Fairfax 2023

Haryana · August 25, 2023

Some people will never buy individual stocks because any significant allocation to move the needle would be too risky.

Some other people will never buy a broad equity index fund because it is too passively dumb and they can do it better.

I see Fairfax as a good balance, somewhere in between an individual stock and an index fund for the following reasons:
1. Global diversification over uncorrelated industries
2. Decentralization as a key that unlocks the gift of diversification
3. Leverage that allows equity like returns with high-grade-bonds like risk profile

SafetyinNumbers · August 25, 2023

1 hour ago, Haryana said:

Some people will never buy individual stocks because any significant allocation to move the needle would be too risky.

Some other people will never buy a broad equity index fund because it is too passively dumb and they can do it better.

I see Fairfax as a good balance, somewhere in between an individual stock and an index fund for the following reasons:
1. Global diversification over uncorrelated industries
2. Decentralization as a key that unlocks the gift of diversification
3. Leverage that allows equity like returns with high-grade-bonds like risk profile

My ETF substitute is E-L Financial. Basically a global quality equity portfolio plus some $VOO for greater than a 50% discount to liquidation (which would take about a week).

Thrifty3000 · August 26, 2023

On 8/24/2023 at 10:36 PM, Haryana said:

Not Thrifty3000 here but let me take a shot at it for now and see if that hits or makes any sense to you or anyone present -

Apparently that table is talking about only the investment portfolio. The expenses you mentioned are reasonably projected to be more than well covered by their underwriting operations and still have profits left over to be added on the bottom line. Income taxes would be significant but still the normalized earnings are surprisingly quite high with conservative assumption.

Yes. You and @treasurehunt are thinking about this correctly. The investment portfolio earnings are pre-interest, taxes, overhead, runoff… And it’s just the earning from the portfolio, so it doesn’t include earnings from underwriting or from “miracles” pulled out of a hat like the billion dollar pet insurance companies or Digit going public.

The purpose was to show how powerful the investment portfolio is on a per-share basis even under a hyper-conservative, dare I say, pessimistic ROI scenario.

Keep in mind, the 2027 table I provided assumed what would be the second lowest investment returns (on a five year rolling basis) in the company’s nearly 40 year history! Second only to the brief period where they hedged their entire equity portfolio! (Oops)

It defies logic to project such a pessimistic future given Fairfax has the strongest investment team, the strongest global network and the strongest portfolio in its history.

Every 1% increase in the portfolio’s ROI increases per share earnings by $30!

My 2027 table projects 4.68% ROI. I think Fairfax’s investment team assumes the portfolio will earn 7% long term (please correct me if I’m wrong). Since inception the portfolio has averaged 7.7% ROI.

A 7% portfolio return equates to over $200 per share in 2027!! And, yes, you would still have to add up to $50 of underwriting earnings and then deduct taxes and overhead, etc.

This is not the time to give Fairfax a no confidence vote on future prospects. The stock price should be at least 50% higher. And, it will be soon enough.

I won’t be surprised if the stock price hits $2,400 USD within 5 years.

Edited August 26, 2023 by Thrifty3000

MMM20 · August 26, 2023

https://www.wsj.com/finance/insurance-catastrophe-reinsurance-hurricane-77a69eab

The industry needs to be talking about the plausibility of $200 billion nominal loss years, which might be more of a near-term possibility than we realize,” says Steve Bowen, chief science officer at brokerage Arthur J. Gallagher & Co.’s Gallagher Re.

The net result, says catastrophe-modeling veteran Karen Clark, is that the industry is facing a turning point akin to Andrew’s wake. And she would know: Back in 1992, Clark faxed around an estimate for Andrew’s loss based on a computer model she had developed that was twice what other industry sources at the time were saying. Her number proved to be the right one. Insurers’ struggle today to price what she calls “frequency peril” risks like wildfires are “a déjà vu moment,” Clark says. “I never thought I would see a disrupted market like after Andrew. But here we are.”

Part of the challenge has been insurers or their clients relying on models like those developed in the 1990s for hurricanes or earthquakes to understand other kinds of risks, including secondary perils like wildfires or “social” risks like litigation. There has also been a glut of capital in the insurance industry, which has helped depress risk pricing. Superlow interest rates led investors to seek out yield in strange places, like “cat” bonds and other insurance-linked securities that paid high rates but bore the risk of catastrophe losses. Reinsurers globally failed to earn back their cost of capital in five of the six years from 2017 to 2022, according to estimates by S&P Global Ratings.

Now, things are changing. Rising interest rates are making it less attractive for investors to pour money into insurance risks when they can get higher yields on simpler things. That has given the upper hand to big reinsurers, which have pushed through big price increases this year. Reinsurers are also often changing the structures of their coverage by raising the so-called attachment points at which they will start to absorb losses, enabling them to focus on the more extreme, existential risks to insurers’ capital. Also aided by the prospect of higher interest rates on their investment portfolios, reinsurers such as Everest Group, RenaissanceRe, Munich Re and Swiss Re have seen their shares rally sharply in the past year.

But with rising attachment points, primary insurers—firms like Allstate or Progressive, which sell policies to consumers or businesses and often buy reinsurance to cover their tail risks—can end up more exposed to these frequent-but-smaller catastrophes. One way they can compensate is to continue to raise the premiums they charge their customers. Another is to pull back from the trickiest markets, like when State Farm said it would stop writing new homeowners’ policies in California. Clark says insurers will need to adapt to newer kinds of models that help price risks like thunderstorms or wildfires. Her firm is updating its wildfire model as often as once a year.

