax’s stock has outperformed the S&P500 by 95% over the past 30 months. That outperformance must make Fairfax one of the top performing large cap (in Canada) stocks over the past 30 months.

 

Does this mean the stock is now expensive? The proverbial ‘big fish that got away’ from investors? Let’s find out. Let’s try and keep an open mind. What do the numbers tell us? And what about management? And future prospects?

 

Let’s start by looking at the traditional valuation tools:

 

Price to earnings ratio (PE)

 

My current estimate has Fairfax earning about $145/share in 2023 and $135 in both 2024 and 2025. I view this as a mildly conservative estimate for the next three years. I’ll provide more details in my 3-year earnings forecast for Fairfax - coming in the next week or so.

 

Importantly, the quality of the earnings being delivered by Fairfax are the highest in the company’s history; it is primarily being delivered by record operating earnings (underwriting profit + interest and dividend income + share of profit of associates). All three individually are at record levels.

 

 

We learn in the chart above that Fairfax is trading today at a forward PE multiple of 5.4 times. That is crazy cheap, especially given the quality and durability of earnings.

 

What is the PE multiple of the overall market?

 

The forward PE multiple of the S&P500 is 20. Fairfax’s stock is trading at a SIGNIFICANT discount to the S&P500. Fairfax’s stock price could double from here and it would still be trading at a 50% discount to the S&P500 multiple.

 

How about compared to some P&C insurance peers?

 

 

Looking at PE, Fairfax is trading at 48% (Chubb) to 70% (Markel) below peers. Fairfax’s stock looks dirt cheap. But let’s keep digging.

 

Price to book value multiple (P/BV) and return on equity (ROE)

 

Let’s now look at the price-to-book value (P/BV) and return-on-equity (ROE). These two are the preferred metrics used to value insurance companies. Let’s start with P/BV.

 

How does Fairfax stack up compared to peers?

 

 

Looking at P/BV, Fairfax is trading 36% (Markel) to 61% (WR Berkley) below peers. How about ROE?

 

 

Looking at ROE, Fairfax is poised to deliver an exceptional 16.8%, at the high end compared to peers.

 

What can we conclude after looking at the valuation metrics?

 

Looking at PE and P/BV, Fairfax’s stock is exceptionally cheap compared to the market and peers. At the same time Fairfax is delivering best-in-class ROE.

 

This makes no sense. Let’s keep digging.

 

What about management?

 

I recently did a long-form post where I reviewed capital allocation at Fairfax over the past 5 years. Bottom line, it can be argued that Fairfax currently has a best-in-class management team (compared to peers).

 

The mystery deepens.

 

What about the future prospects of Fairfax?

 

Fairfax has three engines driving its business:

1. Insurance: Fairfax has grown net premiums written by 400% over the last 9 years. At a 95CR, underwriting profit is on track to be a record $1 billion in 2023.
2. Investments - fixed income: Fairfax has navigated the spike in interest rates masterfully in their $40 billion fixed income portfolio, moving to 1.2 years average duration in Dec 2021 and then pivoting and moving to 2.5 years average duration in Q1 2023, locking in higher yields. As a result interest and dividend income is expected to be a record +$1.5 billion for each of 2023, 2024 and 2025.
3. Investments - equities: Fairfax’s $16 billion equity holdings have been performing very well, lead by Eurobank and total return swaps on 1.96 million FFH shares.

Most importantly, all engines are performing very well at the same time, perhaps for the first time in the company’s history. Significant asset sales over the past 12 months have been icing on the cake: pet insurance ($1.4 billion), Resolute ($626 million+$183 million CVR), Ambridge Partners ($400 million).

 

In short, Fairfax’s prospects have never looked better.

 

What are external groups saying?

 

AM Best, the credit ratings agency who specializes in insurance companies, just upgraded Fairfax’s ratings (including those of its two largest subs - Odyssey and Allied) because of its much improved financial profile.

 

Most sell-side analysts have been warming to Fairfax over the past year, repeatedly increasing their estimates and target prices. Most have Fairfax as ‘outperform’ and a few have it as a ‘top pick’.

 

Conclusion

 

What did we learn about Fairfax?

