Fairfax 2023

[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...

[Haryana]

34 minutes ago, dartmonkey said:

 

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...

 

You are right, I understand what you were doing there. Just like to point out that a change of annualized return rate from 4.6% to about 7% is huge on its own even if it looks less so when compared to some other larger number like 14%.

 

Also, to point out, even though a start of 2006-end includes the winning macro bet before 2008, it still includes all of the losing shorting bet and thus the 2006-end can be argued to be a far more neutral starting point than the 2011-end.

 

Overall, nobody knows the future but the point is to show how easy it is for the masses to be fooled by the numbers.

 

[Madpawn]

On 7/10/2023 at 2:40 PM, Viking said:

@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  
 

 

I remember seeing you post in recent days that your portfolio is about 35% Fairfax. May I ask if that includes FIH? I'm surprised FIH is not getting nearly as much attention as FFH does.

[Viking]

41 minutes ago, Madpawn said:

I remember seeing you post in recent days that your portfolio is about 35% Fairfax. May I ask if that includes FIH? I'm surprised FIH is not getting nearly as much attention as FFH does.

@Madpawn my holding as of today is 100% Fairfax. I just added to Fairfax when it went under C$960. I prefer to primarily hold Fairfax today given how cheap i think it is (and i am way overweight). I have held Fairfax India in the past (i recently sold my small remaining position at just just under $14), and sometimes large stakes. But i use it more as a trading vehicle. That works when a stock moves in a sideways band (like Fairfax India has been the past couple of years). But if/when it pops higher then i am toast. I often get too cute with situations like Fairfax India.
 

Fairfax India is unambiguously cheap. And the potential catalysts are there (big undervaluation, holdings are performing well, BIAL is a jewel/trophy asset, management buying back stock, Anchorage IPO, general interest in India). It has a very good management team. The stock is bumping up against $14, so someone is buying… If it sold off I likely would add back. But it would not surprise me to see the stock just keep powering higher.

Edited July 12, 2023 by Viking

[newtovalue]

On 7/10/2023 at 2:40 PM, Viking said:

@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  
 

 

Ty as always! I unfortunately have no understanding about IFRS 17 - but look forward to what the other brilliant members of this board are able to add

[MMM20]

13 hours ago, Haryana said:

Overall, nobody knows the future but the point is to show how easy it is for the masses to be fooled by the numbers.

 

Whenever you see a comparison over some specific and arbitrary time horizon rather than something like rolling 3-/5-/10-year periods, you should squint your eyes a little and wonder why they picked that specific period.

 

I think that's a useful thing for every investor to understand and apply across the board.

 

Edited July 12, 2023 by MMM20

[SafetyinNumbers]

18 hours ago, dartmonkey said:

 

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...

They also started that period trading at the same P/B multiple but Fairfax’s multiple down by almost 30% and BRK’s went up by an identical amount. I showed that makes up most of the difference between the two returns. I also think most of Fairfax’s positions are further away from intrinsic value so perhaps the return are even closer than they look when normalized.

 

I think the exercise is interesting to show that Fairfax fundamental performance wasn’t as bad as the stock would suggest and that’s the margin of safety/opportunity now.

 

The blog chose that date because that’s when it started. 

[Haryana]

 

I would use 03-2003 as the start date if I wanted to showcase Fairfax -

 

[Crip1]

On 7/12/2023 at 9:01 AM, MMM20 said:

 

Whenever you see a comparison over some specific and arbitrary time horizon rather than something like rolling 3-/5-/10-year periods, you should squint your eyes a little and wonder why they picked that specific period.

 

I think that's a useful thing for every investor to understand and apply across the board.

 

+1 (actually, I'd plus more than one if it was possible)

 

-Crip

[Haryana]

On 7/12/2023 at 1:02 PM, Haryana said:

 

I would use 03-2003 as the start date if I wanted to showcase Fairfax -

 

Someone chooses their chart start date based on their blog date.
I choose March 2003 as my chart start because that is about when I left New York!

