Fairfax 2023

[Munger_Disciple]

1 hour ago, StubbleJumper said:

 

 

Mr. Market likely doesn't believe that EPS of $150 is sustainable.  Your EPS of $150 contains $60 of underwriting income which can disappear pretty quickly if capital flows into the industry, and the $100 of interest can turn into $75 by 2027 if the fed moves away from it's tightening process and instead adopts a loosening posture.

 

FFH will almost certainly have 2 or 3 good years of income and its share price likely has some distance left to go, but we need to attenuate our long-term expectations.  Ignore the PE ratio entirely when you are at the top of the insurance cycle.  Instead develop a forecast of BV for December 2025 and select what you believe is an appropriate multiple of book for a company that is selling a commodity product (insurance policies) in an industry with minimal barriers to entry.  That BV multiple should likely be one of 0.8x, 0.9X, 1.0x, 1.1x or 1.2x.   As a point of interest, CAD$1375 is roughly 1.2x...

 

 

SJ

 

 

There is no way FFH or any other insurer can maintain a 94 CR over the long term. The best one can hope is 100 CR over a full cycle. Insurance is too much of a commodity business to expect anything else. That's why BRK's goal is to have cost free float. Having said that, it is quite possible for FFH to do quite well in the next 2-3 years in a hard market. 

Edited August 6, 2023 by Munger_Disciple

[Red Lion]

7 hours ago, Luca said:

Yep, friends of mine who also invest say they don't and cant understand insurance (fair enough, its a blackbox) and the history doesn't look appealing to them which stops them from digging deeper. I shared a lot of things from the board, but skepticism is strong against future underwriting (climate change), they still think rates will come down hard soon and that the interest income leg will fall away for fairfax (they know they locked in rates but are still skeptical)+their equity portfolio is not something where one immediately sees value. 

 

Hence the opportunity.

The funny thing is climate change should be bullish for insurance in the long term since it implies much larger risks and higher premiums which means more float and hopefully underwriting profit. 

[MMM20]

5 hours ago, StubbleJumper said:

I see some truly enthusiastic valuation levels being proposed on this board for a company that sells a commodity product with few barriers to entry.

I’ve yet to see anyone arguing FFH should trade at even a market multiple. Have you? Half that would be a ~2x!  
 

What if the board actually skews too cautious - too quick to tamp down enthusiasm and assume there is a shoe to drop, or that we’ll revert to some worst case scenario for underwriting profitability and investment returns? Maybe we are still too anchored to 2010-18 and not believing the new reality, because we as value investors reflexively blanch at anything that sounds like “this time is different.”

 

Maybe there really has been the fundamental transformation in through-cycle earnings power (even assuming breakeven underwriting) that many of us think we see here, and Mr Market has just been slow to react b/c he is anchored to the recent past.

 

Frankly, I could argue that the stock is easily worth $3,000+ USD to a permanent owner right now — with slightly better than breakeven underwriting through cycles, more historically normal interest rates and equity returns, and great capital allocation — if  Prem and team prove to be great capital allocators for another decade or two or three. 
 

Wait until Mr Market starts doing the math again on what ~6-8% investment returns translate to for shareholders when sustainably levered ~1:1 - ~2:1 with the best possible type of leverage. I think many people are still afraid to get laughed at for doing that math. But what if that’s reality?

 

And BTW Charlie Munger tells us that he welcomes downturns because great businesses take share when their competitors are in distress. Does that not look like Fairfax right now? And in large part b/c they were willing to look stupid and not reach for yield… b/c of a sustainable structural advantage.
 

I assume I’ll be laughed off the board for that but there’s your enthusiastic valuation level

 

 

Edited August 6, 2023 by MMM20

[MMM20]

4 hours ago, StubbleJumper said:

Ignore the PE ratio entirely when you are at the top of the insurance cycle.  Instead develop a forecast of BV for December 2025 and select what you believe is an appropriate multiple of book for a company that is selling a commodity product (insurance policies) in an industry with minimal barriers to entry.  That BV multiple should likely be one of 0.8x, 0.9X, 1.0x, 1.1x or 1.2x.   As a point of interest, CAD$1375 is roughly 1.2x...

I could not disagree more with this approach or characterization.
 

The ability to underwrite profitability and operate for long term shareholder value creation and not short term optics is a massive moat in this industry full of bureaucrats and hired-gun MBAs who nearly blew up their collective balance sheet by simply matching duration risk and sticking with long terms bonds even though interest rates were at 5,000 year lows — human nature and principal agent problem, misaligned incentives. You can’t afford to risk looking dumb for a decade if you dont have an incredible 25 track record and huge personal ownership. That more than any cost advantage is what makes a moat in this business. That will not change anytime soon, even when capital re-enters and drives underwriting profitability down.

 

Prem did what was right from a risk/reward perspective of a permanent owner and it has structurally transformed the cash flow power of the business going forward. This is far from reflected in book value right now and an output of it may very reasonably be, with conservative assumptions around underwriting and investment returns, that book value triples over the next decade.  Because the cash flows and incremental return on those retained are what matters. 
 

