Fairfax 2023

[TwoCitiesCapital]

4 hours ago, SafetyinNumbers said:

Thankfully, Fairfax is not a commodity but that still doesn’t mean we won’t have another drawdown at any moment. Investing to avoid drawdowns is hard and I think it’s part of the reason we are stuck near a $1000. Today was the 6th time through. Maybe the sellers are finally done or we’ll chop away all summer. Ultimately, it shouldn’t matter in the long term.

 

Seasonally it's the rough part for Fairfax/insurance too. Its also fighting some technicals like being overbought for so long on basics like RSI and etc

 

Obviously anything could happen, but I think it's more likely than not we get a pullback. Have been waiting to repurchases some shares I trimmed at $730-750 USD sub-$700. 

[SafetyinNumbers]

43 minutes ago, TwoCitiesCapital said:

 

Seasonally it's the rough part for Fairfax/insurance too. Its also fighting some technicals like being overbought for so long on basics like RSI and etc

 

Obviously anything could happen, but I think it's more likely than not we get a pullback. Have been waiting to repurchases some shares I trimmed at $730-750 USD sub-$700. 

You might be absolutely right but I think there is a chance the quarter is good enough that we don’t revert back under 0.82x book despite technical conditions. I can’t say I hope you get a chance to buy those shares back cheaper!

[TwoCitiesCapital]

Just now, SafetyinNumbers said:

You might be absolutely right but I think there is a chance the quarter is good enough that we don’t revert back under 0.82x book despite technical conditions. I can’t say I hope you get a chance to buy those shares back cheaper!

 

It's only been a slight trim. I still do well of we continue upward, but tryna finesse more shares and "make my own dividend" with these swing trades. 

 

In the meantime the cash gets deployed into names that are oversold and often times they get a pop while I'm waiting for the other to drop. Don't keep detailed enough records to know what the alpha is across all trades, but wouldn't be surprised if it added 2-3% per year in portfolio return while increasing my shares in longer term positions. 

[SafetyinNumbers]

11 minutes ago, TwoCitiesCapital said:

 

It's only been a slight trim. I still do well of we continue upward, but tryna finesse more shares and "make my own dividend" with these swing trades. 

 

In the meantime the cash gets deployed into names that are oversold and often times they get a pop while I'm waiting for the other to drop. Don't keep detailed enough records to know what the alpha is across all trades, but wouldn't be surprised if it added 2-3% per year in portfolio return while increasing my shares in longer term positions. 

That’s awesome. My trader instincts have diminished significantly since leaving the bank. I don’t even try any more. 

[MMM20]

What if the hard market reaccelerates and @Viking's '24/'25 numbers are way too low?

 

https://www.wsj.com/articles/facing-big-storm-losses-insurers-aim-to-boost-rates-f70211d6?st=mu1hv017qtasvf1&reflink=desktopwebshare_permalink

 

 

Edited July 21, 2023 by MMM20

[Blugolds11]

1 hour ago, MMM20 said:

What if the hard market reaccelerates and @Viking's '24/'25 numbers are way too low?

 

https://www.wsj.com/articles/facing-big-storm-losses-insurers-aim-to-boost-rates-f70211d6?st=mu1hv017qtasvf1&reflink=desktopwebshare_permalink

 

 

 

Was just talking about this with a buddy. I have a cabin up north and last week they were sending me video of a hail storm, golf ball size, literally bouncing off the ground, deck, driveway, it was insane, ground was covered. Everyone in area got hit....then again just yesterday..same thing. 

 

2 crazy storms within a week or so of each other. My buddy had claim for siding, windows, fascia and roof repair, also both vehicles totaled from hail.  

