Fairfax 2023

MMM20 · September 18, 2023

2 minutes ago, Munger_Disciple said:

To each his own

Yes, I'll continue to assume Fairfax will not light capital on fire

SafetyinNumbers · September 18, 2023

Ultimately, it doesn’t really matter if we think it’s under or overvalued. Current supply is probably from those that think it’s fairly valued. Most of those likely sold earlier in hurricane season (why not if it’s fairly priced in their opinion) and perhaps that explains why volumes have diminished recently. Active buyers might wait until we are through hurricane season before becoming more aggressive and I think they will be accompanied by index huggers who buy on VWAP (that buying never stopped).

There seems to be relatively high certainty despite the consensus estimates that book value is going to be at least 50% higher in 3-5 years and as long as the stock tracks book that means the weighting in the index will be going up all else being equal. It’s at 87bps now and based on the near term earnings, it seems likely the stock will be through 100bps soon. At that point, it will be much harder for the PMs that “hate Prem” to not take another look. It’s a much easier decision to buy than chasing CSU as a value manager in 2018 when it crossed 100bps but now that everyone is a quality growth manager they will have to find a way to forget the past and buy FFH based on its quality growth.

Analysts will get bolder with their estimates and will start to model in growth in earnings. Instead of declining ROEs, they might model a steady 15% which they know will be wrong but shows growth year over year based on compounding. That will bring quant investors in droves which will invite every other active investor left to take a look. My concern is selling too early in this process. Momentum is more pronounced than it’s ever been given the popularity of passive and quants. Things could get out of hand and I’m here for it.

Munger_Disciple · September 19, 2023

@Viking

I think @StubbleJumper explained very well the difference between our views. At a high level you are focusing on 2 or 3-year estimates whereas I am looking at what sustainable normalized earnings may look like.

Your arguments about me not taking compounding into account & thus looking at FFH as a non-growing static entity are not valid. With my assumptions, I implicitly assumed FFH can compound at 10% per year by reinvesting earnings back into its business with any added P/B expansion juicing the results a tiny bit (thus adding an additional 1-2% return per annum for awhile, but not forever). And I would be happy with 10% compounded results over the next decade.

More importantly, you seem to be thinking that $160 per share earnings for the next couple of years are already in the bag. This ignores a fundamental fact. Insurance underwriting is a probabilistic game. One could be right about the odds and still lose money on any single bet (or in any single accident year). You only know whether you are winning or losing in a probabilistic game with a large number of repeated trials, or in the case of an insurance company over many years covering long cycles. As an example let us say someone offers you 3 to 1 odds on a fair coin toss coming up heads. You would take that bet all day. But on any given coin toss you could lose; that doesn't mean you made a mistake in underwriting that bet. And the Kelly Criterion tells us what % of bankroll we should bet on a game where the expected value of the outcome is positive but we could naturally lose money on any single throw. Similarly, Fairfax could lose a ton of money in insurance next year due to hurricanes, fires, mud slides, terrorism, whatever; that doesn't necessarily mean that their insurance underwriting is bad. It just means that they are playing a probabilistic game. So no, your $160 estimate is not in the bag because you incorrectly assume that underwriting profit is a given in the next year or two.

Edited September 19, 2023 by Munger_Disciple

jbwent63 · September 19, 2023

Terrific discourse here folks. My $0.02 is that in valuing businesses you try to come up with maintainable earnings (EBITDA, EBIT etc.) which are based not only on history but your assessment of the future. Like some, I believe FFH has turned a corner and that the past is not a good indicator of the future. Of course with P&C insurance the CR could be 90 or 110, but based on recent history and the track record of underwriting FFH's subsidiaries have created, I would be more inclined to discount the chance of 110 much more than the liklihood of 90. In any event we all see things differently and I appreciate the views expressed by the above writers.

Viking · September 19, 2023

25 minutes ago, Munger_Disciple said:

More importantly, you seem to be thinking that $160 per share earnings for the next couple of years are already in the bag.

@Munger_Disciple to be clear, i may have a lot of conviction in my estimate for 2023. I have never said any estimate is ‘in the bag’. That, of course would be idiotic. As we move to 2024, the estimate gets less clear. 2025 even less. And i don’t even attempt to forecast 2026 as there are too many moving parts.

