Fairfax 2023

[petec]

1 hour ago, Xerxes said:

0% rates forces capital into the industry and CR's UP, and 5% rates have the opposite effect.

 

Exactly. Sorry. My point is that when rates are low, capital goes hunting returns and some of it lands in insurance. When rates are higher, less capital goes into insurance, so both interest income AND combined ratios improve for FFH.

 

35 minutes ago, MMM20 said:

I’ll model it out for you and maybe we’ll both get the chance to sell to compounder bros. 

 

Amen! But at root you're saying this thing can earn $400/share in perpetuity (to hit a 10% return from $4000). I'll take the under!

 

10 minutes ago, SafetyinNumbers said:

Lots of discussion of what might happen to the downside without a lot of odds or timing included.

 

Agreed. I stopped trying to figure out odds or timing in any precise way years ago. I have a gut feeling that Viking will be roughly right on fwd 3y earnings. But the chances of the flywheel going the other way well above 0. That's all I am saying.

 

12 minutes ago, SafetyinNumbers said:

A lot of positive things could also happen with the equity portfolio which seemingly almost no one is counting on for a contribution to ROE.

 

Absolutely. I love the equity portfolio.

 

13 minutes ago, SafetyinNumbers said:

I’m also curious what kind of valuation multiple the momentum and index hugging buying can take us.

 

Yes - this is a really good point and I appreciated SiN's longer post on this topic above.

 

Separately, having been one of the stauncher (perhaps even dogmatic) defenders of FFH and its management during the dog years, it rather amuses me to be trying to inject some calm into the froth! How things change. It's amazing (to me) to think that I have held this stock continuously since 2008 and actually done ok in it despite the many years of darkness.

[SafetyinNumbers]

45 minutes ago, petec said:

 

Exactly. Sorry. My point is that when rates are low, capital goes hunting returns and some of it lands in insurance. When rates are higher, less capital goes into insurance, so both interest income AND combined ratios improve for FFH.

 

 

Amen! But at root you're saying this thing can earn $400/share in perpetuity (to hit a 10% return from $4000). I'll take the under!

 

 

Agreed. I stopped trying to figure out odds or timing in any precise way years ago. I have a gut feeling that Viking will be roughly right on fwd 3y earnings. But the chances of the flywheel going the other way well above 0. That's all I am saying.

 

 

Absolutely. I love the equity portfolio.

 

 

Yes - this is a really good point and I appreciated SiN's longer post on this topic above.

 

Separately, having been one of the stauncher (perhaps even dogmatic) defenders of FFH and its management during the dog years, it rather amuses me to be trying to inject some calm into the froth! How things change. It's amazing (to me) to think that I have held this stock continuously since 2008 and actually done ok in it despite the many years of darkness.

I object to 1x BV being froth!

[petec]

12 minutes ago, SafetyinNumbers said:

I object to 1x BV being froth!

 

Ha - I thought that might provoke a reaction. Of course it isn't. But the mood on the board has certainly shifted (and in a pro-cyclical way). A few years back I seem to remember lots of people questioning whether book value was accurate, even, let alone whether FFH should trade at 1x when it was run by a nepotistic ego who'd lost his edge. Today we are completely ignoring the fact that book value just got a meaningless boost from IFRS17 and think it's run by a genius. 

 

I am exaggerating, of course, but hopefully you see what I am getting at.

[MMM20]

@petec in the outside world, we are still generally looking at a mix of indifference, skepticism and disdain and that is still reflected in valuation... let’s see if the Vikings of the world see the light, not just our own @Viking...

 

Edited August 25, 2023 by MMM20

[petec]

3 hours ago, MMM20 said:

in the outside world, we are still generally looking at a mix of indifference, skepticism and disdain and that is still reflected in valuation

 

Agreed. 