 

I guess upshot for insurance companies is at least storms were consecutive, once claims filed, cant total an already totaled car LOL

[UK]

https://www.barrons.com/articles/travelers-stock-climate-change-insurance-investing-6a8535e1

 

Unusually high catastrophe losses left The Travelers , a New York-based property and casualty insurer, in the red last quarter, but the stock rose nevertheless. That underscores a misperception about insurance stocks. Investors aren’t betting on the weather and the damage it brings, which can fluctuate drastically from year to year even as climate change makes storms more intense. What matters is how insurers charge for and manage that risk over longer periods. Although insurance companies’ balance sheets have been hammered by increasingly frequent and severe natural catastrophes in recent years, their stocks haven’t plunged. Insurance shares in the S&P 500 index are down about 1% since the beginning of the year, but up by 13% from a year ago. Investors aren’t losing faith in the group because insurers have been able to boost premium rates, taking in revenue that they will invest to cover future losses. Many have also been pulling out of risky markets, including California and Florida, where they couldn’t charge high enough rates to make profits, given the storms and wildfires that plague those states. The Travelers (TRV) is an example of how it is playing out. On Thursday, the company reported a loss of $14 million in its second quarter, or seven cents per share, a sharp fall from the $551 million in income, or $2.27 per share, it recorded in the same quarter last year.  The red ink was mainly due to higher catastrophe losses from “numerous severe wind and hail storms in multiple states,” according to the company. In the second quarter, the firm paid $1.5 billion in catastrophe damages, twice as much as the $746 million in the year-earlier period. “We had six events surpassed the $100 million mark in Q2, the most ever for a single quarter since we began disclosing the table in 2013,” said CFO Daniel Frey on a call to discuss the results with investors. Nevertheless, the stock gained 1.8% in Thursday trading as investors were more focused on the firm’s net written premiums, which grew 14% from last year to $10.3 billion. Net written premiums—the amount collected minus payments for reinsurance—in the business insurance segment increased by 18%, partially driven by higher rates for renewed policies. And despite the higher prices, retention was strong at 88%, according to the firm. In the personal insurance line, net written premiums were 13% higher than in the year-earlier quarter.

[Thrifty3000]

Sounds like insurers are taking a beating. I couldn’t believe how much Travelers jacked up my rate this year. 40% increase on a homeowner policy (only increased coverage by 20%). I started to shop it but got distracted with vacation.

[Thrifty3000]

On 7/16/2023 at 10:20 AM, Thrifty3000 said:

@Viking

 

Amazing analysis. You’re a saint for doing this.

 

You mentioned your “big ‘miss’ is related to capital allocation”.
 

If we assume they will net $9.5 billion over the next 3 years, then it looks to me like at least half of that is already earmarked for things like:

 

- buying out the minority stakes of some of their existing portfolio companies.

- retention/reinvestment by associates.

- paying common share dividends.

- buying GIG.

 

After paying for the fairly easily predictable items like those above, what do we have left, maybe $3 or $4 billion?

 

If they buy back another 1.5 million shares at an average price of $900 per share, then we’re looking at another $1.35 billion spend.

 

I don’t think there is too much to be concerned about with the uses listed so far.

 

So, I assume that leaves them with maybe a couple billion dollars to play with over the next 3 years for which we can’t easily predict the use. That’s where the fun stuff happens.

 

 

Circling back to forecasting what Fairfax will likely do with those $9.5 billion of profits rolling in over the next 3 years, here are some more specifics in order of predictability.

 

Purchasing GIG: $860 million

 

Common share dividends: $660 million

 

Options to purchase minority stakes and Riverstone portfolio: $2.675 billion (see summary below)

 

Total: $4.195 billion

 

 

 

 

For reference: summary of options to purchase:

 

- Allied: FFH Can buy 17.1% by 9/24. They bought 12% for $733.5 in 2022. I assume the 17.1% will cost around $1.1 billion.

 

- Odyssey Re: FFH can buy 10% for $900 mil beginning 1/25.

 

- Brit: FFH can buy 13.9% for $375 mil beginning 10/23.

 

- Riverstone: FFH can buy/sell certain securities in the Riverstone portfolio. I’m not clear on all the puts and takes on this one so I’m just earmarking $300 mil for it.

[MMM20]

On 7/21/2023 at 8:44 AM, Thrifty3000 said:

Sounds like insurers are taking a beating. I couldn’t believe how much Travelers jacked up my rate this year. 40% increase on a homeowner policy (only increased coverage by 20%). I started to shop it but got distracted with vacation.

 

Maybe this should be a DM, but check out https://www.credible.com/home-insurance - no spam calls, first heard about it from Mr Money Mustache https://www.mrmoneymustache.com/mmm-recommends/credible/ - they handled the shopping around part and quite literally saved me ~15% by switching to GEICO (—> Liberty Mutual).
 