You have built an estimate… i have built an estimate. We both have provided our logic. Discussing the build is how we learn. I appreciate the opportunity to debate.
—————

Below is what i said in my response to you two days ago

What is the major flaw with my estimates?

Am I being way too optimistic? Perhaps. But my problem the past 3 years is I have been way too pessimistic with my forecasts - they have consistently been way too low.

I lean heavily on what I think i know today. I only go out max 3 years with my forecasts. And I admit my year-3 forecast is not as clear as my year-1.

As new news comes in I update my forecasts. Quickly. If bad news starts to pour in I will take down my estimates. Same if the opposite happens and good news comes in - I'll take up my estimate. So far, I have only been making upward revisions.

Another flaw with my forecasts is I do not incorporate compounding in very well. So my estimates in 2024 and 2025 for asset growth is too low. Higher assets likely means higher earnings. This is a big reason I think my forecasts are mildly conservative (overall).

Crip1 · September 19, 2023

Respectful disagreement discussions allow far better opportunity to learn than any other, so thanks to all for the viewpoints and the means by which said viewpoints are presented.

A perfect crystal ball does not exist, so nobody is going to be right. What looks to be clear now is that Fairfax is in the middle of an extraordinary (albeit finite) growth period where the hard market is juicing the returns for the company. I think that Viking makes a compelling case that 2023 – 2025 will show extraordinary returns, so I like the idea of using his 3 year projection (with a haircut if one is so inclined). As the ’23-’25 projections are not guaranteed, any projections beyond that time are most certainly unknown. Munger_Disciple’s projections (Combined Ratio, returns on Fixed Income and Equity Portfolios, etc) present a reasonable look at what we can expect 2026 and beyond.

The goal would be two fold. First, look at Viking’s projection to calculate the annual cash flows between now and 2025. Second, using the size of the company at the end of 2025, apply the MD’s methodology to project the next 3-5 years cash flows. From there, the company will clearly still have a value which we can approximate as BV at the end of the 3-5 year period. Finally, discount all of these back to present value and that will give us an implied value now. The more that value is above current price, the better a buy the company is today (and, of course, if that value is less than current price, the company is not worth the investment.

Obviously, there are so many variables that this cannot be counted upon with precision. Rather, it gives an idea of what the company should be worth right now. Any attempts to be more precise are likely going to be fruitless, rather, we’re going to have to be happy with being approximately right as opposed to being precisely wrong.

-Crip

MMM20 · September 19, 2023

More broadly, I've come to the conclusion that most investors won't give Fairfax a fair look. For most, it's either outside their circle of competence or they're indexers/quants who will never care or will need to see the transformation if in the reported numbers for at least this year. Others have too much baggage and can't look at the company anew. Still others for the sake of conservatism will simply use arbitrarily low estimates that imply a dim view of the company's transformation. Therefore, the stock will have to continue climbing a wall of skepticism. That's fine. Without any heroic assumptions, it might give the company the chance to take out 20%+ of the shares at a steep discount to IV over the next few years, depending of course on alternative uses of capital. I'm just here for the ride unless it triples overnight or something fundamental changes out of left field.

Edited September 20, 2023 by MMM20

StubbleJumper · September 19, 2023

Funny story about my most recent FFH two-bagger.

As everybody knows, in late 2021 FFH initiated a substantial issuer bid which ultimately was priced at US$500/sh. Wanting to do a little low risk arbitrage, I reorganized a pile of assets in my tax-advantaged accounts and loaded up on FFH at ~US$450/sh and then tendered the whole works. To my great surprise, the tender offer was over-subscribed and I was prorated, with only 90% of my tender being accepted. As it worked out, tendering 90% of those shares at US$500 gave me a full return of the capital that I had used to buy 100% of the shares at US$450. My intention was to unload the 10% extra shares some time in early 2022 as I already owned a boat-load of FFH prior to the tender announcement.

Well, what does Buffett say about investing? It requires long periods of inactivity bordering on sloth. And sometimes it also involves a wee bit of neglect, sloppiness and other forms of inattention. I never did get around to selling those 10% of shares that were not accepted in the tender. Nearly two years later, those surplus shares are perilously close to becoming a two-bagger.