• The stock price is unambiguously cheap in absolute terms and when compared to peers.
• The quality of the earnings are high and durable.
• The management team is best-in-class.
• Future prospects have never been better.
• Ratings agencies are drinking the Kool-Aid, with upgrades.
• Sell side analysts are drinking the Kool-Aid, with upgrades.

The cheap stock price stands out like a sore thumb.

 

How do we explain it?

 

The answer is simple: Mr. Market is wrong. Now I know, according to EMT, this is not supposed to happen. What we have today is a real life example of where the efficient market hypothesis is bullshit. At least in the short run.

 

We have situation where Mr. Market is grossly mis-pricing a stock. Now I do think the EMT is generally accurate over the medium to long term… the mis-pricing usually does not last for long.

 

The disconnect with Mr. Market is fundamentals. The fundamentals have been improving at Fairfax for the past couple of years but are just now showing up in earnings.

 

It’s like Mr. Market has been standing on the beach the last couple of years wondering why the water is running out to sea. The answer is we have a tsunami of earnings coming from Fairfax in the coming quarters and years. Mr. Market will figure it out. But in usual fashion, only when the wall of water comes crashing in (wiping out all the wrong-headed thinking on the company in the process). "What a shocker!" everyone will say. "Who could have known?" A similar thing happened to Fairfax in the 2006-2009 period.   

 

The coming spike in earnings is not a surprise to those who follow the company closely. So we are in this surreal environment where the future is kind of knowable (a spike in earnings leading to a spike in the share price).

 

What to do? Trust the analysis (be right). Get the correct position size. Have patience (sit tight).

—————

“And right here let me say one thing: after spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: it never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight! It is no trick at all to be right on the market. You always find lots of early bulls in bull markets and early bears in bear markets . I’ve known many men who were right at exactly the right time, and began buying and selling stocks when prices were at the very level which should show the greatest profit. And their experience invariably matched mine - that is, they made no real money out of it. Men who can both be right and sit tight are uncommon. I found it one of the hardest things to learn. But it is only after a stock operator has firmly grasped this that he can make big money. It is literally true that millions come easier to a trader after he knows how to trade than hundreds did in the days of his ignorance.” Reminiscences of a Stock Operator

 

@Viking I think you need to make allowance for the fact that FFH now reports book value based on IFRS unlike US domiciled insurers which still use GAAP, so head-to-head comparison needs to take the differences into account. Not disagreeing with your overall thesis but the P/B differences are narrower than they appear in your table. 

 

I wish FFH reported their book value according to both GAAP & IFRS as we digest this accounting change. 

Edited July 10, 2023 by Munger_Disciple

[Viking]

14 hours ago, SafetyinNumbers said:

Value investors already own their shares and are likely the sellers near a $1000 because it’s a big figure and we are entering hurricane season. Investors are trying to avoid drawdowns but there seems to be decent demand keeping the stock close to all time highs. I think the buyers are the vast majority of closet indexers and index enhancers. That’s most of actively managed institutional capital benchmarked to the S&P/TSX Composite. The market cap of the benchmark is 3.1T but I’m not sure how much is benchmarked to it. Some estimates suggest 8% is owned directly by ETFs. For Fairfax, I think another 18% is owned between Prem and the TRS. I think FFH is pretty tightly held since the share turnover is relatively low vs the average stock but that could change if the stock gets closer to intrinsic value. 

 

I don’t have access to the data but I think this might have happened with FFH from 1995-1998. The stock went up 6x from C$98 to almost C$600 ending above 3x book at the end of 1998. The share count went up at the time and book value was growing fast at the time going from US$39 to US$112. The P/B multiple went up a lot too.

I think the current situation is an analog except, the starting valuation is incredibly low, it’s very cheap on earnings and while book value is growing quickly it’s not growing as quickly as 95-98. 

Fairfax’s stock price has a history of selling off around 15% in June-Oct. This makes sense as this is hurricane season, and losses from catastrophes in recent years have been elevated. Last year the stock was trading around $550 in April and $450 in Oct; this decline happened AFTER announcing the pet insurance sale which delivered an after tax gain of $990 million. In 2021, the stock traded at $470 in May and bottomed around $410 in October. 
 

Where will the stock trade the rest of this year? No idea. Sometimes history repeats; sometimes it doesn’t. I like to look at it to understand potential outcomes… so i do not get caught by surprise when something happens.
 