And a stock is worth the net present value of future cash flows, not what the accountants say it is worth based on historical artifacts. Accounting book value almost completely misses the point in this case at this point in time, and nearly all others.  Respectfully, investors are totally missing what is going on here if you they are focused on that metric. It is useful just to understand how the stock may trade in the short run, I agree on that much.
 

Anyway, sorry, this gets me fired up, and maybe I’m wrong. I’ve been dead right on this for 2.5+ years now on my biggest position by ~3x in the face of skepticism bordering on derision so maybe I’m just riding high and overconfident. “What do I know?” — Montaigne

 

I guess this is what makes a market!

 

Edited August 6, 2023 by MMM20

[Haryana]

 

My math is very easy.

 

I can take my $1000 to the treasury market and get treasuries worth $1000.

 

OR

 

I can take my $1000 to the Fairfax stock and get treasuries worth $2000.

 

 

Not even expecting any profits from their underwriting or equity investments.

 

Please criticize.

 

[StubbleJumper]

5 hours ago, MMM20 said:

What if the board actually skews too cautious - too quick to tamp down enthusiasm and assume there is a shoe to drop, or that we’ll revert to some worst case scenario for underwriting profitability and investment returns? Maybe we are still too anchored to 2010-18 and not believing the new reality, because we as value investors reflexively blanch at anything that sounds like “this time is different.”

 

 

It's not a worst case scenario.  It's merely a more normal scenario.  What we are seeing today is not normal.  It's a top of the cycle underwriting situation.  And with respect to interest rates, who really knows?  All we know is that the fed has engaged in a tightening stance for a particular reason, and if the economy slows, the fed will likely reverse that stance to some extent.  All that to say, we are living nearly perfect operating conditions for a well capitalized P&C insurer right now, and if you project that forward very far, you do so at your own risk and peril.

 

 

5 hours ago, MMM20 said:

Frankly, I could argue that the stock is easily worth $3,000+ USD to a permanent owner right now — with slightly better than breakeven underwriting through cycles, more historically normal interest rates and equity returns, and great capital allocation — if  Prem and team prove to be great capital allocators for another decade or two or three. 

 

That is a possibility.  It's always possible that Hamblin Watsa shoots out the lights for the next 20 years and we will see truly extraordinary investment results.  The question is whether it's wise to make that kind of assumption.

 

5 hours ago, MMM20 said:

Wait until Mr Market starts doing the math again on what ~6-8% investment returns translate to for shareholders when sustainably levered ~1:1 - ~2:1 with the best possible type of leverage. I think many people are still afraid to get laughed at for doing that math. But what if that’s reality?

 

 

It could happen.  But, if you have a business model that requires you to keep roughly two-thirds of your investments in fixed income and preferreds, you need a particular set of circumstances to get you 6-8% returns overall.  You can definitely get there right now when you can average 4.5% on the fixed income component because means you only need ~9% on your investments in equities/associates to get your overall 6% return.  But, again, you might want to be a little cautious about projecting that sort of thing forward because we are likely near the end of a tightening phase.

 

We are seeing a truly amazing set of circumstances right now.

 

 

SJ

[StubbleJumper]

5 hours ago, MMM20 said:

And a stock is worth the net present value of future cash flows, not what the accountants say it is worth based on historical artifacts. Accounting book value almost completely misses the point in this case at this point in time, and nearly all others.  Respectfully, investors are totally missing what is going on here if you they are focused on that metric. It is useful just to understand how the stock may trade in the short run, I agree on that much.

 

Well, it's true that a stock is worth the present value of future cashflows.  If you hold the view that FFH's fair value is much higher than BV, you pretty much need to make the argument that there is some hidden value on the balance sheet, that FFH is a best in class underwriter, or that management is so talented that it will be able to obtain a return on equity that far exceeds market return.  Hidden value can definitely exist, and it probably does in assets such as the Bangalore airport and possibly a few undervalued investments like Eurobank.  But, most of the other portfolio assets that FFH holds and most of its investments in associates have fair value that is pretty close to reported book.  And that's the nature of an insurance company.

 

The most valid argument in favour of FFH being worth more than the book value of its assets is its investing prowess.  That argument definitely does hold water, but you need to be very thoughtful of just how significant that advantage is.  An insurer is inescapably constrained to holding a large percentage of fixed income investments.  If FFH can get some alpha on its investment in equities and associates, it is definitely worth more than book.  But, there are limits to that.  Even Berkie only trades at 1.5x, and Berkie has a significantly undervalued railroad on its books among other long-held operating businesses that are worth far more than book.

 

 

SJ

[StubbleJumper]

8 hours ago, Viking said:

@StubbleJumper i have enormous respect for your knowledge about all things insurance. So please keep the comments coming. I agree there is a risk that the hard market could quickly reverse and become a shit show - which would hit underwriting income. But what is the probability of that actually happening? My understanding is when the last hard market ended things went sideways for 3 or 4 years - it did not deteriorate into a shit show. My point is risks need to be considered. And probabilities attached. 
 

Insurance companies are laser focussed on generating an acceptable return for shareholders. Pricing (rate increases) look like it actually accelerated a little higher in Q2. 
 