Good thing for me that the SIB ended up being oversubscribed and that I got busy in early 2022 and failed to sell the excess shares. Sometimes it's better to be lucky instead of good.

SJ

Crip1 · September 19, 2023

14 minutes ago, StubbleJumper said:

Funny story about my most recent FFH two-bagger.

As everybody knows, in late 2021 FFH initiated a substantial issuer bid which ultimately was priced at US$500/sh. Wanting to do a little low risk arbitrage, I reorganized a pile of assets in my tax-advantaged accounts and loaded up on FFH at ~US$450/sh and then tendered the whole works. To my great surprise, the tender offer was over-subscribed and I was prorated, with only 90% of my tender being accepted. As it worked out, tendering 90% of those shares at US$500 gave me a full return of the capital that I had used to buy 100% of the shares at US$450. My intention was to unload the 10% extra shares some time in early 2022 as I already owned a boat-load of FFH prior to the tender announcement.

Well, what does Buffett say about investing? It requires long periods of inactivity bordering on sloth. And sometimes it also involves a wee bit of neglect, sloppiness and other forms of inattention. I never did get around to selling those 10% of shares that were not accepted in the tender. Nearly two years later, those surplus shares are perilously close to becoming a two-bagger.

Good thing for me that the SIB ended up being oversubscribed and that I got busy in early 2022 and failed to sell the excess shares. Sometimes it's better to be lucky instead of good.

SJ

Mae West: Too much of a good thing can be wonderful.

Viking · September 19, 2023

52 minutes ago, Crip1 said:

Respectful disagreement discussions allow far better opportunity to learn than any other, so thanks to all for the viewpoints and the means by which said viewpoints are presented.

A perfect crystal ball does not exist, so nobody is going to be right. What looks to be clear now is that Fairfax is in the middle of an extraordinary (albeit finite) growth period where the hard market is juicing the returns for the company. I think that Viking makes a compelling case that 2023 – 2025 will show extraordinary returns, so I like the idea of using his 3 year projection (with a haircut if one is so inclined). As the ’23-’25 projections are not guaranteed, any projections beyond that time are most certainly unknown. Munger_Disciple’s projections (Combined Ratio, returns on Fixed Income and Equity Portfolios, etc) present a reasonable look at what we can expect 2026 and beyond.

The goal would be two fold. First, look at Viking’s projection to calculate the annual cash flows between now and 2025. Second, using the size of the company at the end of 2025, apply the MD’s methodology to project the next 3-5 years cash flows. From there, the company will clearly still have a value which we can approximate as BV at the end of the 3-5 year period. Finally, discount all of these back to present value and that will give us an implied value now. The more that value is above current price, the better a buy the company is today (and, of course, if that value is less than current price, the company is not worth the investment.

Obviously, there are so many variables that this cannot be counted upon with precision. Rather, it gives an idea of what the company should be worth right now. Any attempts to be more precise are likely going to be fruitless, rather, we’re going to have to be happy with being approximately right as opposed to being precisely wrong.

-Crip

@Crip1 well said. What are your thoughts about the interplay between underwriting profit and investment returns? Are they linked? Can we put numbers to each?

At the end of the day, publicly traded P/C insurance companies need to make a 8-10% ROE over time. The CEO’s want to hit their bonus payouts and also keep their jobs.

As a result, i think CR and investment results are linked. Let’s assume fixed income yields stay at the elevated levels we are seeing today. Can a 100 CR get a company to a 10% ROE? Maybe Fairfax today because of the leverage they have with float. But i think most P&C insurers would struggle to deliver an ROE of close to 10%. Given most have taken a capital hit on their fixed income portfolios due to rising interest rates i just don’t see a big or rapid turn to a soft insurance market. Bond yields are still too low. And insurance companies lots of near term risks they need to build into their models when pricing (elevated catastrophe losses, reinsurance costs, inflation etc).

Edited September 19, 2023 by Viking

TwoCitiesCapital · September 19, 2023

20 minutes ago, Viking said:

@Crip1 well said. What are your thoughts about the interplay between underwriting profit and investment returns? Are they linked? Can we put numbers to each?