No affiliation but delete if too tangential / off topic...

 

 

Edited July 23, 2023 by MMM20

[Thrifty3000]

1 minute ago, MMM20 said:

 

Maybe this should be a DM, but check out https://www.credible.com/home-insurance - no spam calls, first heard about it from Mr Money Mustache https://www.mrmoneymustache.com/mmm-recommends/credible/ - they handled the shopping around part and quite literally saved me ~15% by switching to GEICO (well, Liberty Mutual)

Awesome! Thanks. Will definitely check it out. 

[UK]

[MMM20]

Still can't believe that Fairfax seems to trade primarily on book value. IMHO this more than closet indexing, technicals, volume, skepticism about Prem or anything else is why the stock is still so ridiculously cheap despite Fairfax's transformation into a top 20 insurer and cash flow machine...

 

Edited July 24, 2023 by MMM20

[backtothebeach]

On 7/20/2023 at 3:33 PM, Xerxes said:

https://podcasts.apple.com/ca/podcast/the-business-brew/id1540847053?i=1000621753971
 

Enjoyed listening to the podcast! Thank you.
One aspect that was new to me, was that the stock price may get a boost from closet indexers finally getting tired of not holding an outperforming stock that’s part of the index, and buying in - after long enough proof that the company’s performance is durable.

[SafetyinNumbers]

9 hours ago, MMM20 said:

Still can't believe that Fairfax seems to trade primarily on book value. IMHO this more than closet indexing, technicals, volume, skepticism about Prem or anything else is why the stock is still so ridiculously cheap despite Fairfax's transformation into a top 20 insurer and cash flow machine...

 

I think book value is entirely appropriate metric to trade on for Fairfax. Most financials that are balance sheet centric trade on book and expected ROE. I wouldn’t want it to change just as our book value is growing 3-5% a quarter. Plus earnings streams are volatile in the insurance business so a P/B multiple in theory should dampen volatility which makes it easier to hold.

[drzola]

Not looking good for  Fairfaxes Farmers Edge  holding it appears.

 

Farmers Edge Reprioritizes Go-to-Market Strategy and Slashes Staff While Co-Founder Launches Competitive Agronomy Business

SHANE THOMAS

JUL 22, 2023

∙ PAID

 

Share

 

At Upstream, the focus has never been to break news or write about industry hearsay. I have no intention of moving away from that focus either. However, when I receive over a dozen consistent messages from those that are a combination of farm customer, employee, ex-employee or enterprise customer I follow that directional arrow closely and analyze the potential implications on the business and industry based on what I am confident in being real.

This article includes:

• Highlights about recent changes to Farmers Edge global business along with their North American business

• Changes in Farmers Edge customer support

• What the news means for Farmers Edge business priorities

• The future of Farmers Edge carbon business

• Will these business changes make Farmers Edge successful long term?

• The news from Farmers Edge also coincides with a separate announcement from their co-founder and former CEO, Wade Barnes, and his new endeavor Ronin Agronomy, which is tied in at the end.

Starting in June I received messages that Farmers Edge had pulled out of Australia and Brazil, with screenshots of messages from the company to customers and staff being sent to me via Twitter direct message. I do not think this was surprising. While I feel for the individuals who have had their livelihood impacted, one of the simplest business decisions for incoming CEO Vibhore Arora to make was to cut costs and focus their business geographically, something I talked about last year.

 

Of note, Australia and Brazil made up about 20% of their employee base and about 20% of their revenue base, according to their company filings:

Our revenue mix by geography for the year ended December 31, 2022 is as follows: 35% Canada, 44% United States, 17% Brazil, 4% other.

 

 

If Farmers Edge is ever to reach cash flow positivity, focus is necessary.

I also suspected they would prioritize their core geography: western Canada and the Northern Plains of the USA, and emphasize enterprise software offered to the likes of ag retailers.

This is where the messages I received this week have come in.

Farmers Edge has allegedly begun to shut down its operations hubs and notified staff that their roles will become obsolete at the end of August in the Canadian provinces of Alberta and Ontario, along with most of its hubs in the USA. Staff members in the affected regions were given until the end of August to close up offices and tie up loose ends.

My understanding is that there will be less than a hand full of hubs operating in Saskatchewan, Manitoba and the northern US states to service their direct-to-farm precision service customers.