With my estimates/forecasts i lean heavily on what i think i know. That is why i only like to look out about 2 years. As new information becomes available i will make updates. 

 

 

One of the most interesting bits that FFH publishes every year is a table depicting FFH's financing differential that appears in Prem's annual letter.  In the early years, he provided the table in its entirety, but over the past 15 years or so, he's only provided an excerpt.  A number of months ago, I went through the annual letters and constructed the long term series to the best of my ability (see attached).

 

The table shows how CRs and long term Canadian fixed income rates have evolved.  The long and the short of it is that the financing differential (long-term bond rate less cost of float) has typically been in the low single digits, with only occasional years higher than 5%.  The unfortunate thing is that the table uses long Canadian bonds, which made a great deal of sense 25 years ago when FFH was mainly a long-tail Canadian insurer.  But, at this point, FFH is effectively a US insurance company with the lion's share of its fixed income investments in shorter-term US treasuries.  A more instructive table would therefore replace the Canadian long-bond return with a 2 or 3 year US treasury, or perhaps a 5 year US treasury.  But, in any case, suffice it to say that when you can easily find a 5% treasury bond, you don't usually also see a -6% cost of float (ie, a 94 CR).  We are currently seeing a financing differential of about 11 percent, which is outstanding...and likely unsustainable.  That enormous financing differential is likely to be competed away as capital enters the industry and companies get a bit more aggressive about growing their book.

 

That leads me to yet another interesting observation about FFH shareholders.  Allied, Odyssey and Northbridge all have plenty of capital to enable an underwriting expansion.  It's fascinating to me that shareholders have not been haranguing Prem during the conference calls to grow those books more aggressively. 

 

 

 

SJ

FFHfloat.xls

[Tommm50]

2 hours ago, StubbleJumper said:

That leads me to yet another interesting observation about FFH shareholders.  Allied, Odyssey and Northbridge all have plenty of capital to enable an underwriting expansion.  It's fascinating to me that shareholders have not been haranguing Prem during the conference calls to grow those books more aggressively. 

 

I hope our shareholders understand It's not that simple.

 

I've been managing underwriting operations for over 30 years and you are a;ways walking on a razor's edge trying to balance growth and profitability. It's been said on this board that Fairfax is in a commodity business but that is not exactly true. Where that concept is most true is in U.S. personal lines and small commercial business, less so in reinsurance and specialty casualty business. Fairfax's portfolio is more tuned to the latter, as well as global and emerging markets. Crum & Forster went from a "main street" insurer (read commodity insurer) when Fairfax bought them to much more of a specialty casualty insurer now. Their results reflect this.

 

In every case in the U.S. market even the largest insurer has a very small market share, you have very little leverage in obtaining your price and terms. You have better conditions in lines of coverage that fewer insurers write. Even here your opportunities are contingent on market conditions. In a hard market you have a better shot at getting your terms but if you are not very disciplined on managing your growth you'll find in a few years your combined ratios will climb as you wrote "middlin' opportunites" rather than the best opportunities. Your combined ratios will revert to 100 or worse.

[Viking]

@StubbleJumper and @Tommm50 , great comments. I have said many times, i am not an insurance guy. So i really appreciate hearing from those who work(ed) in the industry. I appreciate the colour. And please point out the flaws in my logic in my posts… otherwise i will just keep repeating my mistakes. Thank you. 

Edited August 7, 2023 by Viking

[steph]

I also do agree that expecting 94 combined ratios long term is not realistic.  97-98 would be nice.  On the other hand I hope to see some nice surprises on the equity side in the coming years: Digit, Eurobank, Atlas,....whatever....and not much credit is given to this possibility. 

In the meantime FFH still trades at what is a historical very low valuation compared to book even though it has never been as solid: great insurance activities (used to be very average) and a AAA bond portfolio.  A 1.5 times book seems acceptable today.  This would be more in line valuation compared to the past and compared to competitors.  And FFH is today better, stronger and more interesting growth profile than ever before. 

[MMM20]

@StubbleJumper the fact that you see it that way makes me think I’m missing something. That's a good thing and I am grateful for that too.

 

Seems like the big vectors are lining up as if we are still in the early-middle innings, which is clearly not consensus! Of course 1100 bps of spread between investment returns and borrowing costs is unsustainable in the long run. Maybe the counterpoint is we could easily end up with 3 more years of wide spreads and then some reversion to the mean, which could easily mean $4-5B+ annual cash flow thereafter through the cycle if we get good to great capital allocation. I don’t know. In other words, even if the current state of things *is* more like a windfall than a new normal, well, it seems like a windfall of such magnitude that with good capital allocation it should permanently transform the earnings power either way. That is not priced into the stock. 

 

“To date, 2023 has been a significant catastrophe year with some estimates suggesting that U.S. insurer losses have already surpassed $25 billion this year. The events this year had been broadly felt with 44 states affected by 43 events. At the company level, these events have added 4.5 points to our combined ratio year-to-date, which is 1.7 points higher than the impact catastrophe events had on our combined ratio for the first half of 2022. Our property business has been most affected by catastrophes, adding almost 46 points to the property loss ratio so far this year, which is about 16 points more when compared to this time in 2022."