[jfan]

Looking at their insurance subsidiary reserve triangles. A few things seem to stand out to me (caveat: not in the insurance business)

 

1) Insurance subs with large premium contribution and consistent favorable reserve developments 

- Northbridge and Odyssey Group

- roughly speaking, Northbridge/Odyssey Group pays out 50% of their policy payments within the 1st 5 years then it tapers off. 

- Eyeballing it, these 2 sub roughly write 2x the reserves for all their policy promises

2) Insurance subs with large premium contribution but turning around reserve developments

- Crum & Forester

- 1st year of favorable reserve development in 2022 but since 2016, their re-estimated reserves are consistently greater than the cumulative payments for each respectively calendar year

3) Insurance subs with large premium contribution but still struggling with reserve developments

- Allied World

4) Insurance subs with small premium contribution and consistent favorable reserve developments

- Zenith

* Didn't look at Brit's triangle

 

This suggests to me that the combined ratios that we see today is really a reflection of the underwriting that was done 5+ years ago . 80% of Northbridge's favorable reserve developments were written for calendar years 2012-2016. Similarly 75% of Odyssey's favorable reserve developments were written for calendar years 2012-2016. 

 

Would this not suggest that their combined ratio should remain sub 100% for more than a few years, especially since most of this reflects their underwriting from 5+ years ago during the soft market?

 

With their insurance writing into this recent hard market, we see the premium growth but with other players having such capital constraints, they have been able to take a big relative advantage of this and presumably have some better than recent historical 95-100% CR in the future.

 

Long and short of it. Even if the market softens, and assuming that the insurance subs avoid writing bad future policies, this suggests to me that they should be able to have better than average underwriting profit moving forward (even without IFRS 17 discounting) given the hard market tailwinds.

 

 

 

[Parsad]

6 hours ago, petec said:

 

Ha - I thought that might provoke a reaction. Of course it isn't. But the mood on the board has certainly shifted (and in a pro-cyclical way). A few years back I seem to remember lots of people questioning whether book value was accurate, even, let alone whether FFH should trade at 1x when it was run by a nepotistic ego who'd lost his edge. Today we are completely ignoring the fact that book value just got a meaningless boost from IFRS17 and think it's run by a genius. 

 

I am exaggerating, of course, but hopefully you see what I am getting at.

 

+1!  Mr. Market and investor psychology swings from extreme pessimism to extreme optimism and then back to extreme pessimism and so forth. 

 

Yesterday, Fairfax was a poor insurer with an ego-driven CEO...today, Fairfax is one of the best investments available run by the most proficient management in insurance! 

 

Until something goes wrong and everyone starts calling them bums again!  It happens in sports, it happens in politics and it happens with companies.  But every time someone calls them bums is when I make money, not when they call them heroes!

 

Cheers! 

[MMM20]

55 minutes ago, Parsad said:

 

+1!  Mr. Market and investor psychology swings from extreme pessimism to extreme optimism and then back to extreme pessimism and so forth. 

 

Yesterday, Fairfax was a poor insurer with an ego-driven CEO...today, Fairfax is one of the best investments available run by the most proficient management in insurance! 

 

Until something goes wrong and everyone starts calling them bums again!  It happens in sports, it happens in politics and it happens with companies.  But every time someone calls them bums is when I make money, not when they call them heroes!

 

Cheers! 

Respectfully, I disagree. If you talk to 100 investment professionals, 90 have no opinion, and they’re still called bums or dinosaurs by, like, 9 of the other 10.

 

A few of us weirdos here are just the 1%! Occupy Wellington Street!
 

Edited August 22, 2023 by MMM20

[Munger_Disciple]

7 hours ago, petec said:

Today we are completely ignoring the fact that book value just got a meaningless boost from IFRS17

 

+1.

If you use GAAP book instead, FFH is probably trading around 1.15x  GAAP Book right now. If one wants to compare FFH to BRK or MKL this is a fairer comparison IMO. 

[MMM20]

1 hour ago, Munger_Disciple said:

 

+1.