Now, when I look at that chart, there is a certain feeling of pity and sympathy for Berkshire.
Certainly, they can get a participation certificate, a consolation prize of sorts because they "also ran".

But, just look at that growing gap, how this thing keeps falling more and more far behind throughout, oh my, what a dog!

 

[Viking]

As we begin Q3, this is a good time to update earnings estimates for Fairfax for 2023. And look ahead to 2024. I am also going to take a stab at 2025. I don’t like to go much beyond 2 years with earnings estimates - there are simply to many moving parts. But it useful to get a three year view on earnings to better be able to value the stock price today - so lets give it a shot.

 

My first big learning has been: the GIG acquisition is going to be a material development for Fairfax when it closes. I need to get up to speed with GIG (I may need to revise my estimates below).

 

Please chime in with your thoughts. Too optimistic? Too pessimistic? Any thoughts on what GIG is going to deliver?  What important things are missing? Please get into the weeds.

 

Conclusion:

 

Let's skip ahead to the conclusion. My estimate is Fairfax will earn about $140/share, on average, over the next three years. I consider this to be a mildly conservative estimate - what i mean by that is i think it is more likely that earnings will come in higher than lower.

 

The big ‘miss’ with my estimates is capital allocation. We don’t know much of what the management team at Fairfax is going to do with all the earnings (around $3.2 billion) coming each of the next 3 years. Looking at the last 5 years, the management team has been best-in-class with capital allocation. My guess is they will continue to make good decisions (on balance) and this will benefit shareholders - providing a tailwind to my forecast.

 

I am also assuming interest rates remain roughly at current levels. Of course this will not be the case. But if rates rise - or go lower - Fairfax will have lots of puts and takes. I am also forecasting no impact from IFRS 17 (as I have stated before, I am still learning how this accounting change affects Fairfax’s reported results over time.)

 

I love the following 8-year snapshot of Fairfax. It communicates really well the dramatic transformation that has happened at the company beginning in 2021. It is a pretty amazing story.

 

 

What are the key assumptions?

 

1.) underwriting profit to be flat to slightly down. Estimates for both premium growth and CR are conservative.

• When the GIG transaction closes (Q4?) Fairfax will be getting a big boost to its insurance business. I think GIG might be adding $1.8 billion to net written premiums. GIG is the driver to top line growth of 8% in 2024. If the hard market continues into 2024 then top line growth at Fairfax will likely be +10%.
• I am forecasting Fairfax’s CR to increase from 94.7 in 2022 to 96 in 2025. Do I think this will happen? No. My guess is they will continue to deliver a 95 CR - until I learn something that tells me something new.
• The hard market will end at some point. But do things quickly turn ugly? Probably not, but not sure.

 

 

2.) interest and dividend income: Will increase modestly. Extending the average duration of the fixed income portfolio to 2.5 years largely locks in these numbers.

 

Tailwinds:

• GIG: will add about $2.4 billion to total investment portfolio. At estimated total return of 4.5% = $110 million. I expect the majority of this would be interest income.
• PacWest loans: $100 million incremental ($200 million total) to interest income? Half in 2H, 2023 and half in 1H, 2024. 
• Eurobank: likely dividend starting in 2024 = $60 million?

Headwind:

• Short term treasury rates likely come down lowering interest on cash/short term balances.

 

3.) Share of profit of associates: Will increase modestly. It fell in 2023 because of the sale of Resolute Forest Products - who contributed $159 million in 2022.

• GIG purchase will subtract $80 million in 2024 (same as what is built in for 2023).
• growing earnings at Eurobank and Poseidon/Atlas will power this higher. My estimates for Stelco and EXCO are very conservative (a combined total of $110 million per year).

 

 

4.) Effects of discounting and risk adjustment (IFRS 17). Interest rate changes drive this bucket. I need time to learn how much. Given I am forecasting interest rates to remain about where they are today I am leaving this number the same over the forecast period.