- Progressive CEO Susan Griffith

 

My underlying point is this.  What if Fairfax has proven to be a truly world class company on both the underwriting and investment side of things?  What are the implications? 

 

Edited August 7, 2023 by MMM20

[Xerxes]

If ever there is a CoBF coffee mug dotted with the handles of the top ten-fifteen posters in the Fairfax thread, I would definitely buy a mug as a memorabilia 

[Viking]

Fairfax just reported Q2-2023 results. The surprise for me? Underwriting profit, interest and dividend income and share of profit of associates all came in higher than I expected. 

 

As a result, I decided it was time to update my earnings estimates for Fairfax for 2023, 2024 and 2025. I have the highest confidence level in my 2023 forecast. My 2025 forecast is largely an educated guess. A lot can change in 2 years (both good and bad). Please keep this in mind as you are reading. 

  

Conclusion:

Let's skip ahead to the conclusion. My rough estimate is Fairfax will earn about $160/share in 2023. This is up from my last estimate which was $145/share (made in early July). The increase reflects the better-than-expected operating earnings Fairfax reported for Q2. 

 

For 2024, my new estimate is $166/share and for 2025 it is $174/share. 

 

The big ‘miss’ with my estimates in 2024 and 2025 is likely capital allocation. We don’t know what the management team at Fairfax is going to do with all the earnings (around $3.6 billion) that is likely coming in each of the next 2.5 years. Looking at the last 5 years, the management team has been outstanding with capital allocation. My guess is they will continue to make good decisions (on balance) and this will benefit shareholders - providing a possible tailwind to my forecasts.

 

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. 

 

Below is an 8-year snapshot for Fairfax. It communicates in a concise manner dramatic transformation that has happened at this company, beginning in 2021. It is a pretty amazing story.

 

 

What are the key assumptions?

 

1.) underwriting profit: Estimated to increase to a record $1.3 billion in 2023. 

• I am forecasting Fairfax’s combined ratio (CR) to remain flat at 94.5 in 2023 (the same as 2022).
• When the Gulf Insurance Group transaction closes in 2H-2023, Fairfax should get a nice boost to its insurance business. I think GIG will add about $1.7 billion to net written premiums, which should drive low double-digit top-line growth in 2024.
• The hard market will end at some point. But do things quickly turn ugly? Probably not, but I am not sure.

2.) interest and dividend income: Estimated to increase to a record $1.9 billion in 2023. 

• The average duration of the fixed income portfolio was increased to 2.4 years in 1H-2023.
• GIG should add about $2.4 billion to the total investment portfolio.
• PacWest loans will deliver incremental interest income (of $80-$90 million?), with half coming in 2H-2023 and the other half in 1H-2024. 
• Eurobank: the plan is to start paying a dividend in 2024. If this happens, we might see dividend income increase by $40 to $50 million.
• Potential headwind: Short-term treasury rates might come down in 2024. If this happens, interest income on cash/short term balances could fall.

3.) Share of profit of associates: Estimated to increase to a record $1.1 billion in 2023. 

• Earnings at Eurobank, Poseidon/Atlas, EXCO, Stelco and Fairfax India, in aggregate, should continue to grow nicely.
• 2023 headwind: Sale of Resolute Forest Products - Contributed $159 million in 2022.
• 2024 headwind: I estimate GIG will contribute $100 million in 2023. When Fairfax’s purchase of Kipco’s stake is approved the financial results for this holding will be reported with Fairfax’s insurance operations. In anticipation of this deal closing later in 2H-2023, I removed $100 million from my 2024 estimate. 

4.) Effects of discounting and risk adjustment (IFRS 17). Interest rate changes drive this bucket. My estimates here could be a little messed up. Given I am forecasting interest rates to remain about where they are today, I am leaving this number the same over the forecast period (at my estimate for June 30, 2023).

 

5.) Life insurance and runoff. This combination of businesses lost $167 million in 2022. I am forecasting this bucket to lose $200 million in each of the next three years.

 

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

 

In the near term, we could get write downs in both Boat Rocker and Farmers Edge. With Covid in the rear-view mirror, earnings at Recipe could move higher ($100 million per year?). Earnings at Dexterra are growing again. AGT is a sleeper holding. Grivalia Hospitality is in its peak investment phase; earnings could grow nicely looking out a year or two. This bucket is poised to grow nicely for Fairfax in the coming years.

 

7.) Interest expense: A slight increase.

8.) Corporate overhead and other: A slight increase.

 

9.) Net gains on investments: Estimated to come in around $900 million in 2023.

• My estimates assume (this is very general):
• Mark-to-market equity holdings of about $7.8 billion increase in value by 10% per year, or $800 million.
• A small bump of $200 to $250 million per year for additional gains (equities and fixed income).

----------

My estimated total return on the investment portfolio for each year is as follows:

• 2023 = 8.0%    = $4.5bn / $56bn
• 2024 = 7.6%    = $4.5bn / $59bn
• 2025 = 7.8%    = $4.7bn / $61bn

What is the math? For each year, add the following line items: 2.) + 3.) + 6.) + 9.) and divided the total by the estimated value of Fairfax’s investment portfolio. These estimated annual percent returns, while high compared to recent years, are driven largely by the spike in interest and dividends and share of profit of associates.