So whether a big one hits or not, this hurricane season is going to be an important measuring stick for insurers. A quiet season or two could actually make things more volatile for the industry if a sense of complacency sets in and pricing momentum slows. As the underwriting adage goes, there is no such thing as a bad risk; only a bad price.

Edited August 26, 2023 by MMM20

Viking · August 27, 2023

Fairfax’s $56.5 Billion Investment Portfolio: What Will It Earn in 2023 to 2025?

Fairfax has two income sources that drive earnings and growth in book value: underwriting and investments. Given their business model (use insurance/float to invest in non-insurance companies) about 20% of their income comes from underwriting and 80% of their income comes from investments. Given its outsized importance to Fairfax, let’s dig into Fairfax’s investment portfolio and try and determine what sort of return it will be able to generate moving forward. This will give us great insight into what Fairfax will earn. And this will enable us to better understand Fairfax’s current valuation.

How big is Fairfax’s investment portfolio? It is about $56.5 billion or $2,435/share.

Has it been growing in size? Yes. From 2018 to 2022 it increased:

in absolute terms by 9.4% per year.
per share by 13.5% per year.

What is the split today?

Fixed income = $40 billion (71%)
Equities/derivatives = $16.5 billion (29%)

What did Fairfax earn on its total investment portfolio in the past?

Prem provided this information in his letter in the 2022AR (attached at the bottom of this post):

From 1986-2010, Fairfax earned an average of 9.7% on its investment portfolio.
- For the first 25 years of its existence, Fairfax’s secret sauce was its return on its total investment portfolio. In aggregate it was very good.
From 2011-2016, Fairfax earned an average of 2.3%
From 2017-2022, Fairfax earned an average of 4.8%
- 2010-2020 was a lost decade for Fairfax shareholders. The issue was not the insurance side of the business. The investment side of the company completely messed up (the equities/derivatives part). The big mistake was the equity hedge/short position. There were also lots of poor equity purchases from 2014-2017.

Let’s focus on the last 5 years. What Fairfax did 10 years ago is interesting. What they did the past 5 years is much more helpful in understanding the current situation. (Please note, I am not sure of the exact build that Prem used to get to the averages that he put in his letter in the 2022AR. My build is outlined below. There will be differences. However, directionally, the comparisons should still be useful.)

From 2018-2022, Fairfax earned an average of 5.1% from their investments (my build is detailed below).
Let’s overlay what happened in financial markets over this same time period:
- historically low interest rates from 2018 to the middle 2022 - this killed returns in the fixed income portfolio for much of the 5 year period.
- 3 different bear markets in stocks: 2018, 2020 and 2022.
- historic bear market in bonds in 2022.

Given the significant headwinds in financial markets from 2018-2022, the fact that Fairfax was able to deliver a total return of 5.1% each year (on average) is actually pretty impressive. What happened? Hamblin Watsa started to get their investing mojo back.

Note: IFRS: I am ignoring for now ‘Effects of discounting and risk adjustment’ = about $480 million to June 30, 2023.

What did the management team at Fairfax do from 2018-2022?

Internal:

Ended equity hedge/shorting strategy. The final short positions (closed out in late 2020) resulted in total losses of $624 million from 2018-2020, or an average of $208 million over each of the three years.
The equity holdings from 2014-2017 have mostly been fixed. Beginning in 2022, and lead by Eurobank, these holdings have gone from being a headwind to earnings (losing hundreds of millions every year in total) to now being a tailwind (making hundreds of millions every year in total). That is likely an improvement (swing) of +$500 million per year (my numbers are very rough and intended to be directionally accurate).
Since 2018, new equity investments have been very good. They are, in aggregate, performing very well. These holdings are a growing tailwind to earnings. Chug, chug, chug.

External:

Interest rates bottomed in late 2021: Fairfax sold $5.2 billion in corporate bonds (yielding 1%) and bought short term treasuries and reduced average duration to 1.2 years.
Interest rates spiked in 2022 and into 2023: average duration has been extended to 2.4 years. I think they bought some Canadian corporate bonds in Q2, 2023...
Covid bear market 2020: got exposure to 1.96 million Fairfax shares at $373/share. Bought back 2 million Fairfax shares in late 2021 at $500/share.
Bear market 2022: spent billions buying more of companies it already owned often at bear market low prices.

The investment team at Fairfax has been putting on a clinic on the benefits of active management over the past 3 years. The extreme volatility we have seen the past three years has actually been a big tailwind to Fairfax and its investment portfolio.

This begs the question: would Fairfax perform better in a ‘safe’ environment or in a ‘shit storm’ environment? Over the medium term (3 year time horizon), i think they would actually do better in a ‘shit storm’ environment. Especially when you include the $3.7 billion in net earnings (much of it from high quality sources that could be reinvested opportunistically) that is likely to be rolling in each year moving forward. That would be ‘buy low’ on steroids. We are going to come back to this point later.

But we are getting ahead of ourselves a little.

How do things look in 2023?

Both equities and fixed income are poised to deliver very good results moving forward - and the table is set for this to last for years into the future. This is the part that most investors still do not get.

Why? The significant ‘internal’ drags that were holding down Fairfax’s returns from 2018-2022 are gone. And significant new tailwinds have emerged.