If you use GAAP book instead, FFH is probably trading around 1.15x  GAAP Book right now. If one wants to compare FFH to BRK or MKL this is a fairer comparison IMO. 

Where are BRK and MKL trading on owners earnings multiples? Also ~4x?

 

Edited August 22, 2023 by MMM20

[petec]

11 hours ago, Munger_Disciple said:

 

+1.

If you use GAAP book instead, FFH is probably trading around 1.15x  GAAP Book right now. If one wants to compare FFH to BRK or MKL this is a fairer comparison IMO. 

 

Does FFH publish under GAAP anywhere? I assume not...

[petec]

11 hours ago, MMM20 said:

Respectfully, I disagree. If you talk to 100 investment professionals, 90 have no opinion, and they’re still called bums or dinosaurs by, like, 9 of the other 10.

 

A few of us weirdos here are just the 1%! Occupy Wellington Street!
 

 

Sure - we are certainly not at the point of speculative excess yet. But the psychological pendulum has swung a long way from the pessimistic extremes. Maybe it's halfway through its swing. And it's closer to the point where you need things to go right to win, rather than things just not to go wrong.

 

All I think Parsad and I are saying is that this is not as easy a buy as it was at the lows, and a lot more is in the price, and as it continues to rise, we should all get more cautious not more excited.

[petec]

15 hours ago, jfan said:

Would this not suggest that their combined ratio should remain sub 100% for more than a few years

 

Absolutely. I think they are socking away significant future reserve releases at this point. Combined with rising long rates, I think we are locking in several years' worth of nice operating earnings, and I am bullish on the portfolio.

[MMM20]

9 hours ago, petec said:

 

Sure - we are certainly not at the point of speculative excess yet. But the psychological pendulum has swung a long way from the pessimistic extremes. Maybe it's halfway through its swing. And it's closer to the point where you need things to go right to win, rather than things just not to go wrong.

 

All I think Parsad and I are saying is that this is not as easy a buy as it was at the lows, and a lot more is in the price, and as it continues to rise, we should all get more cautious not more excited.

Doesn’t this come down to how much of the improvement in earnings power is structural vs cyclical? It seems like FFH has taken pricing and share as many others have been semi-permanently(?) weakened. If true, the stock may be cheaper now than back then. Like, maybe the range of outcomes was super wide ~2-3 years ago before rates and weather related losses spiked, and now we’re on an upside path in that decision tree. Does that makes sense?
 

And looking at competitors and the supply/demand dynamics, it seems like we might still be in the early days of an insurance supercycle (at least in some pockets) in which demand constantly outstrips supply due to a confluence of factors including weather/climate losses, migration patterns, ESG(?) and regulation warding off new entrants, the impact of higher rates on balance sheets and capital formation, etc. Famous last words, I know… not my base case.

 

Knowing what we know now, with all the commentary we are seeing from various management teams, macro and micro factors — would it be shocking if pricing in certain big pockets ~1.5-2x’d (and well ahead of expected losses) over the next ~5 years, generating a whole lot more negative cost float… and oh yeah, coincident with investment income spiking higher?
 

This is just a hypothesis and doesn’t need to be true for us to do very well from this price... maybe just one truly lollapalooza returns scenario. And I am not in the insurance biz so looking for more insider views on how this compares to prior cycles as of now.

 

Edited August 23, 2023 by MMM20

[Viking]

7 hours ago, petec said:

 

Sure - we are certainly not at the point of speculative excess yet. But the psychological pendulum has swung a long way from the pessimistic extremes. Maybe it's halfway through its swing. And it's closer to the point where you need things to go right to win, rather than things just not to go wrong.

 

All I think Parsad and I are saying is that this is not as easy a buy as it was at the lows, and a lot more is in the price, and as it continues to rise, we should all get more cautious not more excited.

@petec So you are saying psychology and price should drive an investors decision? Yes, a few people on this board are optimistic on Fairfax. And the stock price has gone up a lot. But really?
 