----------

10.) Gain on sale/deconsol of insurance sub: This is a wild card.

 

This is where I put the large asset sales. In 2022, it was the sale of pet insurance business. In 2023, it was the sale of Ambridge and the pending purchase of GIG (resulting in a write-up of the existing holding).

 

For 2024 and 2025, I estimate no gains from sales/write up of assets. There could be something:

• Perhaps we get a Digit or AGT IPO.
• Perhaps Fairfax sells another holding for a large gain.

This ‘bucket’ is perhaps where I will be most wrong with my forecast. Developments here will likely 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: Estimated that effective shares outstanding is reduced by 500,000 per year. This is in line with a normal year from Fairfax. 

 

Notes:

• Underwriting profit: Includes insurance and reinsurance; does not include runoff or Eurolife life insurance.
• Interest and dividends: Includes insurance, reinsurance and runoff.

 

Edited August 7, 2023 by Viking

[Xerxes]

Last week Ackman talked about his short position on the long end (via options) arguing for a repricing of its yield to the upside … if that steepening does happen FFH could lock in the interest stream for longer duration (at a cost of liquidity) 

 

I don’t think Prem & Co had envisioned that, as the sequence that they have in mind is :

 

1) short term goes up (yield inversion)

2) credit spread widens (recession)

3) long term goes up (yield steepens)

 

We are now in phase (1), but what if (2) does not happen and we go straight to (3) ??

 

if “soft landing/no recession” scenario plays out, the higher interest stream is as good as its low duration. 

[Haryana]

On 8/6/2023 at 11:39 AM, Haryana said:

 

My math is very easy.

 

I can take my $1000 to the treasury market and get treasuries worth $1000.

 

OR

 

I can take my $1000 to the Fairfax stock and get treasuries worth $2000.

 

 

Not even expecting any profits from their underwriting or equity investments.

 

Please criticize.

 

 

(Let me critique myself!)

 

Critic: Aye yo, what up. You think it's that easy. What's on all that debt on them books?

 

Retort: Yo bro, okay. Remember what pensies offered for 10% of Odyssey. Them insusubs are likely worth many times what they are carried on cost. Let this bird trade twice the book.

 

[Parsad]

On 8/6/2023 at 9:02 AM, Tommm50 said:

Parsad, you know I have deep suspicions surrounding the hedge funds market manipulations. They have before and likely now have analysts in their pockets. This analysis of Fairfax is so far off it simply seems to be there to justify a short campaign.

 

I don't have anything personal against analysts (although I never use them or read them) and I have no idea if there is anything nefarious behind it...but I agree with you that it is so far off that only a complete moron could come to those conclusions.  I could see this report being written three years ago when it was at $450 per share and interest rates were low.  But really, only someone who has no understanding about insurance companies could come to the estimate he has based on the information available.  

 

Viking has laid out the case about as carefully crafted as you could.  But you don't need Viking's reports or posts to tell you that Fairfax is extremely well positioned, with guaranteed positive cash flow coming in well over $100 a year for the next three years, while insurance subs are writing huge business at very profitable rates.  Just interest income alone would justify a price around $900 USD.  Forget insurance profits and non-fixed income/associate profits.  How do you come to a price of $750 CDN?

 

Cheers!

[Parsad]

On 8/6/2023 at 4:15 PM, StubbleJumper said:

 

It's not a worst case scenario.  It's merely a more normal scenario.  What we are seeing today is not normal.  It's a top of the cycle underwriting situation.  And with respect to interest rates, who really knows?  All we know is that the fed has engaged in a tightening stance for a particular reason, and if the economy slows, the fed will likely reverse that stance to some extent.  All that to say, we are living nearly perfect operating conditions for a well capitalized P&C insurer right now, and if you project that forward very far, you do so at your own risk and peril.

 

 

 

That is a possibility.  It's always possible that Hamblin Watsa shoots out the lights for the next 20 years and we will see truly extraordinary investment results.  The question is whether it's wise to make that kind of assumption.

 

 

It could happen.  But, if you have a business model that requires you to keep roughly two-thirds of your investments in fixed income and preferreds, you need a particular set of circumstances to get you 6-8% returns overall.  You can definitely get there right now when you can average 4.5% on the fixed income component because means you only need ~9% on your investments in equities/associates to get your overall 6% return.  But, again, you might want to be a little cautious about projecting that sort of thing forward because we are likely near the end of a tightening phase.

 

We are seeing a truly amazing set of circumstances right now.

 

 

SJ

 

+1!  Look I'm the biggest Fairfax groupie and I love Prem like he was family, but never fall in love with a stock or investment.  Be it BRK, FFH, or whatever...never become so attached that you ignore reality and any possibility of regression to the mean.  Markets flow both ways...too optimistic and too pessimistic.  

 

By all means hold a large position if you believe in the company, management, fundamentals, etc.  But never bet the farm!  You only have to be wrong once and the farm is gone.  I can't imagine starting all over again at my age (54), and I certainly don't want to start again at 75!  