Equities:

No more losses from the equity hedge/short trade.
The equity purchases from 2014-2017 are now delivering very good returns.
The equity purchases from 2018 to date continue to performing well.
Importantly, Fairfax boosted their stakes in many companies they already own at bear market low prices. This will be a tailwind for future earnings.
Covid headwinds have flipped to tailwinds at Recipe, Thomas Cook and BIAL.

Bottom line, the underlying earnings power of Fairfax’s $16.5 billion equity portfolio is finally fully delivering on its potential. It was already doing much better in 2022. All an investor had to do was look at share of profit of associates, which spiked to over $1 billion in 2022, to see the transformation of the companies captured in that bucket. But the improved performance in 2022 was masked by the general bear markets in bonds and stocks and the subsequent large unrealized investment losses that were reported.

Fixed income:

As good as the story is in equities, it is even better in fixed income. Going short duration of 1.2 years in late 2021 was, with hindsight, pure genius. Probably the best investment decision Fairfax has ever made in its history. Bond yields have since spiked higher. As a result, interest income has been spiking higher. It began picking up steam in 2022. But it has really got going in 2023. And 2024 is shaping up to be even better. And now Fairfax is extending duration.

The big increases in the returns in both the equity and fixed income portfolios is now spiking the return on Fairfax’s $56.5 billion total investment portfolio. Most importantly, the increase in earnings we are seeing in the equity portfolio (to higher quality) and the bond portfolio (to longer duration) make these higher earnings durable.

Ok. Enough talk. Show me the money!

What is the current estimate of what Fairfax might earn on its total investment portfolio in 2023?

My current estimate for Fairfax to generate an total investment return of about $4.5 billion in 2023, or a return of 8% on its total investment portfolio.

Assumptions to get to $4.5 billion in 2023:

We are already half way through the year in terms of reported results. And we are almost 2 months into Q3. So it is a pretty straight forward exercise to come up with reasonable estimates for the remainder of this year:

Interest and dividend income was $465 million in Q2. My guess is the current run rate is over $500 million per quarter so $1.9 billion for the year looks about right.
- $40 billion fixed income portfolio: my estimate for average yield in 2023 is 4.5%.
Share of profit of associates was $603 million in 1H. My estimate of $1.1 billion for FY is likely low.
Consolidated equities was -$36 million in 1H. This should reverse in 2H, driven by Recipe, Thomas Cook, Fairfax India and other holdings, and finish the year at $50 million.
Net gains on investments was $450 million in 1H. I am estimating this to finish the year at $900 million.
Gain on sales = Ambridge closed in Q2 and the GIG revaluation is expected to happen in 2H.

The assumptions above are hardly heroic. And they get us to an 8% return on the investment portfolio for 2023.

What is the current estimate for 2024 and 2025?

My forecast is for Fairfax to earn an average of 8% on its total investment portfolio in both 2024 and 2025. And I think this is a conservative number. Why?

For all the reasons I outlined above: many of the tailwinds to the equity and fixed income portfolios that are just now fully flowing through to reported results and this improvement should continue into 2024, although at a slower pace.
Significant net earnings rolling in: an estimated $3.7 billion per year (mostly high quality).
A management team with proven best-in-class capital allocation skills.
I am sandbagging my forecast for ‘net gains on investments’ for 2024 and 2025. I am going low with my estimate because, of course, i don’t know where they are going to come from.

Today, the management team at Fairfax has so many good options:

Buy Fairfax stock trading at 5.2PE (to estimated 2023 earnings) and 1 x BV (which is well below intrinsic value).
Shift from treasuries to high quality corporate bonds that are now yielding 6% to 6.5%.
Given the increase in rates further out on the curve, continue to extend duration of the fixed income portfolio.
Lots of equities are trading at low valuations (the run up in the market averages YTD in 2023 was largely driven by the ‘magnificent 7).

Bottom line, it would not surprise me if Fairfax delivers a return of better than 8% on total investments in each of 2024 and 2025.

What if my estimate of 8% on average over the next 3 years is approximately right?

An 8% return on investments equates to net earnings of about $160/share in 2023. ($160 in earnings also assumes a full year CR of 95). This level of earnings should grow nicely in the future. The stock is currently trading at $834. Book value is $834/share. An 8% average return on investments means the current share price is indeed crazy cheap - sorry to keep repeating this point… but it is what it is.

So what is it investors are missing?

The total earnings that Fairfax is currently delivering is so big that investors simply don’t believe it. Fairfax’s historical numbers and my estimates do not match up - not even close. It makes sense for most investors to believe that Fairfax’s numbers will revert back over time to their lower historical levels.

Investors also don’t believe that the high earnings number, if it actually happens in 2023, is sustainable. So even if a big number happens in 2023, well, it will be a fluke. They say “That baby’s coming down!” Why does the number have to come down in 2024? You pick the reason:

‘Interest rates are coming way down.’
‘An economic recession is coming.’
‘A stock market correction in coming.’
'In 2026 (you fill in the bad thing that has to happen).'

The pushback from investors is driven mostly by either disbelief or macro concerns. Nothing to do with Fairfax and what the company is actually doing or based on the results that it is currently delivering.

What is it Peter Lynch suggests that an investor should focus on when doing their research on a company? Facts and earnings. What about macro? He thinks investors who focus on macro are nuts.

Here is the really interesting thing… even if all of those scary macro things happen… I think they might actually make Fairfax’s future performance even better. Heads I win. Tails you lose. I love that type of bet.