If we do get a sell off it makes sense to me that Fairfax would get more aggressive on the share buyback front, but perhaps not until we are on the other side of hurricane season.

[Viking]

28 minutes ago, Munger_Disciple said:

 

@Viking I think you need to make allowance for the fact that FFH now reports book value based on IFRS unlike US domiciled insurers which still use GAAP, so head-to-head comparison needs to take the differences into account. Not disagreeing with your overall thesis but the P/B differences are narrower than they appear in your table. 

 

I wish FFH reported P/B according to both GAAP & IFRS as we digest this accounting change. 

@Munger_Disciple i agree. That is why i look at both BV and ROE together. IFRS popped BV for Fairfax but it also depressed ROE. Looking at the two together provides a more accurate picture.
 

If we used old GAAP for Fairfax then P/BV would be a little higher for Fairfax’s (probably a little over 1 x BV) but ROE would be approaching 20% (much higher than peers). It would lead to the same conclusion - Fairfax’s stock is too cheap compared to peers.
 

That is also why i like looking at PE. 
 

What other large stock is trading at a 5.4PE today? And the earning are real. And not abnormally high, driven by some one time event - my current mildly conservative estimate is Fairfax will earn an average of $135/year in 2023, 2024 and 2025. There are lots of catalysts am not including that could drive earnings higher (like a Digit IPO, more asset sales etc).

 

And i am still learning about IFRS 17. It will take me 6-12 more months to get more comfortable with all the puts and takes (i am slow to grasp some stuff… but i do get it eventually). So my estimates could be off due to IFRS 17 impacts i do not yet understand.

Edited July 10, 2023 by Viking

[Viking]

22 hours ago, newtovalue said:

@Viking - any estimate where you see Q2 2023 Book value standing when FFH reports later this month?

@newtovalue i have not done a Q2 estimate yet. I will put something together before they report. The problem i am having is understanding the impact of much higher interest rates and IRFS 17. Any insight other posters have on interest rate changes and impact on IFRS 17 would be appreciated  
 

 

[Tommm50]

19 hours ago, Thrifty3000 said:

But, back in 2015 FFH had reserved $896 million for asbestos. In my mind that suggests FFH expected to eventually pay $896 million. However, since 2015 they’ve actually paid something like $1.2 BILLION and they are still showing reserves of over $800 million.

This is an issue all major insurers who were doing business in the 60's and 70's are dealing with, these old "legacy issues". Asbestos is a great example. We are decades removed from when the insurance industry was blindsided by a tsunami of claims from the plaintiffs bar using the infamous "triple trigger" strategy.

 

It's very hard to estimate how much is left of this to go. If FFH reserved it at $896M in 2015 and, as you say, paid out $1.2B over the last eight years you can clearly say they under-reserved it 2015. If their 2022 reserve is still over $800M you could argue they are currently over-reserved. It would be instructive to see what the annual payouts were. Were they annually declining, increasing, or relatively constant. In any event my guess is it's a trivial number in the grand scheme of things.

[Thrifty3000]

12 minutes ago, Tommm50 said:

This is an issue all major insurers who were doing business in the 60's and 70's are dealing with, these old "legacy issues". Asbestos is a great example. We are decades removed from when the insurance industry was blindsided by a tsunami of claims from the plaintiffs bar using the infamous "triple trigger" strategy.

 

It's very hard to estimate how much is left of this to go. If FFH reserved it at $896M in 2015 and, as you say, paid out $1.2B over the last eight years you can clearly say they under-reserved it 2015. If their 2022 reserve is still over $800M you could argue they are currently over-reserved. It would be instructive to see what the annual payouts were. Were they annually declining, increasing, or relatively constant. In any event my guess is it's a trivial number in the grand scheme of things.

I agree it’s likely trivial and under control. Here are the annual payments since 2015:

 

2015: $130

2016: $197

2017: $174

2018: $170

2019: $138

2020: $141

2021: $152

2022: $132

 

> $1.2 billion paid over 8 years.

 

Would be easy enough to benchmark their numbers against a few other insurers.

[dartmonkey]

6 hours ago, SafetyinNumbers said:

I did the math to solve for the DRIP and the multiple expansion for BRK and contraction for FFH. The spread narrows quite a bit. That’s what I call margin of safety.

 

I did the calculation too, since I wasn't sure whether Brooklyn Investor had included the dividends. 