 

I've got all my Fairfax stock in taxable accounts and I'll hold that regardless going forward...just way too much in gains!  I would feel sick paying tax on it! 

 

But the biggest advantage I have in my non-taxable accounts is, that I can sell when something is over intrinsic value without worrying about taxes, and then patiently wait for the next fat pitch.  Cheers!

[Parsad]

18 hours ago, MMM20 said:

 

My underlying point is this.  What if Fairfax has proven to be a truly world class company on both the underwriting and investment side of things?  What are the implications? 

 

 

It is already and has been for a long-time.  But world class companies make mistakes too!  Look at META, DIS, BUD, TSLA, GE, KO, AMEX, AAPL (1st incarnation), DELL, IBM, etc...you name it, they've effed up to some degree at some point.  Sears was the most dominant retailer in the world for a good 80 years!  And then in less than 15 years it essentially disappeared.

 

Other than Solomon, BRK is the exception and has never really been at risk or done something stupid of significance!  Maybe that's why people expect other companies to be like Berkshire, but it's not possible.  There is only one Buffett.  As a risk manager, he is one of one...or maybe two (Jain)!  

 

There's a thread on the BRK board asking about who is smarter...Buffett or Munger?  If I was hiring one of them, I would hands down hire Buffett or Ajit Jain...ahead of Munger.  Why?  Because as risk managers they are exceptional...maybe the best to have ever roamed the business world.  And Munger is no slouch...but look at BABA.  If it went further the wrong way, it could have been catastrophic!  Buffett has never had any such loss in the hundreds/thousands of investments he's made. 

 

So world class doesn't mean things can't go wrong.  Cheers! 

[MMM20]

7 hours ago, Parsad said:

 

It is already and has been for a long-time.  But world class companies make mistakes too!  Look at META, DIS, BUD, TSLA, GE, KO, AMEX, AAPL (1st incarnation), DELL, IBM, etc...you name it, they've effed up to some degree at some point.  Sears was the most dominant retailer in the world for a good 80 years!  And then in less than 15 years it essentially disappeared.

 

Other than Solomon, BRK is the exception and has never really been at risk or done something stupid of significance!  Maybe that's why people expect other companies to be like Berkshire, but it's not possible.  There is only one Buffett.  As a risk manager, he is one of one...or maybe two (Jain)!  

 

There's a thread on the BRK board asking about who is smarter...Buffett or Munger?  If I was hiring one of them, I would hands down hire Buffett or Ajit Jain...ahead of Munger.  Why?  Because as risk managers they are exceptional...maybe the best to have ever roamed the business world.  And Munger is no slouch...but look at BABA.  If it went further the wrong way, it could have been catastrophic!  Buffett has never had any such loss in the hundreds/thousands of investments he's made. 

 

So world class doesn't mean things can't go wrong.  Cheers! 

 

Base rates are skewed heavily against us in the very long run, and something could blow us up over the next few years too. But we are looking for wildly mispriced bets and this is *still* a fat pitch, IMHO - arguably more so than at ~$350 ~3 years ago.

 

I get the argument for selling some if it has become a huge position, though. A famous investor once told me that if you're lucky enough to find yourself in this situation and struggling with the sizing decision, no one ever went mad (or broke) just cutting it in half.

 

I'm constantly reminding myself that given a high enough rate of compounding, even ~7%, you double your money roughly every decade. Then you just focus on your lifespan/healthspan. The exponent is really what matters. Longevity of compound > everything. That might be the #1 lesson from Buffett, IMHO. Well, that and the value of float

 

~5% cash is looking pretty damn good right now… but our "problem" is that Fairfax might be the single best way to invest in that thesis!

 

Appreciate your thoughts!

 

Edited August 8, 2023 by MMM20

[dartmonkey]

21 minutes ago, MMM20 said:

~5% cash is looking pretty damn good right now… but our "problem" is that Fairfax might be the single best way to invest in that thesis!

 

Exactly. I like to think my portfolio is half cash, half conservative stocks. Except that the cash half is actually levered 2:1, plus a dollop of underwriting income and savvy investing in gems like Eurobank, Poseidon and (lest we forget the downside) Blackberry...

[UK]

On 8/7/2023 at 6:12 PM, Viking said:

4.) Effects of discounting and risk adjustment (IFRS 17). Interest rate changes drive this bucket. My estimates here could be a little messed up. Given I am forecasting interest rates to remain about where they are today, I am leaving this number the same over the forecast period (at my estimate for June 30, 2023).

 

Viking, thanks for update!

 

I am not sure I understand this IFRS 17 effect correctly (or at all:)), but wouldnt constant rates imply, that this line more likely would be a zero in the future, as only further rising rates would translate into some positive number (and vice versa)? 

 

'On the mechanics of IFRS 17':

 

 

Edited August 8, 2023 by UK

[SafetyinNumbers]

25 minutes ago, UK said:

 

Viking, thanks for update!