 

5.) Life insurance and runoff. This combination of business lost $167 million in 2022. I am forecasting this bucket to lose $175 million in each of the next three years. We should expect Eurolife to grow its earnings nicely over time.

 

6.) Other (revenue-expenses): improving results from consolidated holdings.

 

In the near term, perhaps we get write downs in both Boat Rocker and Farmers Edge. Recipe should deliver solid and growing earnings of better than $100 million per year. Earnings at Dexterra are growing again. AGT is a sleeper holding. Grivalia Properties is in its peak investment phase; earnings should grow nicely looking out a year or two. This bucket could really start to shine through for Fairfax in the coming years.

 

7.) Interest expense: modest increase.

8.) Corporate overhead and other: took the average of last 3 years and added 10%

 

9.) Net gains on investments: This is a wild card.

 

My estimates assume:

• mark-to-market equity holdings of $7.8 billion increase in value by 10% per year = $800 million.
• there is a small bump of $200-$300 million per year in additional gains (equities and fixed income).

Total return on investment portfolio is:

• 2023 = 7.5%
• 2024 = 6.8%
• 2025 = 7.0%

(I get this by adding up the following line items: 2.) + 3.) + 6.) + 9.) and divided the total by the value of their investment portfolio).

 

These percent returns, while high compared to recent years, are hardly heroic given Fairfax is currently earnings about 4% on their fixed income portfolio.

 

10.) Gain on sale/deconsol of insurance sub: this is where I put the really large monetizations. 2022 was the sale of pet insurance and Resolute. 2023 was the sale of Ambridge and the purchase of GIG (resulting in a write up of the existing holding).

 

I am building in nothing for 2024 and 2025 and this is highly unlikely.

• We likely will get a Digit IPO at some point over the next year and this could result in a significant gain for Fairfax.
• We could get an event that triggers a revaluation of Eurobank (carrying value is currently $500 million below market value and this will likely widen significantly in the coming years).
• We could see an AGT IPO.
• Fairfax is likely to sell another large holding for a significant gain.

Bottom line, this is probably where I will be most wrong with my forecast. Developments here will have a material positive impact to Fairfax’s reported results (earnings and book value).

 

11.) Income taxes: estimated at 19%

12.) Non-controlling interests: estimated at 11% (not really sure)

 

13.) Shares Outstanding: reduced by 500,000 per year. This is in line with a normal year from Fairfax. It would not surprise me to see Fairfax do one more big repurchase to take advantage of the low share price while it lasts.

Edited July 14, 2023 by Viking

[Viking]

As i mentioned in my previous post, the closing of the Gulf Insurance Group (GIG) deal (Q4?) - boosting Fairfax’s ownership to 90% - will be an important growth driver of Fairfax’s 2024 results. 
 

GIG recently updated their web site. They added a bunch of new information. Below is the link to a 40 page report that provides a great overview of the company.

- https://www.gulfinsgroup.com/Frontend/EN/GIG-Corporate-Profile-ENG.pdf?download=false

 

Here are the financial highlights (2022):

• Net premiums written = $1.7 billion
• Underwriting surplus = $164 million
• Total Investments = $2.4 billion
• Shareholders equity = $748 milion
• Net profit = 125 million (Q1, 2023 = $34 million)

The purchase price of the 46% owned by Kipco is $860 million. However, the true cost to Fairfax is far less, due to the time value of money. Fairfax will pay $200 million at close and then 4 annual instalments of $165 million. If we use an 10% discount rate, the cost to purchase Kipco’s stake when it closes in Q4 is closer to $700 million ($200+$149+$134+$120+$108).
 

This is a good example of solid capital allocation on the part of Fairfax. They are paying a premium for quality. That is interesting. They are also playing the long game with this purchase as it is a very strategic purchase for them that solidifies their presence in the MENA region. It is also anther example of using their current robust cash flow to take out a partner in a business they understand very well.

 

Edited July 14, 2023 by Viking