Fairfax 2023

[Haryana]

 

Thank you for your great analysis.

 

Net earnings in Q3 was over a billion.

 

Income in Q4 is likely to be higher in each of Insurance, Interest and Investments.

 

This makes me guess Q4 earnings to be over 1.5 billion after adding ~300mm for GIG. 

 

Thus earnings per share in Q4 could be about 65/share taking the 2023 total to 185/share.

 

Looking forward to annual earnings of about 200/share to get normalized over the coming years.

 

Certainly, there will be lumpiness but how about we project 1000/share of earnings over five year periods.

 

This fits in well as quick mental model to get a double every 5 years and you are getting annual return of 15%.

 

[petec]

Apologies if this has been discussed upthread, but how do people feel about Fairfax at USD900 if rates fall from here?

 

In my view rising rates have been the most significant driver of earnings over the last few years. I do not mean to detract from all the other good things that have happened, but higher earnings on the bond portfolio AND premium growth AND lower combined ratios have transformed operating earnings. All three are largely driven by rates: bond earnings obviously are, and I suspect premium growth and lower CRs are too since rates drive tourist capital in and out of the industry.

 

If so, then a return to significantly lower rates would cause operating earnings to drop back down, possibly significantly. The next 3 years of earnings are somewhat locked in (especially in bonds) but the three years after that could look very different. Book value will probably be in the $1300 range by then, but the stock has clearly traded below book when interest rates are low.

 

How does the stock react if the 10y goes back to say 2% over the next year or two (regardless of how likely you think that is)?

 

 

[hardcorevalue]

well locking in the duration is locking in a big part of the market cap in terms of earnings so it’s still really cheap regardless of if we get back to 2%. Also, call me crazy but I still believe in higher for longer, 7% US deficits aren’t sustainable, especially with the obligations the US has. 

 

[MMM20]

5 hours ago, petec said:

Apologies if this has been discussed upthread, but how do people feel about Fairfax at USD900 if rates fall from here?

 

In my view rising rates have been the most significant driver of earnings over the last few years. I do not mean to detract from all the other good things that have happened, but higher earnings on the bond portfolio AND premium growth AND lower combined ratios have transformed operating earnings. All three are largely driven by rates: bond earnings obviously are, and I suspect premium growth and lower CRs are too since rates drive tourist capital in and out of the industry.

 

If so, then a return to significantly lower rates would cause operating earnings to drop back down, possibly significantly. The next 3 years of earnings are somewhat locked in (especially in bonds) but the three years after that could look very different. Book value will probably be in the $1300 range by then, but the stock has clearly traded below book when interest rates are low.

 

How does the stock react if the 10y goes back to say 2% over the next year or two (regardless of how likely you think that is)?

 

 

 

You can argue that earnings in the out years would be lower (I'm skeptical) but don't forget that the fair multiple of those earnings would be higher - holding ERP constant at least.

 

Edited December 19, 2023 by MMM20

[Tommm50]

5 hours ago, petec said:

All three are largely driven by rates: bond earnings obviously are, and I suspect premium growth and lower CRs are too since rates drive tourist capital in and out of the industry.

 

I don't believe lower CR's are driven by higher interest rates, if fact, the opposite. If an insurance company is not making income on the investment side it is forced to try to make it on the underwriting side i.e. lower CR's. I'm not sure the relationship to growth but growth is not as important as profit.

[TwoCitiesCapital]

5 hours ago, petec said:

Apologies if this has been discussed upthread, but how do people feel about Fairfax at USD900 if rates fall from here?

 

In my view rising rates have been the most significant driver of earnings over the last few years. I do not mean to detract from all the other good things that have happened, but higher earnings on the bond portfolio AND premium growth AND lower combined ratios have transformed operating earnings. All three are largely driven by rates: bond earnings obviously are, and I suspect premium growth and lower CRs are too since rates drive tourist capital in and out of the industry.

 

If so, then a return to significantly lower rates would cause operating earnings to drop back down, possibly significantly. The next 3 years of earnings are somewhat locked in (especially in bonds) but the three years after that could look very different. Book value will probably be in the $1300 range by then, but the stock has clearly traded below book when interest rates are low.

 

How does the stock react if the 10y goes back to say 2% over the next year or two (regardless of how likely you think that is)?