 

I am not sure I understand this IFRS 17 effect correctly (or at all:)), but wouldnt constant rates imply, that this line more likely would be a zero in the future, as only further rising rates would translate into some positive number (and vice versa)? 

 

'On the mechanics of IFRS 17':

 

 

All else being equal (rates stay flat, premiums are growing) discounting the reserves under IFRS results in higher underwriting profit than under the old paradigm. While FFH is still reporting the old combined ratio metrics, when I calculate the combined ratio from the disclosure I get a lower IFRS-adjusted combined ratio. That makes intuitive sense.

 

Besides the discounting of new reserves, by moving one period forward, the balance of reserves accrete each quarter. That offsets some of the benefit but is also included in the adjusted combined ratio. If rates are coming down, that should increase the accretion as the whole reserve balance is discounted at a lower rate and we are moving forward a quarter. There should be an offsetting gain in bonds but I can see in that scenario how the IFRS adjusted combined ratio may not be lower than the reported combined ratio but I don’t know if it’s possible to do a sensitivity given the reserves are opaque.
 

Intact Financial discloses two combined ratios to illustrate the difference when they report with almost a 400bps difference between the two last quarter. You can see the spread is smaller last year when the interest rate curve was lower.

 

I’m not sure if I’m right in how I’m interpreting it despite formerly practicing as a CA/CPA and having a MAcc so if anyone knows better please share.

[UK]

10 hours ago, SafetyinNumbers said:

All else being equal (rates stay flat, premiums are growing) discounting the reserves under IFRS results in higher underwriting profit than under the old paradigm. While FFH is still reporting the old combined ratio metrics, when I calculate the combined ratio from the disclosure I get a lower IFRS-adjusted combined ratio. That makes intuitive sense.

 

Besides the discounting of new reserves, by moving one period forward, the balance of reserves accrete each quarter. That offsets some of the benefit but is also included in the adjusted combined ratio. If rates are coming down, that should increase the accretion as the whole reserve balance is discounted at a lower rate and we are moving forward a quarter. There should be an offsetting gain in bonds but I can see in that scenario how the IFRS adjusted combined ratio may not be lower than the reported combined ratio but I don’t know if it’s possible to do a sensitivity given the reserves are opaque.
 

Intact Financial discloses two combined ratios to illustrate the difference when they report with almost a 400bps difference between the two last quarter. You can see the spread is smaller last year when the interest rate curve was lower.

 

I’m not sure if I’m right in how I’m interpreting it despite formerly practicing as a CA/CPA and having a MAcc so if anyone knows better please share.

 

Thanks very much!

 

I guess, on the other hand, all this again is also a very good remainder (at least for me) that with an insurance business you really have to trust managment a lot.

 

I remember I first tried to look at some insurance companies (other than BRK) in 2010 or 2011, after BRK invested in Munich RE and also when AIG was starting its second life:). This is when I also discovered this board and FFH for the first time:). Maybe WB letters and warnings on insurance had a big influence, but at that time I came to a very simple (stupid?) conclusion: no other insurance company other than BRK is investable for me at that time (good sleep), at least for big/high conviction position. I bought some FFH in 2012, but generally just went with BRK for large allocation, which was also quite cheap in 2011-2012 period. Even today, together with other leveraged financials (also after some very different expierence of investing in banks: worked generally really good with US, not so with EU:)) I do not like these companies: no traditional pricing power, high leverage and all the dangers of "creating profits" with pen, dancing till the music stops etc. More so when they are not owner operated etc. On the other hand BRK (and some other companies) has proved, that a well run insurance operation, especially combined with well run investment side of the business, could do wonders for investors. So the crux with FFH, at least for me, is do I trust them with that? I think (or hope), that the answer after the last decade is finally yes with FFH? So I would be very worried if something bad came out of their insurance operations or if they would made another very big insurance acquisition. But it seems so far so good on this side?

 

 

Edited August 9, 2023 by UK

[Viking]

What kind of an investor is Fairfax?

 

Most people would answer: ‘value investor.’ That is the right answer but it doesn’t really tell us much. What kind of a value investor?

 

To answer this question we are going to look at what Fairfax has been doing. What have they actually been buying? What can we learn? We are going to go back three years (June 30 2020, to Aug 11 2023).

—————

But first, let’s set the table.

 

1.) "The single most important thing (when investing in the stock market)… is to know what you own." Peter Lynch

 

The problem with Peter Lynch is he says so many smart (and funny) things that his ‘most important thing’ gets lost in the shuffle. This is the ‘north star’ of everything else he writes. From this naturally flows another of Peter Lynch’s nuggets of gold.

 

2.) "The best stock to buy is the one you already own." Peter Lynch

 

This makes intuitive sense. You have already done the research on the stocks you own. You know ‘the story’ and you like it (that’s why you own it). Assuming the fundamentals are still solid, then buying more should be a no brainer. Buffett takes this idea a little further with the following quote:

 

3.) "Diversification may preserve wealth, but concentration builds wealth." Warren Buffett

 

The idea is to invest with conviction around you best ideas. Especially if the stock is on sale. This leads us to our next point.