I think facts should be the primary driver of an investors decision. What are earnings going to be? What is their quality? How durable are they? How good is the management team at capital allocation? 
 

Fairfax trades at a PE of 5.2. The earnings are high quality (mostly operating) and durable. The management team has been best in class ofr the past 5 years in terms of capital allocation. Those are the facts.
 

The stock trading at a 5.2PE suggests to me that investors in Fairfax are still VERY bearish. Yes, there are a few people posting positive things about Fairfax on this board - that is a tiny sample size. Go survey the institutional guys - my guess is they are still very bearish on Fairfax (and underweight with their holdings). 
 

People are seriously arguing that Fairfax should trade at a 5.2PE because it will be earning too much over the next 3 years? The stock needs to be penalized because it is earning too much? I am sorry, that is crazy talk. You penalize a stock because it is underperforming. Fairfax really is becoming the Rodney Dangerfield of insurance.

 

If other insurance companies were trading at a 5PE i would get it. Every other quality insurance company trades at a PE of at least 10 and most are higher. Fairfax is the clear outlier. And based on the facts, that makes no sense to me. 

 

 

Edited August 23, 2023 by Viking

[Munger_Disciple]

7 hours ago, petec said:

 

Does FFH publish under GAAP anywhere? I assume not...

 

No, FFH doesn't publish GAAP book (sadly). But they did get a jump up in book value per share of roughly $100 not that long ago, so I am using that as the difference between IFRS and GAAP book values.

[Parsad]

10 hours ago, petec said:

 

Sure - we are certainly not at the point of speculative excess yet. But the psychological pendulum has swung a long way from the pessimistic extremes. Maybe it's halfway through its swing. And it's closer to the point where you need things to go right to win, rather than things just not to go wrong.

 

All I think Parsad and I are saying is that this is not as easy a buy as it was at the lows, and a lot more is in the price, and as it continues to rise, we should all get more cautious not more excited.

 

+1!  Cheers!

[Parsad]

6 hours ago, MMM20 said:

Doesn’t this come down to how much of the improvement in earnings power is structural vs cyclical? It seems like FFH has taken pricing and share as many others have been semi-permanently(?) weakened. If true, the stock may be cheaper now than back then. Like, maybe the range of outcomes was super wide ~2-3 years ago before rates and weather related losses spiked, and now we’re on an upside path in that decision tree. Does that makes sense?
 

And looking at competitors and the supply/demand dynamics, it seems like we might still be in the early days of an insurance supercycle (at least in some pockets) in which demand constantly outstrips supply due to a confluence of factors including weather/climate losses, migration patterns, ESG(?) and regulation warding off new entrants, the impact of higher rates on balance sheets and capital formation, etc. Famous last words, I know… not my base case.

 

Knowing what we know now, with all the commentary we are seeing from various management teams, macro and micro factors — would it be shocking if pricing in certain big pockets ~1.5-2x’d (and well ahead of expected losses) over the next ~5 years, generating a whole lot more negative cost float… and oh yeah, coincident with investment income spiking higher?
 

This is just a hypothesis and doesn’t need to be true for us to do very well from this price... maybe just one truly lollapalooza returns scenario. And I am not in the insurance biz so looking for more insider views on how this compares to prior cycles as of now.

 

 

This is just too much work!  I would rather wait for something else to get dirt cheap and just buy that.  Structural changes could lead to higher returns and justify a higher valuation, but this starts to get into "six-foot, seven-foot hurdle" territory.  I have no advantage and my estimate of margin of safety could be VERY wrong!  Cheers!

[Thrifty3000]

When thinking about FFH's longer term EPS potential I have to frame it more like...

 

Over the next 10 years will average annual EPS exceed:

• $100 USD (almost certainly)
• $150 USD (likely)
• $200 USD (possibly)

I think we can safely assume the "normalized" earning power of the business is currently in the neighborhood of $100 to $150 per share.