For those farm customers that worked directly with Farmers Edge and received boots-on-the-ground support that fall out of the geography of the in-person support, they will be transitioned to virtual support, apparently a call center. If farmers are newly into a long-term contract with Farmers Edge, this is likely to be an unfortunate change to their service experience.

Farm customers that purchased services through enterprise retail customers will have support from their retail contacts.

“Virtual” support is notable. The unit economics of in-person, boots-on-the-ground support has been one of the biggest challenges with Farmers Edge business model. It’s also been a differentiator for them— implementing precision agronomy can be a full-time job for even great farmers and comes with a lot of complexity.

Farmers Edge made up one side of the precision ag paradox — employ staff for a high-touch service offering, and you get high costs and lower margins. The alternative side is offer a low-touch service, and you get low grower implementation and high turnover, albeit higher margins on the few you retain.

Given this, one has to assume Farmers Edge knows many of these virtually serviced acres will turnover— but the ones that do remain will have a much higher contribution margin to the business.

This service change illustrates that their direct-to-farmer business will be a small contributor to their future revenue and profits. It then becomes apparent they are focusing in two areas:

• Enterprise offerings (FarmCommand as ag retail SaaS, crop input marketplace CommoditAg)

• Carbon business (Soil lab, carbon offsets, insetting efforts)

Note: They do have an insurance business too.

Their enterprise offerings have a fit, albeit they are in a competitive space with the likes of TELUS Agriculture (which renamed their ag retail software, Agrian, to TELUS Agronomy this week) plus in a space I am not bullish on with crop input marketplaces. There is a long tail of farmers that could want access to inexpensive crop inputs such direct shipments of straight urea or generic crop protection products, but I don’t see that taking Farmers Edge to success. For background, they sold just $5.6 million in crop inputs in 2022 and even if they 5x that over the coming two years, they are selling the equivalent of just one good-sized ag retail location.

What stands out the most to me with this news though, is the future of their carbon business.

Share Upstream Ag Insights

Can Carbon Get Farmers Edge to Profits?

 

Like precision ag implementation, carbon offset creation is challenging for farmers to do on their own.

At it’s most simple, the Farmers Edge carbon business would rely on three things to create an offset:

1. Successful implementation of carbon-reducing practices, such as variable rate fertilizer application or lower tillage that are consistent with a qualifying protocol, as two examples.

2. Effective soil sampling.

3. Data to verify compliance with the protocol.

With the help and support of boots-on-the-ground agronomists, all three of these points can be accomplished and Farmers Edge has successfully done so according to Amit Pradhan, vice-president of strategy with Farmers Edge in the Manitoba Cooperator:

We have done a good job at serializing these offsets. Where we have not done a good job is selling them

Without the boots-on-the-ground staff, the job of serialization gets more challenging. It’s not impossible, but it likely requires more staff in the carbon business and more part-time soil samplers at the very least. Again, implementation of these practices can be a challenge without in-person support.

The second half of the comment is interesting, too, because if they can’t sell the off-sets today to make money, farmers will be even less open to working with them on future carbon initiatives.

What is it that could be driving this inability to sell off-sets? I don’t know, but three potential things come to mind (or a combination of them):

• Higher expectations for prices per offset/view on the future market going higher (eg: not willing to sell below a certain price)

• No demand for their off-set quality or protocol used.

• Lowering demand for agriculture carbon off-sets in general.

Two of these can be managed, the last is a fundamental question that remains uncertain for all companies relying on the carbon market.

[Parsad]

35 minutes ago, SafetyinNumbers said:

I think book value is entirely appropriate metric to trade on for Fairfax. Most financials that are balance sheet centric trade on book and expected ROE. I wouldn’t want it to change just as our book value is growing 3-5% a quarter. Plus earnings streams are volatile in the insurance business so a P/B multiple in theory should dampen volatility which makes it easier to hold.

 

+1!  Berkshire has three powerful engines that differentiate it...insurance, investment portfolio and most importantly cash-flow positive operating subs.  When Buffett talks about why book value is less meaningful, he's referring to why it shouldn't be the sole factor in deciding intrinsic value...like in Berkshire's case...where the carrying value of the operating subs tend to be recorded at cost rather than fair value. 