 

4.)"‘The three most important words in investing are margin of safety." Warren Buffett

 

Ben Graham introduced ‘margin of safety’ as the central concept of investing in Chapter 20 of his book, The Intelligent Investor. The idea is to only purchase stocks when they are trading at a big discount to their intrinsic value (buy something for $0.50 that is worth $1.00). This approach limits your downside if you are wrong and it provides significant upside if you are right.

 

What do we get when we combine these four points?

 

Often, your best investment is to simply buy more of something you already own - especially when it is on sale.

 

One added twist:

 

5.) "If you search world-wide, you will find more bargains and better bargains than by studying only one nation." John Templeton

 

Invest wherever in the world the best opportunities are.

—————

What does all of this have to do with Fairfax?

 

Well, guess what Fairfax has been doing for the past 3 years? It has invested close to $6.2 billion in stuff it already owns. Yes, during this time Fairfax has been investing in new ventures but the amount spent is much smaller. In short, Fairfax has been feasting at the buffet of companies it already owns.

 

Let’s review the actual investments that Fairfax has been making the past 3 years (Aug 2020 to Aug 2023) that fit this theme to see what we can learn.

 

1.) Buy Fairfax stock = $2.26 billion

• Late 2020/early 2021: purchased total return swaps giving them exposure to 1.96 million Fairfax shares
  • Total investment = $732 million (notional) = $372/share

 

• Late 2021 - dutch auction: purchased 2 million Fairfax shares
  • Total investment = $1 billion = $500/share
• June 30, 2020-June 30, 2023 - SIB purchase of an additional 1.133 million shares
  • Total investment = $535 million = $490/share

 

 

Over the past 3 years Fairfax has ‘purchased’ 5.09 million shares of Fairfax, 19.3% of total effective shares outstanding, at an average cost of $445/share. With shares trading today at $843, the value creation for Fairfax shareholders has been $2 billion.

 

 

Fairfax saw incredible value in their shares. They invested with conviction (backed up the proverbial truck). Shareholders are now making out like bandits (the value created by Fairfax is flowing though to a much higher share price). Value investing at its best.

 

Who does this string of purchases remind you of?

 

Not Lynch, Buffet or Graham. Who then? Henry Singleton. Who is this guy?

 

From Prem’s letter in Fairfax’s 2018AR: ““I mentioned to you last year that we are focused on buying back our shares over the next ten years as and when we get the opportunity to do so at attractive prices. Henry Singleton from Teledyne was our hero as he reduced shares outstanding from approximately 88 million to 12 million over about 15 years.”

 

At the time, many laughed at Prem for making this comment. I don’t think these same people are laughing at Prem today.

 

2.) Increase Ownership of Insurance Businesses - Buy Out Partners = $1.9 billion

 

Insurance is the most important economic engine Fairfax has. Top line growth in the insurance businesses is critical to sustainable profit growth at Fairfax over time. And profitability is what determines the share price over the medium to long term.

 

Fairfax is slowly and methodically taking out the minority partners in its insurance companies. They spent $1.9 billion over the past 3 years doing this. As a result they own a larger share of (growing) future earnings of these high quality companies.

 

 

3.) Increase Ownership of Equity investments:

• Consolidated Equities = $0.67 billion

These are the equity investments that Fairfax exerts a great deal of control over. They invested $666 million the past three years. The big purchase was taking Recipe private and being able to buy the stock at a big pandemic discount.

 

 

• Remaining Equity Holdings = $1.4 billion

These are the equity investments Fairfax doe not exert a great deal of control over. They invested $1.4 billion the past three years. The biggest deal was expanded the partnership with Kennedy Wilson in real estate, with the 2 transactions below being part of much the bigger deal (debt platform and PacWest loans). There are lots of solid single type of investments on this list.

 

 

In total, over the past three years, Fairfax has invested a total of $6.2 billion to increase ownership in companies it already owns. Many of the investments were opportunistic and made at bear market low prices. Investments were made all over the world - value drove the decision, not geography. As a result Fairfax (and its shareholders) now own a greater proportion of the future earnings streams of these many businesses. The returns on the investments made in recent years are starting to come in and they are very good (in aggregate). With lots of upside in the future.

 

 

Conclusion: What did we learn?

 

How Fairfax is investing right now is incredibly simple. Invest in what you know. Buy at a discount. Act with conviction. Cast a wide net (global). Boring. Safe. Generating a very good return for shareholders. Something i think the masters would approve of. In short, Fairfax has been putting on a master-class in value investing over the past three years.

 

So, after all that, let’s get back to our initial question.

 

What kind of an investor is Fairfax?

 

Fairfax is a value investor. Their approach is a hybrid of 5 masters: Lynch, Buffett, Graham, Templeton and Singleton.

—————

Some of the companies Fairfax owns are doing the same thing:

 

The best example is Stelco who has reduced shares count by 38% over the past 2.5 years, which has increased Fairfax’s stake in the company from 14.7% to 23.6%.

 

 

Actions like these provide additional benefits to Fairfax and its shareholders. When combined with what Fairfax is doing, they have a ‘multiplicative’ effect for Fairfax shareholders (in terms of owning larger proportion of future earnings).

Edited August 13, 2023 by Viking