 

Working for us we have roughly:

• $2,500 of Investments Per Share
• $1,000 of Insurance Premiums Per Share

Slap a reasonable ROI on those investments, a reasonable CR on those premiums, and assume a reasonable growth rate over time, and FFH easily earns an average of $150+ annually per share over the next decade.

 

Now, what can we expect over the next decade for earnings and growth? Well, Prem gave us his version of guidance on each of these things in his annual letter. He provided charts of FFH's key historical trends, explained that profitable growth has always been in FFH's DNA, and argued we should expect profitable growth going forward.

 

In the 2 charts attached and in his accompanying commentary Prem essentially laid out the most important guiderails for investor assumptions:

• ROI on the investment portfolio will likely fall somewhere between 2.3% and 11%, and Prem believes the miserable days of 2.3% ROI are well behind us.
• Combined ratios will likely fall between 96% and 114%, and Prem believes the last 17 years of sub-100% CRs are more indicative of likely future performance.
• Revenue will grow, as it has in every 10 year period since 1985, almost certainly by no less than 50% and very likely by more than 100%. (I will be surprised if premiums aren't at least $50 billion a decade from now.)

Reasonable Assumptions?

 

After reviewing the historical charts and reading the annual report would it be unreasonable to assume normalized:

• 5% ROI on Investment Portfolio = $125 per share
• 97.5% Combined Ratio = $25 per share
• 7% annual growth
• $150 USD of normalized annual per share earning power growing to $300 USD per share by 2033.

I don't think it's that hard to make the case that those assumptions are too conservative, and I think @Viking and Prem are doing a good job of making that case.

 

 

Edited August 24, 2023 by Thrifty3000

[SafetyinNumbers]

50 minutes ago, Thrifty3000 said:

When thinking about FFH's longer term EPS potential I have to frame it more like...

 

Over the next 10 years will average annual EPS exceed:

• $100 USD (almost certainly)
• $150 USD (likely)
• $200 USD (possibly)

I think we can safely assume the "normalized" earnings power of the business is currently in the neighborhood of $100 to $150 per share.

 

Working for us we have roughly:

• $2,500 of Investments Per Share
• $1,000 of Insurance Premiums Per Share

Slap a reasonable ROI on those investments, a reasonable CR on those premiums, and assume a reasonable growth rate over time, and FFH easily earns $150+ annually per share over the next decade.

 

Now, what can we expect over the next decade for earnings and growth? Well, Prem gave us his version of guidance on each of these things in his annual letter. He provided charts of FFH's key historical trends, explained that profitable growth has always been in FFH's DNA, and to expect profitable growth going forward.

 

In the 2 charts attached and in his accompanying commentary Prem essentially laid out the most important guiderails for investor assumptions:

• ROI on the investment portfolio will likely fall somewhere between 2.3% and 11%, and Prem believes the miserable days of 2.3% ROI are well behind us.
• Combined ratios will likely fall between 96% and 114%, and Prem believes the last 17 years of sub-100% CRs are more indicative of likely future performance.
• Revenue will grow, as it has in every 10 year period since 1985, almost certainly by no less than 50% and very likely by more than 100%. (I will be surprised if premiums aren't at least $50 billion a decade from now.)

Reasonable Assumptions?

 

After reviewing the historical charts and reading the annual report would it be unreasonable to assume normalized:

• 5% ROI on Investment Portfolio = $125 per share
• 97.5% Combined Ratio = $25 per share
• 7% annual growth
• $150 USD of normalized annual per share earnings power growing to $300 USD per share by 2033.

I don't think it's that hard to make the case that those assumptions are too conservative, and I think @Viking and Prem are doing a good job of making that case.

 

 

Excellent post Thrifty3000.