At the end of the day, publicly traded P/C insurance companies need to make a 8-10% ROE over time. The CEO’s want to hit their bonus payouts and also keep their jobs.

As a result, i think CR and investment results are linked. Let’s assume fixed income yields stay at the elevated levels we are seeing today. Can a 100 CR get a company to a 10% ROE? Maybe Fairfax today because of the leverage they have with float. But i think most P&C insurers would struggle to deliver an ROE of close to 10%. Given most have taken a capital hit on their fixed income portfolios due to rising interest rates i just don’t see a big or rapid turn to a soft insurance market. Bond yields are still too low. And insurance companies lots of near term risks they need to build into their models when pricing (elevated catastrophe losses, reinsurance costs, inflation etc).

Supposedly they are linked, but weren't CRs high while interest rates were low in the late 2010s?

And now CRs have been low for a bit while interest rates have been rising quite a bit?

And the higher interest rates go destroys more capital keeping CRs low due to higher underwriting prices?

The rationale of why they are linked makes a lot of sense to me, but I'm not seeing it in the results. At what point does the "rationale" assert itself? And why has it not been asserting itself in the last 5-7 years?

Santayana · September 19, 2023

I completely understand @Munger_Disciple's points about the risks, but I feel like the biggest risks to Fairfax at this are actually industry risks, and that Fairfax is better positioned than most right now.

SafetyinNumbers · September 19, 2023

Has anyone done analysis on the administrative expense of underwriting i.e. the part of the combined ratio that does not include claims paid? It seems like Fairfax insurance businesses have grown so much recently that should result in scale advantages which all else being equal makes the combined ratio structurally lower. A point or two really matters.

Viking · September 19, 2023

1 hour ago, TwoCitiesCapital said:

Supposedly they are linked, but weren't CRs high while interest rates were low in the late 2010s?

And now CRs have been low for a bit while interest rates have been rising quite a bit?

And the higher interest rates go destroys more capital keeping CRs low due to higher underwriting prices?

The rationale of why they are linked makes a lot of sense to me, but I'm not seeing it in the results. At what point does the "rationale" assert itself? And why has it not been asserting itself in the last 5-7 years?

I think the last true hard market in PC insurance was around 2004. That suggests the insurance cycle can run in a 20 year cycle from hard to soft and back to a hard market. At the same time, you also have an interest rate cycle. Interest rates peaked in 1980 and the trough was 2020. That 1/2 cycle in rates was 40 years.

What does this tell us about how to value Fairfax today? I am pretty sure the two are linked. But i have no idea how to overlay that linkage to how i value Fairfax.

Perhaps management is the key. Good management teams will usually thrive over time. Bad management teams will usually struggle/fail. And cycles will happen like they always do.

Munger_Disciple · September 19, 2023

4 hours ago, Crip1 said:

Respectful disagreement discussions allow far better opportunity to learn than any other, so thanks to all for the viewpoints and the means by which said viewpoints are presented.

Crip1 · September 20, 2023

16 hours ago, Viking said:

@Crip1 well said. What are your thoughts about the interplay between underwriting profit and investment returns? Are they linked? Can we put numbers to each?

At the end of the day, publicly traded P/C insurance companies need to make a 8-10% ROE over time. The CEO’s want to hit their bonus payouts and also keep their jobs.

As a result, i think CR and investment results are linked. Let’s assume fixed income yields stay at the elevated levels we are seeing today. Can a 100 CR get a company to a 10% ROE? Maybe Fairfax today because of the leverage they have with float. But i think most P&C insurers would struggle to deliver an ROE of close to 10%. Given most have taken a capital hit on their fixed income portfolios due to rising interest rates i just don’t see a big or rapid turn to a soft insurance market. Bond yields are still too low. And insurance companies lots of near term risks they need to build into their models when pricing (elevated catastrophe losses, reinsurance costs, inflation etc).

Viking, you asking me a question like this is not unlike Bill Belichick asking me about football!

Interest rates most definitely have an impact on combined ratio as higher interest rates will, all things being equal, allow for higher combined ratio. Laws of supply and demand factor in as well as excess capital will apply upward pressure to CRs.