You can do it with FRFHF in USD ($10 dividend every year) or with FIH in CAD ($10US dividend converted to CAD at prevailing exchange rate). There's still a big gap with BRK, but it does narrow a bit:

 

 

 

So 13.9% from Berkshire, and 6.9% from Fairfax still hurts, but it's not as bad as the 4.6% you would calculate if you ignored the dividend. 

 

FIH gets a better return, but only because the exchange rate has gone from rough parity in 2011 to 1.33 now. To compare apples with apples, Berkshire's 13.9% in USD has to be compared to the FRFHF return in USD; a Berkshire investment in USD would be even better than 13.9% annualized for a Canadian, who would also benefit from having invested in USD.

 

Boy, it's pretty depressing typing in those FRFHF share price numbers, going nowhere, with share price lower in January 2021 than in December 2011, almost 10 years prior. Hopefully that's over at last!

 

 

 

 

Edited July 10, 2023 by dartmonkey

[Haryana]

53 minutes ago, dartmonkey said:

I did the calculation too, since I wasn't sure whether Brooklyn Investor had included the dividends. 

You can do it with FRFHF in USD ($10 dividend every year) or with FIH in CAD ($10US dividend converted to CAD at prevailing exchange rate). There's still a big gap with BRK, but it does narrow a bit:

 

 

 

So 13.9% from Berkshire, and 6.9% from Fairfax still hurts, but it's not as bad as the 4.6% you would calculate if you ignored the dividend. 

 

FIH gets a better return, but only because the exchange rate has gone from rough parity in 2011 to 1.33 now. To compare apples with apples, Berkshire's 13.9% in USD has to be compared to the FRFHF return in USD; a Berkshire investment in USD would be even better than 13.9% annualized for a Canadian, who would also benefit from having invested in USD.

 

Boy, it's pretty depressing typing in those FRFHF share price numbers, going nowhere, with share price lower in January 2021 than in December 2011, almost 10 years prior. Hopefully that's over at last!

 

 

 

 

 

There is nothing holy about using end of 2011 as the start date, go just 5 years further back and you get this:

[glider3834]

3 hours ago, Tommm50 said:

This is an issue all major insurers who were doing business in the 60's and 70's are dealing with, these old "legacy issues". Asbestos is a great example. We are decades removed from when the insurance industry was blindsided by a tsunami of claims from the plaintiffs bar using the infamous "triple trigger" strategy.

 

It's very hard to estimate how much is left of this to go. If FFH reserved it at $896M in 2015 and, as you say, paid out $1.2B over the last eight years you can clearly say they under-reserved it 2015. If their 2022 reserve is still over $800M you could argue they are currently over-reserved. It would be instructive to see what the annual payouts were. Were they annually declining, increasing, or relatively constant. In any event my guess is it's a trivial number in the grand scheme of things.

yes Fairfax which started around 1986 effectively 'acquired' these liabilities via acquisitions of subs they made

 

On the positive side higher investment returns, asbestos liabilities becoming increasingly smaller relative to shareholders equity and Fairfax has been reducing its long tail exposure eg sale of Riverstone Europe 

 

Riverstone US/TRG - Run-off - shareholder equity (31Dec)

2022 $405M (3% of FFH shareholder equity)

2012 $1,773M  (23% of FFH shareholder equity)

 

 

 

 

Edited July 10, 2023 by glider3834

[dartmonkey]

On 7/10/2023 at 5:00 PM, Haryana said:

 

There is nothing holy about using end of 2011 as the start date, go just 5 years further back and you get this:

 

Yes, of course you are right, I just used the same dates that Brooklyn Investor used to show that Berkshire is the real thing, the Berkshire wannabees are also-rans. I just wondered if that particular fairly non-natural 11.5y period might have been not quite so bad, if one counted dividends. The answer is no, it takes us from 4.6 to 6.9% annualized, still a long way from Berkshire's 13.9%.

 

Of course Fairfax looks a lot better if you include the big macro bet put on before the global financial crisis that paid off handsomely. And the period chosen is the almost the worst imaginable period for Fairfax, beginning about the same time as the catastrophic shorting adventure. hopefully behind us now forever. Going back a bit farther, things are not so bad. And also, hopefully, going forwards a bit farther will do the same trick...