 

I’m trying to get people to appreciate how big the right tail could be if one of the biggest unconstrained investors in the world gets to keep reinvesting $3b+ in profits every year in one of the most inefficient markets ever. It could get even bigger if valuation gets aggressive as momentum and index huggers try to keep up allowing the company to raise equity at silly multiples. ROE’s could be 20%+ for a period of time. The narratives will of course be different but the book value growth will be real. I think the odds are decent given the high float to market cap, the expectation of lower interest rates, the high float to book value ratio and the cheap equity portfolio.

[MMM20]

23 hours ago, Parsad said:

 

This is just too much work!  I would rather wait for something else to get dirt cheap and just buy that.  Structural changes could lead to higher returns and justify a higher valuation, but this starts to get into "six-foot, seven-foot hurdle" territory.  I have no advantage and my estimate of margin of safety could be VERY wrong!  Cheers!

 

Not sure I agree that it's not worth thinking through the scenarios, but I hear you and appreciate the good reminder that "[to] invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework." - The Intelligent Investor

 

I did just make a lunch bet with a friend on FFH vs AMZN over the next 5 years. EPS growth should be similar but maybe FFH valuation expands ~3x while AMZN's contracts ~3x. We'll see.

 

My best guess is FFH valuation expands over the next few years as higher earnings power translates to sharp growth in per share accounting book value... b/c it trades on book value.

 

The bottom line IMHO is there is a completely reasonable case to be made that FFH earnings power doubles and valuation triples over that timeframe. Still, I get the skepticism!

 

Edited August 24, 2023 by MMM20

[Luke]

11 minutes ago, MMM20 said:

I did just make a lunch bet with a friend on FFH vs AMZN over the next 5 years. I'm thinking EPS growth will be similar and FFH valuation will expand ~3x while AMZN's will contract ~3x. We'll see.

Yep, terminal multiple can ruin returns on a good growing business if bought too high. 1x Book doesn't seem egregious at all for FFH and still a strong buy considering the tailwinds etc. DCFs for Amazon, Alphabet etc make sense with a 25x exit multiple but 13-15x looks a lot worse. 

 

Edited August 24, 2023 by Luca

[UK]

On 8/23/2023 at 10:05 PM, Parsad said:

 

This is just too much work!  I would rather wait for something else to get dirt cheap and just buy that.  Structural changes could lead to higher returns and justify a higher valuation, but this starts to get into "six-foot, seven-foot hurdle" territory.  I have no advantage and my estimate of margin of safety could be VERY wrong!  Cheers!

 

Not to derail the thread, but since I recently tried to look at it: does M seems somehow a lower hurdle for you vs FFH, even at current prices? I may be very wrong on M, no strong opinion on it, but especially for a big and surer bet, I actually think it is the opposite, meaning why even bother with M, if FFH is still so cheap?*

 

 *initially was questioning something similar about META vs GOOG a year ago:)

 

Edited August 25, 2023 by UK

[Thrifty3000]

By gum, I think I'm starting to see eye to eye with @Viking on this argument that FFH is selling for around 5X normal earnings - and not 5X temporary hard-market-induced inflated earnings!

 

Here is what the current investment portfolio would look like with very conservative ROI estimates for each asset class (ie. 1% ROI on cash instead of today's 5%). Notice that even with conservative ROI estimates the contribution per share would be $116.

 

[Thrifty3000]

Now, if we fast forward to 2027, and project a scenario where the hard market has cooled and short term interest rates have moderated, we could easily be looking at something more like this (I simply increased each asset class by a total of 15% to account for 3 years of conservative growth, and I reduced the share count a bit)...

 

4 years from now, after the cliff of locked in near term interest rates has past us by, the portfolio will still be able to produce $140+ per share without needing to do anything spectacular from an investment standpoint!

 

You can add, say, $10 to $50 per share for insurance underwriting profits and we really are looking at the normalized 20% returns @Viking has been proclaiming. And, again, the all star investment team barely has to show up to work to produce the kinds of returns I'm forecasting. These estimates are probably too conservative.