—————

From Prem’s letter in the 2022AR:

Edited August 27, 2023 by Viking

Daphne · August 27, 2023

Viking, I believe you’re dead on with respect to macros (as well as everything else). Most recall that the driver behind the disastrous hedges was Prem’s macro call on the economy.

nwoodman · August 27, 2023

15 hours ago, Viking said:

Fairfax’s $56.5 Billion Investment Portfolio: What Will It Earn in 2023 to 2025?

Fairfax has two income sources that drive earnings and growth in book value: underwriting and investments. Given their business model (use insurance/float to invest in non-insurance companies) about 20% of their income comes from underwriting and 80% of their income comes from investments. Given its outsized importance to Fairfax, let’s dig into Fairfax’s investment portfolio and try and determine what sort of return it will be able to generate moving forward. This will give us great insight into what Fairfax will earn. And this will enable us to better understand Fairfax’s current valuation.

How big is Fairfax’s investment portfolio? It is about $56.5 billion or $2,435/share.

Has it been growing in size? Yes. From 2018 to 2022 it increased:

in absolute terms by 9.4% per year.

per share by 13.5% per year.

What is the split today?

Fixed income = $40 billion (71%)

Equities/derivatives = $16.5 billion (29%)

What did Fairfax earn on its total investment portfolio in the past?

Prem provided this information in his letter in the 2022AR (attached at the bottom of this post):

From 1986-2010, Fairfax earned an average of 9.7% on its investment portfolio.

For the first 25 years of its existence, Fairfax’s secret sauce was its return on its total investment portfolio. In aggregate it was very good.

From 2011-2016, Fairfax earned an average of 2.3%

From 2017-2022, Fairfax earned an average of 4.8%

2010-2020 was a lost decade for Fairfax shareholders. The issue was not the insurance side of the business. The investment side of the company completely messed up (the equities/derivatives part). The big mistake was the equity hedge/short position. There were also lots of poor equity purchases from 2014-2017.

Let’s focus on the last 5 years. What Fairfax did 10 years ago is interesting. What they did the past 5 years is much more helpful in understanding the current situation. (Please note, I am not sure of the exact build that Prem used to get to the averages that he put in his letter in the 2022AR. My build is outlined below. There will be differences. However, directionally, the comparisons should still be useful.)

From 2018-2022, Fairfax earned an average of 5.1% from their investments (my build is detailed below).

Let’s overlay what happened in financial markets over this same time period:

historically low interest rates from 2018 to the middle 2022 - this killed returns in the fixed income portfolio for much of the 5 year period.

3 different bear markets in stocks: 2018, 2020 and 2022.

historic bear market in bonds in 2022.

Given the significant headwinds in financial markets from 2018-2022, the fact that Fairfax was able to deliver a total return of 5.1% each year (on average) is actually pretty impressive. What happened? Hamblin Watsa started to get their investing mojo back.

Note: IFRS: I am ignoring for now ‘Effects of discounting and risk adjustment’ = about $480 million to June 30, 2023.

What did the management team at Fairfax do from 2018-2022?

Internal:

Ended equity hedge/shorting strategy. The final short positions (closed out in late 2020) resulted in total losses of $624 million from 2018-2020, or an average of $208 million over each of the three years.

The equity holdings from 2014-2017 have mostly been fixed. Beginning in 2022, and lead by Eurobank, these holdings have gone from being a headwind to earnings (losing hundreds of millions every year in total) to now being a tailwind (making hundreds of millions every year in total). That is likely an improvement (swing) of +$500 million per year (my numbers are very rough and intended to be directionally accurate).

Since 2018, new equity investments have been very good. They are, in aggregate, performing very well. These holdings are a growing tailwind to earnings. Chug, chug, chug.

External:

Interest rates bottomed in late 2021: Fairfax sold $5.2 billion in corporate bonds (yielding 1%) and bought short term treasuries and reduced average duration to 1.2 years.

Interest rates spiked in 2022 and into 2023: average duration has been extended to 2.4 years. I think they bought some Canadian corporate bonds in Q2, 2023...

Covid bear market 2020: got exposure to 1.96 million Fairfax shares at $373/share. Bought back 2 million Fairfax shares in late 2021 at $500/share.

Bear market 2022: spent billions buying more of companies it already owned often at bear market low prices.

The investment team at Fairfax has been putting on a clinic on the benefits of active management over the past 3 years. The extreme volatility we have seen the past three years has actually been a big tailwind to Fairfax and its investment portfolio.

This begs the question: would Fairfax perform better in a ‘safe’ environment or in a ‘shit storm’ environment? Over the medium term (3 year time horizon), i think they would actually do better in a ‘shit storm’ environment. Especially when you include the $3.7 billion in net earnings (much of it from high quality sources that could be reinvested opportunistically) that is likely to be rolling in each year moving forward. That would be ‘buy low’ on steroids. We are going to come back to this point later.

But we are getting ahead of ourselves a little.

How do things look in 2023?

Both equities and fixed income are poised to deliver very good results moving forward - and the table is set for this to last for years into the future. This is the part that most investors still do not get.

Why? The significant ‘internal’ drags that were holding down Fairfax’s returns from 2018-2022 are gone. And significant new tailwinds have emerged.

Equities:

No more losses from the equity hedge/short trade.

The equity purchases from 2014-2017 are now delivering very good returns.

The equity purchases from 2018 to date continue to performing well.

Importantly, Fairfax boosted their stakes in many companies they already own at bear market low prices. This will be a tailwind for future earnings.

Covid headwinds have flipped to tailwinds at Recipe, Thomas Cook and BIAL.