-Crip

SafetyinNumbers · September 20, 2023

16 hours ago, SafetyinNumbers said:

Has anyone done analysis on the administrative expense of underwriting i.e. the part of the combined ratio that does not include claims paid? It seems like Fairfax insurance businesses have grown so much recently that should result in scale advantages which all else being equal makes the combined ratio structurally lower. A point or two really matters.

In 2018 ~$2b in other underwriting expenses vs ~$12b in net premiums. In 2022 ~$2.7b in other underwriting expenses vs ~$21b in net premiums. Not sure how that compares to others but it’s a material improvement in the expense ratio.

UK · September 20, 2023

8 minutes ago, SafetyinNumbers said:

In 2018 ~$2b in other underwriting expenses vs ~$12b in net premiums. In 2022 ~$2.7b in other underwriting expenses vs ~$21b in net premiums. Not sure how that compares to others but it’s a material improvement in the expense ratio.

This is a very good point! So from almost 17 to 13 per cent. Almost all improvement in CR and all structural? Also, if I recall correctly, Prem talked about scale needed, while was acused for empire building...

SafetyinNumbers · September 20, 2023

25 minutes ago, UK said:

This is a very good point! So from almost 17 to 13 per cent. Almost all improvement in CR and all structural? Also, if I recall correctly, Prem talked about scale needed, while was acused for empire building...

I think that’s the right way to interpret the data but I’m not an insurance expert.

Using stock at 1.3x book value to get scale in insurance is part of the Singleton playbook that investors generally don’t focus on but it’s part of why the stock got so depressed (a lot more shares for investors to absorb) and why the opportunity is so good now.

Hamburg Investor · September 20, 2023

18 hours ago, Santayana said:

I completely understand @Munger_Disciple's points about the risks, but I feel like the biggest risks to Fairfax at this are actually industry risks, and that Fairfax is better positioned than most right now.

Spot on. And it's not only better positioned; it's valued way cheaper.

Hamburg Investor · September 20, 2023

On 9/18/2023 at 10:20 AM, Viking said:

To help investors value a stock, Warren Buffett tells the story of Aesop: "a bird in the hand is worth two in the bush."

According to Buffett, investors need to determine 3 things:

How many birds are in the bush?

When are you going to get them out?

How sure are you?

The prevailing interest rate is also important:

If interest rates are 15%, then two birds out in 5 years makes sense.

If interest rates are 3%, then two birds out in 20 years makes sense.

-----------

@Munger_Disciple Thanks for taking the time to put together an earnings estimate for Fairfax. It is great to get different perspectives.

When I read your estimate above I immediately thought: "two birds in the hand are worth one in the bush." Of course, I know this was not what you are trying to say. But that was my take-away from your estimate.

Let me explain. Let's start with your estimate:

Now let's pivot to my current estimate for 2023. My current estimate is Fairfax will earn $160/share in 2023. We are almost 9 months into the year. Yes, something bad could happen. But something good could also happen. My view is the tail risks to my forecast (too high or too low) are about equally distributed. So I think $160 is a reasonable number.

What about 2024? I am at earnings of $166/share for 2024 and $174 for 2025. I think my 2024 and 2025 estimates are mildly conservative.

Let's compare out two numbers: You are at $84/share and I am at $160/share. You are 1/2 of my number. That is a big difference.

So what explains the difference?

Let's compare our estimates.

1.) Underwriting: Your CR is 100 and mine is 94.5 for 2023 and 95 for 2024.

Your rationale: You say Warren Buffett's goal is 100.

My rationale: That is where Fairfax is currently tracking (the last 3 years).

Yes, we likely are late in the hard market. But everything I read suggests the hard market is likely to continue into 2024. Reinsurance (property cat) just started its hard market.

Will Fairfax's CR trend higher in the coming years? Probably. I am modelling 94.5, 95 and 95.5 from 2023-2025. Over time, as I get new information I will adjust accordingly.

Bottom line, Fairfax is tracking to earn $1.27 billion in 2023. Taking that to zero today and every year into the future just seems bizarre to me.