 

In Fairfax's case, some of the insurance businesses are undervalued on the books, but not so much the operating subs.  Thus using book value is a good measure of estimating intrinsic value.  Remember, for many years until Berkshire's operating subs became the dominant engine, Buffett was perfectly fine using book value as a measure when he would compare BRK performance based on change in book value versus the S&P500...this did not change until the 2019 annual report where he started using BRK's market change versus the S&P500.  

 

And whether shareholders like it or not, leverage does not increase the quality of earnings, but reduces it.  In FFH's case, it is more leverage than say a Berkshire or Markel.  While earnings power is there, and is fixed for the next three years due to the bond portfolio, historically the leverage has cut both ways.  If FFH wants to be valued at a higher P/B, reduce leverage and still make the same amount of money!  Greater earnings quality will mean higher valuations.  There is a reason why Coke or Google are valued where they are.  Cheers!

[MMM20]

@SafetyinNumbers@Parsad I respectfully disagree!

 

All that matters in the intrinsic value calculation is the net present value of distributable cash flows to a permanent owner. So all I care about is the core cash flowing power and how it will be retained and reinvested. That will of course drive growth in book value, but that’s a lagging output.

 

Aren’t low cost commodity producers classically great businesses? That’s about as volatile an earnings stream as you can get! And if one ever trades at a low multiple of mid cycle earnings, isn’t that an opportunity for value investors? Look at what Buffett is buying nowadays!

 

Let’s say a new company raises $100M and succeeds wildly. They are doing $1B in annual EPS right away with a long runway and wide moat. Do we still value the stock at ~1.5x the ~$100M BVPS because “that’s where peers are trading” - or something else?

 

I would argue Fairfax recently did something like that with its mid 2010s insurance acquisitions. Would Fairfax’s intrinsic value be higher if they replaced their now massive quantum of float with fixed rate debt? Earnings would be lower but more predicable year to year. Would the company therefore be *worth* more?
 

Fairfax should trade at a higher multiple if it has more insurance float - truly an asset and not a liability - due to the impact on cumulative future cash flows - even though they will certainly be *more* volatile!

 

I understand that Fairfax may *trade* at a lower valuation than a company of similar quality with a lower but smoother stream of cash flows, because Mr Market tends to prefer smooth… but isn't that exact disconnect a classic opportunity for value investors?

 

A stock is also not worth less just because GAAP accounting doesn’t slap us in the face with the underlying value. Float is a textbook example - it is an accounting liability but an economic asset. If we are comparing to BRK, Buffett has told us exactly that repeatedly over the years. And if BRK’s float was ~1.5x its equity book value today, you gotta think Buffett would still be writing a whole lot about valuing float.
 

Float is a truly massive economic asset for Fairfax now. NAV is US$1500-2000 per share, and float is a big chunk of the delta to accounting BV. It may appear like theyre be overearning right now, but if you do the work to adjust accounting BV to economic reality, ~$150 ‘23E EPS makes a lot of sense as a normalized number!

 

I think the crux of the opportunity in FFH right now can be best summarized as exactly that: accounting book value significantly understates intrinsic value and mostly because of the massive float growth of the past few years - both how it has changed the core earnings power and what it says about Fairfax management!

 

A business with a durable competitive advantage that earns elevated returns over long periods of time and has ample room for growth should be considered great whether or not (1) those returns are volatile or (2) it shows up properly in GAAP EPS or BVPS.
 

Accounting often misleads the value investor and we have to do the work to get at economic reality. That is true here in an extreme way.

 

Sorry for the long and rambling post. I am right and you are smart so you will see it my way eventually. Is that the munger quote? Lol. 

 

Edited July 25, 2023 by MMM20

[SafetyinNumbers]

20 minutes ago, MMM20 said:

 

 

I think the crux of the opportunity in FFH right now can maybe be best summarized as exactly that: accounting book value significantly understates intrinsic value and mostly because of the massive float growth of the past few years. 
 

 

 

 

If book value understates intrinsic value then ROE should be above 10% assuming 10% is a reasonable return on IV. MKL and BRK trade at around 1.5x suggesting the market expects 15% ROE going forward. Alternatively, the market has much lower return expectations for MKL and BRK which might also be true. 10% ROE on a 1.5x book is only a 6.7% return.