Bottom line, the underlying earnings power of Fairfax’s $16.5 billion equity portfolio is finally fully delivering on its potential. It was already doing much better in 2022. All an investor had to do was look at share of profit of associates, which spiked to over $1 billion in 2022, to see the transformation of the companies captured in that bucket. But the improved performance in 2022 was masked by the general bear markets in bonds and stocks and the subsequent large unrealized investment losses that were reported.

Fixed income:

As good as the story is in equities, it is even better in fixed income. Going short duration of 1.2 years in late 2021 was, with hindsight, pure genius. Probably the best investment decision Fairfax has ever made in its history. Bond yields have since spiked higher. As a result, interest income has been spiking higher. It began picking up steam in 2022. But it has really got going in 2023. And 2024 is shaping up to be even better. And now Fairfax is extending duration.

The big increases in the returns in both the equity and fixed income portfolios is now spiking the return on Fairfax’s $56.5 billion total investment portfolio. Most importantly, the increase in earnings we are seeing in the equity portfolio (to higher quality) and the bond portfolio (to longer duration) make these higher earnings durable.

Ok. Enough talk. Show me the money!

What is the current estimate of what Fairfax might earn on its total investment portfolio in 2023?

My current estimate for Fairfax to generate an total investment return of about $4.5 billion in 2023, or a return of 8% on its total investment portfolio.

Assumptions to get to $4.5 billion in 2023:

We are already half way through the year in terms of reported results. And we are almost 2 months into Q3. So it is a pretty straight forward exercise to come up with reasonable estimates for the remainder of this year:

Interest and dividend income was $465 million in Q2. My guess is the current run rate is over $500 million per quarter so $1.9 billion for the year looks about right.

$40 billion fixed income portfolio: my estimate for average yield in 2023 is 4.5%.

Share of profit of associates was $603 million in 1H. My estimate of $1.1 billion for FY is likely low.

Consolidated equities was -$36 million in 1H. This should reverse in 2H, driven by Recipe, Thomas Cook, Fairfax India and other holdings, and finish the year at $50 million.

Net gains on investments was $450 million in 1H. I am estimating this to finish the year at $900 million.

Gain on sales = Ambridge closed in Q2 and the GIG revaluation is expected to happen in 2H.

The assumptions above are hardly heroic. And they get us to an 8% return on the investment portfolio for 2023.

What is the current estimate for 2024 and 2025?

My forecast is for Fairfax to earn an average of 8% on its total investment portfolio in both 2024 and 2025. And I think this is a conservative number. Why?

For all the reasons I outlined above: many of the tailwinds to the equity and fixed income portfolios that are just now fully flowing through to reported results and this improvement should continue into 2024, although at a slower pace.

Significant net earnings rolling in: an estimated $3.7 billion per year (mostly high quality).

A management team with proven best-in-class capital allocation skills.

I am sandbagging my forecast for ‘net gains on investments’ for 2024 and 2025. I am going low with my estimate because, of course, i don’t know where they are going to come from.

Today, the management team at Fairfax has so many good options:

Buy Fairfax stock trading at 5.2PE (to estimated 2023 earnings) and 1 x BV.

Shift from treasuries to high quality corporate bonds that are now yielding 6% to 6.5%.

Given the increase in rates further out on the curve, continue to extend duration of the fixed income portfolio.

Lots of equities are trading at very good valuations (the run up in the market averages YTD in 2023 was largely driven by the ‘magnificent 7).

Bottom line, it would not surprise me to see Fairfax deliver a better than an 8% return on investments in 2024 and 2025.

What if my estimate of 8% on average over the next 3 years is approximately right?

An 8% return on investments equates to net earnings of about $160/share in 2023. ($160 in earnings also assumes a full year CR of 95). This level of earnings should grow nicely in the future. The stock is currently trading at $834. Book value is $834/share. An 8% average return on investments means the current share price is indeed crazy cheap - sorry to keep repeating this point… but it is what it is.

So what is it investors are missing?

The total earnings that Fairfax is currently delivering is so big that investors simply don’t believe it. Fairfax’s historical numbers and my estimates do not match up - not even close. It makes sense for most investors to believe that Fairfax’s numbers will revert back over time to their lower historical levels.

Investors also don’t believe that the high earnings number, if it actually happens in 2023, is sustainable. So even if a big number happens in 2023, well, it will be a fluke. They say “That baby’s coming down!” Why does the number have to come down in 2024? You pick the reason:

‘Interest rates are coming way down.’

‘An economic recession is coming.’

‘A stock market correction in coming.’

'In 2026 (you fill in the bad thing that has to happen).'

The pushback from investors is driven mostly by either disbelief or macro concerns. Nothing to do with Fairfax and what the company is actually doing or based on the results that it is currently delivering.

What is it Peter Lynch suggests that an investor should focus on when doing their research on a company? Facts and earnings. What about macro? He thinks investors who focus on macro are nuts.

Here is the really interesting thing… even if all of those scary macro things happen… I think they might actually make Fairfax’s future performance even better. Heads I win. Tails you lose. I love that type of bet.

—————

From Prem’s letter in the 2022AR:

It seems strange to me that Fairfax groups bond returns and equity returns together to create an average return on “investments’. I think this actually does their investment framework a disservice. I am sure HWIC are acutely aware that the only returns that matter are real returns and that guides a lot of their investment positioning. Might be a fun job on a rainy day to back out inflation and to get their “real return on investments” which is likely more telling of their investment prowess.