PS: Warren Buffett also thinks float is better to have than an equal amount of equity.

2.) Fixed Income: $40 billion earning 4.5%. We are pretty close here.

The difference is compounding. My guess is the fixed income portfolio will grow in total size at 8-10% per year the next couple of years:

Top line growth: increased premiums (currently running at 8%) will grow float

GIG acquisition will boost total investments

Earnings: 4.5% yield will deliver earnings of $1.8 billion pre tax

My point is the $40 billion will likely be $50 billion by the end of 2025. I also think the yield will be closer to 5% in 2024.

Bottom line, ignoring the power of compounding gives you a lower number here.

3.) Preferred stock $2.4 billion = $170 million. I don't break out preferred stock as a separate line item. Let's assume we are on the same page here (it is a small number)

4.) Equities/derivatives. You are $13 billion at 10% = $1.3 billion. We are off quite a bit here. My tracker has this bucket with a value of $16.9 billion today. This includes some preferred stock ($850 million). I also value the FFH-TRS at notional ($1.6 billion).

For this bucket I am at $2.4 billion for 2024 and growing in future years:

Mark to market gains on portfolio of $8 billion = $800 million (10%). The FFH-TRS is driving this bucket (every $100 move in FFH = $200 million).

Dividends = tracking around $140 million per year (includes preferred stock)

Share of profit of associates on portfolio of $6 billion = tracking around $1.15 billion. Yes, close to 20%. This is a build of the current trend of the companies included in this bucket, driven by Eurobank.

Associates - YOY change in fair value vs carrying value = $100 million. Although not captured in book value, this is value creation for shareholders.

Operating companies (Recipe, TCI, Dexterra etc) pre-tax earnings: $150 million.

Investment gains (sales/revaluation) = $250 million (lumpy)

Let's take $170 million off my number to account for preferred stock already counted in 3 above. That brings my equity number to $2.23 billion. What will cause my number to fall by $900 million to your number of $1.3 billion? An economic depression?

I think my equity/derivative number is going to grow by 10% per year. Like underwriting, we are miles apart here.

5.) Corporate + Interest expense = $400 + $520. We are the same here.

Summary:

Two buckets explain most of the difference in our forecasts:

Underwriting: you are $1.2 billion below me

Return equity/derivative portfolio will deliver: you are $900 million below me

It looks to me like you are also assuming Fairfax stops growing today: assets, liabilities, equity.

Fairfax will likely grow its assets significantly in the coming years (organic growth + earnings reinvested). Growth in float will also increase liabilities. And shareholders equity will be increasing (earnings). The power of compounding at Fairfax could be significant the next couple of years (larger in size than anything we have seen).

My current estimate has Fairfax earning $3.7 billion in 2023 and a total of $11.3 billion 2023-2025. That is more than 50% of current shareholders equity. It is a huge number. This is likely coming in the next 10 quarters (2 have already been delivered) - not the next 10 years.

How many birds are in the bush? $3.7 billion per year and growing.

When are you going to get them out? One is coming every year (a little plumper).

How sure are you? Its in line of sight.

Today, Fairfax shareholders currently have one bird firmly in one hand (2022) and the second bird is just about to land in the second hand (2023). The third one is getting ready to take flight. It looks to me like your analysis assumes away 1/2 of the birds - it just pretends they don't exist. Hence my analogy of "two birds in the hand are worth one in the bush" kind of logic.

What is the major flaw with my estimates?

Am I being way too optimistic? Perhaps. But my problem the past 3 years is I have been way too pessimistic with my forecasts - they have consistently been way too low.

I lean heavily on what I think i know today. I only go out max 3 years with my forecasts. And I admit my year-3 forecast is not as clear as my year-1.

As new news comes in I update my forecasts. Quickly. If bad news starts to pour in I will take down my estimates. Same if the opposite happens and good news comes in - I'll take up my estimate. So far, I have only been making upward revisions.

Another flaw with my forecasts is I do not incorporate compounding in very well. So my estimates in 2024 and 2025 for asset growth is too low. Higher assets likely means higher earnings. This is a big reason I think my forecasts are mildly conservative (overall).