[Munger_Disciple]

1 hour ago, Parsad said:

 

+1!  Berkshire has three powerful engines that differentiate it...insurance, investment portfolio and most importantly cash-flow positive operating subs.  When Buffett talks about why book value is less meaningful, he's referring to why it shouldn't be the sole factor in deciding intrinsic value...like in Berkshire's case...where the carrying value of the operating subs tend to be recorded at cost rather than fair value. 

 

In Fairfax's case, some of the insurance businesses are undervalued on the books, but not so much the operating subs.  Thus using book value is a good measure of estimating intrinsic value.  Remember, for many years until Berkshire's operating subs became the dominant engine, Buffett was perfectly fine using book value as a measure when he would compare BRK performance based on change in book value versus the S&P500...this did not change until the 2019 annual report where he started using BRK's market change versus the S&P500.  

 

And whether shareholders like it or not, leverage does not increase the quality of earnings, but reduces it.  In FFH's case, it is more leverage than say a Berkshire or Markel.  While earnings power is there, and is fixed for the next three years due to the bond portfolio, historically the leverage has cut both ways.  If FFH wants to be valued at a higher P/B, reduce leverage and still make the same amount of money!  Greater earnings quality will mean higher valuations.  There is a reason why Coke or Google are valued where they are.  Cheers!

 

+1, Excellent post @Parsad! Clearly summarizes the difference between BRK & FFH. 

[Munger_Disciple]

2 hours ago, SafetyinNumbers said:

I think book value is entirely appropriate metric to trade on for Fairfax. Most financials that are balance sheet centric trade on book and expected ROE. I wouldn’t want it to change just as our book value is growing 3-5% a quarter. Plus earnings streams are volatile in the insurance business so a P/B multiple in theory should dampen volatility which makes it easier to hold.

 

I agree book value & its growth are excellent metrics for FFH which resembles early years of  Berkshire before its transformation into a collection of cash flow generating operating businesses in addition to the insurance mother ship with its associated marketable securities. 

 

I don't think ROE is a good metric to use for insurance companies because earnings can be so volatile. Instead, I just focus on the rolling 5-year rate of growth in book value. 

[Munger_Disciple]

1 hour ago, MMM20 said:

I respectfully disagree!

 

Every stock is worth the net present value of distributable cash flows. Fairfax should trade at a higher multiple because it has more of the highest possible quality leverage, insurance float - truly an asset and not a liability - and the impact on expected future cash flows, even though they will certainly be volatile!

 

A stock is not worth less simply because the cash flows are more volatile. I understand that it may trade at a lower valuation for that reason…but that’s an opportunity.

 

Here is an example. Company A and Company B are exactly the same business but Company A owners and management don’t care at all about volatility. Let’s assume all earnings are distributed as dividends to keep it simple.

 

Let’s say Company A is expected to earn $150, $150, $150, $0, -$10, $200, and then 0 terminal value.

 

Let’s say Company B is expected to earn $20, $25, $30, $40, $50, $60, and then 0 terminal value.

 

Is Company B worth more than Company A because the earnings are less volatile?

 

All that matters in the intrinsic value calculation is the net present value of distributable earnings to a permanent owner. Accounting book value is an *extremely* rough proxy. 

 

I think that is the opportunity in many public companies and that will probably always be the case.

 

To me that’s really a core first principle of value investing so I’m surprised it’s controversial in this case.

 

All I care about with Fairfax is the core cash flowing power and how it will be retained and reinvested. That will drive the growth in book value but IMHO that’s just an output of what actually matters. 

 

I think the crux of the opportunity in FFH right now can maybe be best summarized as exactly that: accounting book value significantly understates intrinsic value and mostly because of the massive float growth of the past few years - both how it has changed the core earnings power and what it says about Fairfax management!

 

Either way I think we probably agree that intrinsic value is at least 50% higher than the current market price, right? The stock is cheap and skepticism still abounds. Let’s see if we ever get to the euphoria phase…

 

 

The problem is Company A's cash flows maybe almost impossible to estimate a priori in your example DCF. This type of companies tend to be very cyclical like commodity companies and IV tends to  fall in a very broad range as opposed to B type companies. For FFH, the cash flows are mainly from its investment portfolio (& not from operating subs like Berkshire) and can only be estimated in the near/medium term of 2-3 years and hence (rightly so as @Parsadexplained) the valuation discount relative to BRK. 