Their bond positioning this time around has been fantastic, some of the best in the business for my money. Capital allocation going forwards, is why/was the discount applied. A full re-rating will occur if they can demonstrate to the market that they are re-investing this windfall in quality assets.

Edited August 27, 2023 by nwoodman

newtovalue · August 27, 2023

hey Viking - great analysis as always!

one thing to ask you - i think we could assume the value of the investments would grow from $57.5BB.

Did you keep it flat to be conservative?

Viking · August 27, 2023

2 hours ago, newtovalue said:

hey Viking - great analysis as always!

one thing to ask you - i think we could assume the value of the investments would grow from $57.5BB.

Did you keep it flat to be conservative?

@newtovalue yes, my estimate for the investment portfolio is low and probably way low:

2023 = $56.5 billion
2024 = $57.5 billion
2025 = $58.5 billion

When the GIG acquisition closes that will cause a material increase to the investment portfolio. Continued organic growth in insurance will help as well. And as earnings roll in each quarter and are reinvested (further growing insurance and non-insurance buckets).

My estimates are pretty dynamic… constantly changing as we get new information. Some numbers will be high and others low. My goal is to get the direction and total reasonably close. So far most of my estimates have been too low and often by quite a bit. So i took things up a fair bit with my last set of revisions. We will know more when Fairfax reports Q3.

Edited August 27, 2023 by Viking

Munger_Disciple · August 27, 2023

Question on Prem's ownership for Fairfax experts on the board. I am not very familiar with SEDAR filings but I looked at the annual information filing for Fairfax for 2023. It states Prem "controls" 100% of multiple voting shares of 1,548,000 and 3.5% of subordinate voting shares which comes to an additional 794,000 shares (I got this from 2023 Proxy). So from this filing, he "controls" a total of 2,342,000 shares (economic interest).

Question is what does this mean? Do Prem & his family own these shares outright or does Prem control some limited partnership in which he owns the GP/ control interest? In that case what exactly is Prem's economic interest in Fairfax? Thanks in advance.

Edit: Here is the additional info in 2023 Proxy (I used to think EDGAR is bad but SEDAR is worse):

Mr. Prem Watsa controls Sixty Two, which owns 50,620 of our subordinate voting shares and 1,548,000 of our multiple voting shares, and himself beneficially owns an additional 741,985, and exercises control or direction over an additional 2,100, of our subordinate voting shares.

Edited August 27, 2023 by Munger_Disciple

Parsad · August 28, 2023

41 minutes ago, Munger_Disciple said:

Question on Prem's ownership for Fairfax experts on the board. I am not very familiar with SEDAR filings but I looked at the annual information filing for Fairfax for 2023. It states Prem "controls" 100% of multiple voting shares of 1,548,000 and 3.5% of subordinate voting shares which comes to an additional 794,000 shares (I got this from 2023 Proxy). So from this filing, he "controls" a total of 2,342,000 shares (economic interest).

Question is what does this mean? Do Prem & his family own these shares outright or does Prem control some limited partnership in which he owns the GP/ control interest? In that case what exactly is Prem's economic interest in Fairfax? Thanks in advance.

Edit: Here is the additional info in 2023 Proxy (I used to think EDGAR is bad but SEDAR is worse):

Mr. Prem Watsa controls Sixty Two, which owns 50,620 of our subordinate voting shares and 1,548,000 of our multiple voting shares, and himself beneficially owns an additional 741,985, and exercises control or direction over an additional 2,100, of our subordinate voting shares.

Yes, Sixty-Two Corporation was the holding company that Prem started with a few very close investors...not sure if Robbert Hartog (Prem's mentor) was part of Sixty-Two...but there were a handful of early investors that joined him. He controls it though. Robbert did put a considerable sum in...not sure if it was through Hamblin-Watsa...or through Sixty-Two...or directly when Prem acquired Markel (now Northbridge). I believe the story is in the 25th Anniversary Book.

So the bulk of his ownership is through Sixty-Two, and the $150M worth of stock he personally bought in the midst of the pandemic makes up about half the subordinate shares he owns outside of Sixty-Two.

His family members also own some shares...some relatives...a lot of the employees and managers at Fairfax...Francis Chou still owns all the stock he bought at $3...etc.

Cheers!

Munger_Disciple · August 28, 2023

1 hour ago, Parsad said:

Yes, Sixty-Two Corporation was the holding company that Prem started with a few very close investors...not sure if Robbert Hartog (Prem's mentor) was part of Sixty-Two...but there were a handful of early investors that joined him. He controls it though. Robbert did put a considerable sum in...not sure if it was through Hamblin-Watsa...or through Sixty-Two...or directly when Prem acquired Markel (now Northbridge). I believe the story is in the 25th Anniversary Book.

So the bulk of his ownership is through Sixty-Two, and the $150M worth of stock he personally bought in the midst of the pandemic makes up about half the subordinate shares he owns outside of Sixty-Two.

His family members also own some shares...some relatives...a lot of the employees and managers at Fairfax...Francis Chou still owns all the stock he bought at $3...etc.

Cheers!

Thanks @Parsad. Do you know what % of 62 does Prem own? Also what happens to multiple voting shares after Prem? Presumably whoever gains control of 62 which in turn controls Fairfax?

Also is Hamblin Watsa completely owned by Fairfax?

Edited August 28, 2023 by Munger_Disciple

Parsad · August 28, 2023

1 hour ago, Munger_Disciple said:

Thanks @Parsad. Do you know what % of 62 does Prem own? Also what happens to multiple voting shares after Prem? Presumably whoever gains control of 62 which in turn controls Fairfax?