20% growth in ROE is a double in 3.6 years (about). I think Fairfax might be able to do that. Looking out 4 years, a double in shareholders equity should result in much higher earnings - Fairfax's track record with capital allocation has been excellent since 2018.

Soft market in insurance? Bear market in stocks? Of course both will happen at some point in the future. Just like they have in the past. And good companies will benefit. And bad companies will fall by the wayside. P/C insurance was in a soft market from 2014-2017. In the last 6 years we have had 3 bear markets in stocks and the biggest bear market ever in bonds. Over the past 3 years Fairfax has thrived. And they didn't have the earnings/cash flow they do now. My guess is Fairfax will be just fine. But I remain open minded.

Very exciting discussion between @Viking and @Munger_Disciple. Thank you!

Maybe some thoughts on this: In the end, Munger's approach reminds me a bit of the early Buffett of Cigar Butt Investments. Of course not really, because Munger is also interested in the PE ratios and not the liquidation value; but Munger just insists on a very cautious assessment of the earnings, also sees no moat, and thus consequently focuses very strongly on the "margin of safety"; and especially this point reminds me of Cigar Butt.

Viking, on the other hand, I often understand to mean that with the many in-depth analyses of the individual parts and the many changes in perspective, he ends up - in my perception - shedding much more light on management and its capabilities, and thus, in my view, the overall picture evolves of a value-oriented company that has become increasingly well-managed over the years and that uses "float" as leverage. Whereas decades ago, CRs were regularly extremely poor relative to the market, Fairfax has averaged a few percentage points better than the market over the past decade. Thus, Prem is following much more closely in the footsteps of a Buffett or Gayner at this point. Fairfax has had by far the strongest premium growth of the top 25 insurers over the past three years. Many investments in India, Greece and the U.S. have paid off or are performing well right now. And so on. And then Viking also builds in a Margin of Safety (one that I personally think is sufficient and reasonable!), but just less conservative than Munger. So the picture that emerges is one of many positive individual decisions that form an overall picture of how Fairfax has changed after 2016. Viking's number analyses are important, but a second layer (management, moat) is forming, and I personally read a strong case for management and the presence of a moat above all else from the mosaic of many individual analyses. And at the end Viking also builds in a Margin of Safety, but to show a possible, conservatively realistic compounding perspective it is lower than Munger's. Both seem perfectly legitimate and consistent to me. They are just completely different methods.

Gayner explained in a podcast some time ago ("the evolution of a value investor") that he now pays much more attention to the development of a company than to its current state. In a sense, he said he is much more interested in the corporate movie that is being created over time than a still image (or something like that). If you have a company with a moat, the best way to recognize it is in a movie, that is, in an analysis over a longer period of time in the past, than by looking at just one point in time. I was very attracted to the idea.

It is probably rare that a company can already be considered cheaply valued without a moat and it (possibly; tbd) also has a moat on top. Otherwise, there would probably not have been this exchange here. Either way, there is a lot to be said for either a good investment or even one along the lines of "Once in a Lifetime" . We will see.

SoonParted · September 20, 2023

On 9/19/2023 at 12:17 PM, Viking said:

@Crip1 well said. What are your thoughts about the interplay between underwriting profit and investment returns? Are they linked? Can we put numbers to each?

At the end of the day, publicly traded P/C insurance companies need to make a 8-10% ROE over time. The CEO’s want to hit their bonus payouts and also keep their jobs.

As a result, i think CR and investment results are linked. Let’s assume fixed income yields stay at the elevated levels we are seeing today. Can a 100 CR get a company to a 10% ROE? Maybe Fairfax today because of the leverage they have with float. But i think most P&C insurers would struggle to deliver an ROE of close to 10%. Given most have taken a capital hit on their fixed income portfolios due to rising interest rates i just don’t see a big or rapid turn to a soft insurance market. Bond yields are still too low. And insurance companies lots of near term risks they need to build into their models when pricing (elevated catastrophe losses, reinsurance costs, inflation etc).

I'm speculating here, but is there an effect where poor underwriting forces a larger proportion (beyond legal requirements) of low-yielding "safe" investments as a reserve against claims? And good underwriting could allow for higher-return investments with a bit more risk.