Edited July 24, 2023 by Munger_Disciple

[dealraker]

In my dreams I buy a long-long-long tail insurance company with 5-8% annual premium growth that breaks even on premiums to claims and has an investments to equity ratio of 3 to 1.  The investment portfolio is one stock always fairly valued that appreciates at about 10% and doesn't pay a dividend.  

 

Management adds share additions to the one stock investment portfolio from the gradually but endlessly increased float - from the profitless enterprise - all while hordes of analysts and investors chant in unison:

 

It has no profits or cash flow

It has no dividend (thus management doesn't "share")

It has no return on equity

Edited July 24, 2023 by dealraker

[Parsad]

3 hours ago, MMM20 said:

@Parsad I respectfully disagree!

 

All that matters in the intrinsic value calculation is the net present value of distributable cash flows to a permanent owner. So all I care about is the core cash flowing power and how it will be retained and reinvested. That will of course drive growth in book value, but that’s a lagging output.

 

Would Fairfax’s intrinsic value be higher if they replaced the float with fixed rate debt? Earnings would be lower but more predicable year to year. Would the company therefore be *worth* more?

 

Aren’t low cost commodity producers classically great businesses? That’s about as volatile an earnings stream as you can get! And if one ever trades at a low multiple of mid cycle earnings, isn’t that an opportunity for value investors? Look at what Buffett is buying nowadays!

 

All else equal, Fairfax should trade at a higher multiple if it has more of the highest possible quality leverage, insurance float - truly an asset and not a liability - due to the impact on cumulative future cash flows, even though they will certainly be *more* volatile!

 

I understand that Fairfax may *trade* at a lower valuation than a company of similar quality with a lower but smoother stream of cash flows, because Mr Market tends to prefer smooth… but isn't that exact disconnect a classic opportunity for value investors?

 

A stock is also not worth less just because GAAP accounting doesn’t slap us in the face with the underlying value. Float is a textbook example - it is an accounting liability but an economic asset. If we are comparing to BRK, Buffett has told us exactly that repeatedly over the years. And if BRK’s float was ~1.5x its equity book value today, you gotta think Buffett would still be writing a whole lot about valuing float.
 

Float is a truly massive economic asset for Fairfax now. NAV is US$1500-2000 per share, and float is a big chunk of the delta to accounting BV. It may appear like theyre be overearning right now, but if you do the work to adjust accounting BV to economic reality, ~$150 ‘23E EPS makes a lot of sense as a normalized number!

 

I think the crux of the opportunity in FFH right now can be best summarized as exactly that: accounting book value significantly understates intrinsic value and mostly because of the massive float growth of the past few years - both how it has changed the core earnings power and what it says about Fairfax management!

 

A business with a durable competitive advantage that earns elevated returns over long periods of time and has ample room for growth should be considered great whether or not (1) those returns are volatile or (2) it shows up properly in GAAP EPS or BVPS.
 

Accounting often misleads the value investor and we have to do the work to get at economic reality. That is true here in an extreme way.

 

 

Float is just a better alternative when utilizing leverage.  It still has the same problem when you are wrong or risk management is off.  I would prefer if they had more float and less debt since they already use more than adequate asset to equity leverage.  While debt is cheap it still means you owe money to others that you don't have...either reduce debt or hold more cash in the holding company.  

 

Banks have enormous earning power because of their leverage...but you saw how quickly things turned a few months ago when their bets go sideways or risk management makes a mistake.  

 

What durable competitive advantage does Fairfax have outside of management?  It's a financial institution like any other.  Other reinsurers have float and their earnings stink!  Even FFH's own insurers were not doing well for nearly a decade until Prem put Andy Barnard in charge of them all...float wasn't helping them then, it was killing them.

 

The biggest advantage FFH has is that it is family-controlled and has a stellar CEO and team.  Leverage is not their biggest advantage. 

 

Buffett has always said, and continues to say, that float is advantageous.  But Berkshire's greatest strength and advantage is its capitalization..."the checks will always clear at Berkshire!"  Cheers!

[DM1]