Also is Hamblin Watsa completely owned by Fairfax?

Yes, Hamblin-Watsa is completely owned by Fairfax and their investment advisory arm for Fairfax's portfolio.

I believe Prem and his wife Nalini control almost 70% of Sixty-Two...maybe more now. The Watsa Family will retain control over Sixty-Two and Fairfax long-term.

Prem and Nalini aren't big on passing on large amounts of inherited wealth. I imagine, not unlike Buffett and his ownership of Berkshire, Nalini will probably pass most of the ownership of Fairfax to their foundation...The Sixty-Three Foundation through which they do their family donations.

The Watsa children and probably Prem & Nalini's grand-children, alongside their advisory board, will be long-term stewards of The Sixty-Three Foundation and indirectly Fairfax. So the family culture will remain with Fairfax for many, many decades!

Cheers!

Munger_Disciple · August 28, 2023

Thanks @Parsad! That was very helpful.

MMM20 · August 28, 2023

Does this apparent elasticity of demand make a dent in the hard market? The beginning of the end?

https://www.wsj.com/personal-finance/americans-are-bailing-on-their-home-insurance-e3395515

Homeowners are increasingly forgoing home insurance, gambling that the likelihood of a disaster isn’t high enough to justify the cost of a policy. Some skipping insurance say they are doing so because they can no longer afford the rising premiums. The national average for home insurance based on $250,000 in dwelling coverage increased this year to $1,428 annually, up 20% from 2022, according to Bankrate.

…

Twelve percent of homeowners in the U.S. don’t purchase homeowners’ insurance. About half of them have annual household incomes of less than $40,000, according to a 2023 survey by Insurance Information Institute, an industry trade group, and the reinsurer Munich Re.

…

People with money are finding ways around the problem.

A client of Angie Newman in coastal Florida figured that the total cost of replacing his vacation home and all of its contents would be about $1.5 million. His longtime insurer recently didn’t renew his policy. The only remaining insurer in the area was offering a policy with flood insurance for about $17,000 a year, up from about $7,000 a year that he paid previously, says Newman, a financial adviser at UBS Financial Services in Florham Park, N.J.

The client separated the possible costs of repairs and rebuilding from his other investible assets and invested the funds instead.

He assumed he could make an average return of about 6% on the roughly $1.5 million while waiting for some other insurers to re-enter the market, Newman says.

Edited August 28, 2023 by MMM20

gary17 · August 28, 2023

On 8/25/2023 at 1:56 AM, Viking said:

Here is some constructive feedback:

1.) my guess is Fairfax earns $160/share in 2023. That is a 5.2 PE. I expect earnings per share to grow in 2024 and 2025. So Macy’s is not cheaper today.

2.) liquidation value. My guess is if Fairfax started to sell off its many assets it would realize significant value for shareholders. Of course that isn’t going to happen so it is kind of a useless exercise. My question: is Macy’s going to liquidate parts of the company?

3.) management: the management team at Fairfax has been executing exceptionally well the past 5 years (best in class among insurance companies). They are going to be getting in the range of another $11.3 billion in net earnings over the next 3 years. I have no idea how good the management team at Macy’s is… but are they that good?

4.) insurance is in a hard market. Retail is… in a terrible market that might get worse ( although i did buy a little Aritzia recently).

Sanjeev, my read is you are significantly underestimating the current earnings power of Fairfax - like many of the posters on this board. And i love it. Stocks usually climb the wall of worry.

PS: i will admit i do not follow Macy’s… but i will do some reading on the weekend. Your banging of the table is what got me back into Fairfax in late 2020. And more recently you nailed META.

Quote

hi Viking - thanks for all this. makes sense.

For me FFH is cheap, but it does seem like they earn a low return on invested capital; they are only showing decent return on equity because it's a leveraged business. my high level observation.

Gary

MMM20 · August 28, 2023

On 8/28/2023 at 2:14 PM, gary17 said:

they are only showing decent return on equity because it's a leveraged business

True, but you could've said the same think about BRK for many decades. The critical point that can't be emphasized enough (I've tried) is that insurance float is very different than broker margin or even corporate credit. It's a sustainable source of free or negative cost (or even just plain cheap) leverage, even through drawdowns that might blow up a bank or hedge fund, as long as they can underwrite to breakeven or better (or even a little worse) through cycles. Rather than a negative thing, what you're pointing out is a (maybe *the*) major structural advantage from the POV of a long term FFH equity investor, and even more of an absolute and relative advantage now than a few years ago with 1) so much more of it, in the wake of smart growth ahead of and into the hard market, and 2) borrowing costs otherwise off the lower bound.

IMHO that *highest quality* leverage is the overarching reason why FFH has been and should continue to be a compounder… and a still misunderstood one still trading at 5-6x sustainable (though, yes, volatile) earnings.

That's my elevator pitch at least. Sorry, I can't help but chime in b/c this is my favorite subject.

Edited August 30, 2023 by MMM20

gary17 · August 28, 2023

1 hour ago, MMM20 said:

True, but you could've said the same think about BRK for many decades. The critical point that can't be emphasized enough (I've tried) is that insurance float is very different than broker margin. It's a sustainable source of free or negative cost (or even just plain cheap) financing, even through drawdowns that might blow up a bank or hedge fund, as long as they can underwrite to breakeven or better (or even a little worse) through cycles. Rather than a negative thing, what you're pointing out is a (maybe *the*) major structural advantage from the POV of a long term FFH equity investor, and even more of an absolute and relative advantage now than a few years ago with 1) so much more of it, in the wake of smart growth ahead of and into the hard market, and 2) borrowing costs otherwise off the lower bound.

IMHO that *highest quality* leverage is the overarching reason why FFH has been and should continue to be a compounder… and a still misunderstood one that just happens to still be trading at 5-6x sustainable (though, yes, volatile) earnings.

That's my elevator pitch at least. Sorry, I can't help but chime in b/c this is my favorite subject.

MMM20, thanks, i totally get what you are saying. The cheap cost of capital is an advantage. I just wish they could get even higher returns for the cheap capital they can get - but I guess the nature of insurance business is such that they can only invest in certain types of securities / fixed income for when there's a payout. I think higher valuation could come when they start transforming to be more like Berkshire with wholly owned subsidiaries.

Gary

Edited August 28, 2023 by gary17

Viking · August 28, 2023

1 hour ago, gary17 said:

hi Viking - thanks for all this. makes sense.

For me FFH is cheap, but it does seem like they earn a low return on invested capital; they are only showing decent return on equity because it's a leveraged business. my high level observation.

Gary

@gary17 i have a question for your. Lets pretend Fairfax delivered an ROE of 15% per year on average for the past 5 years. This year they are on track to deliver an ROE of around 19%. Prospects for 2024 and 2025 look good (mid teens ROE). What multiples (PE and P/BV) would be reasonable to pay today?

Edited August 28, 2023 by Viking

StevieV · August 28, 2023

3 hours ago, MMM20 said:

3 hours ago, MMM20 said:

People with money are finding ways around the problem.

The client separated the possible costs of repairs and rebuilding from his other investible assets and invested the funds instead.

He assumed he could make an average return of about 6% on the roughly $1.5 million while waiting for some other insurers to re-enter the market, Newman says.

It's a stretch to call this finding a way around the challenge of increasing insurance rates. It is simply choosing to forego insurance. "Instead" of buying insurance, the homeowner will pay for a rebuild out of pocket if something happens. Those are typically the two options.

Edited August 28, 2023 by StevieV

Munger_Disciple · August 28, 2023

34 minutes ago, StevieV said:

It's a stretch to call this finding a way around the challenge of increasing insurance rates. It is simply choosing to forego insurance. "Instead" of buying insurance, the homeowner will pay for a rebuild out of pocket if something happens. Those are typically the two options.

If the homeowner carries a mortgage, he is required to purchase homeowner insurance.

Thrifty3000 · August 28, 2023

35 minutes ago, StevieV said:

It's a stretch to call this finding a way around the challenge of increasing insurance rates. It is simply choosing to forego insurance. "Instead" of buying insurance, the homeowner will pay for a rebuild out of pocket if something happens. Those are typically the two options.

People who have mortgages or loans against their property will be required by the lender to have insurance. Only people who own property free and clear will be able to self insure.

gary17 · August 28, 2023

20 minutes ago, Viking said:

@gary17 i have a question for your. Lets pretend Fairfax delivered an ROE of 15% per year on average for the past 5 years. This year they are on track to deliver an ROE of around 19%. Prospects for 2024 and 2025 look good (mid teens ROE). What multiples (PE and P/BV) would be reasonable to pay today?

If I was any good i wouldn't be on this forum all the time for great insight from the smart people ! lol

for me i think because FFH is trading close to book, so ROE is also close to return on my investment. If it's a stable business and the prospects are good, i think i'd be happy to pay at least 8- 10x or whatever the market is at. I've found over the years paying market price for good business worked out just fine.

At 8-10x, that'd make this $1280 - $1600usd/share - and by that measure FFH is certain under-valued.

I am not sure what the market is also factoring in, but perhaps the cost of borrowing for the investors - if one can get 4 - 5% from fixed income, certainly reduces appetite for stocks. Also opportunity cost of what else is in the investment universe . And perhaps the market is still waiting to be convinced the underlying investment philosophy - the lost decade - won't be repeated.

gary17 · August 28, 2023

Just to clarify, the 8x to 10x = 10% ~ 12.5% return on investment for me - and i think that's OK given the risk free rate is around 5% - so demanding another 5 % - 7% return on the risks.

but clearly it's not trading at 8x - 10x; it's trading at 5.5x or 18% ROI. So market is pricing the risk at mucher than my 5 - 7%. So the market may know something i don't.

Parsad · August 29, 2023

On 8/27/2023 at 8:15 PM, Parsad said:

Yes, Hamblin-Watsa is completely owned by Fairfax and their investment advisory arm for Fairfax's portfolio.

I believe Prem and his wife Nalini control almost 70% of Sixty-Two...maybe more now. The Watsa Family will retain control over Sixty-Two and Fairfax long-term.

Prem and Nalini aren't big on passing on large amounts of inherited wealth. I imagine, not unlike Buffett and his ownership of Berkshire, Nalini will probably pass most of the ownership of Fairfax to their foundation...The Sixty-Three Foundation through which they do their family donations.

The Watsa children and probably Prem & Nalini's grand-children, alongside their advisory board, will be long-term stewards of The Sixty-Three Foundation and indirectly Fairfax. So the family culture will remain with Fairfax for many, many decades!

Cheers!

Thanks to Kyle Holmes for confirming from the 1992 FFH Letter that Prem owns 100% of Sixty-Two since buying out the minority shareholders in 1992. For some reason, I thought he increased his stake to 70%+, but he bought control of the whole entity. Cheers!

Fairfax 2023

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