 

 

 

You could make a case for either direction. Honestly, itl don't have a strong opinion one way or the other. 2018 might be instructive where it was expensive given its earnings power potential while interest rates were low. I made the case back then that I saw limited path for it to generate decent returns from $550 USD/share without a significant rise in rates which wasn't in the cards then.

 

Hindsight was that turned out to be right in the short term - the stock suffered massively through covid and then was very slow to recover. But even if you'd bought it in 2018, you did alright - primarily because things like GoDigit worked out extraordinarily well in generating BV returns even while interest rates were low. 

 

1 hour ago, hardcorevalue said:

well locking in the duration is locking in a big part of the market cap in terms of earnings so it’s still really cheap regardless of if we get back to 2%. Also, call me crazy but I still believe in higher for longer, 7% US deficits aren’t sustainable, especially with the obligations the US has. 

 

+1 

 

That's why I've been such an advocate for them locking in and not trying to call the top. Having the foresight of 1+ billion in interest income is going to be huge regardless of what rates do. Unfortunately, it seems the Fed was just jawboning the "higher for longer" mantra - but now that Fairfax has ~3 years to maturity on most of its bonds we can wait out a turn on the credit cycle. Won't make a killing on duration most likely, but will have plenty of interest income to reinvest to make a difference. 

 

They missed the prior turn in 2018 and we sat for 3-4 years at basically 0 interest in response (in addition to the (1-2 years we already sat there pre-2018 waiting through the hiking cycle). Just glad we're not going to do that again! 

Edited December 19, 2023 by TwoCitiesCapital

[Thrifty3000]

5 hours ago, petec said:

Apologies if this has been discussed upthread, but how do people feel about Fairfax at USD900 if rates fall from here?

 

In my view rising rates have been the most significant driver of earnings over the last few years. I do not mean to detract from all the other good things that have happened, but higher earnings on the bond portfolio AND premium growth AND lower combined ratios have transformed operating earnings. All three are largely driven by rates: bond earnings obviously are, and I suspect premium growth and lower CRs are too since rates drive tourist capital in and out of the industry.

 

If so, then a return to significantly lower rates would cause operating earnings to drop back down, possibly significantly. The next 3 years of earnings are somewhat locked in (especially in bonds) but the three years after that could look very different. Book value will probably be in the $1300 range by then, but the stock has clearly traded below book when interest rates are low.

 

How does the stock react if the 10y goes back to say 2% over the next year or two (regardless of how likely you think that is)?

 

 

The investment portfolio will probably be closing in on $70 bil in 3 years. Bonds and cash will probably make up 60% of the portfolio. A blended 4.5% return, or $3.2 bil, should net around $100 per share.

 

If the bonds are only earning 2% then the rest of the portfolio has to earn 8% to maintain the $100 per share bogey. I don’t think that’s too big of a hurdle for the investment team.

 

I also think if interest rates are 2% that it’s not far-fetched to assume sub-100 combined ratios, which should help FFH stay in the neighborhood of $150 EPS through the cycle.  

[Crip1]

34 minutes ago, Thrifty3000 said:

The investment portfolio will probably be closing in on $70 bil in 3 years. Bonds and cash will probably make up 60% of the portfolio. A blended 4.5% return, or $3.2 bil, should net around $100 per share.

 

If the bonds are only earning 2% then the rest of the portfolio has to earn 8% to maintain the $100 per share bogey. I don’t think that’s too big of a hurdle for the investment team.

 

I also think if interest rates are 2% that it’s not far-fetched to assume sub-100 combined ratios, which should help FFH stay in the neighborhood of $150 EPS through the cycle.  

In addition to the previously discussed dynamics, all of which are relevant, one should consider the anticipated Fairfax “pivot”. For years they have almost exclusively been in very safe US Treasuries because the spread between treasury and corporate rates has not been sufficient relative to the risk. At some point, presumably, that’s going to change and they’re going to, likely selectively, shift a portion of their FI investments to Corporates which will presumably generate higher yields, offsetting a declining rate environment.

 

Somewhat separately, all of the posts over the past couple of days illustrate and validate Viking’s consistent assertions that he’s not going to project out more than 2-3 years since there are so many variables at play. He’s right. The returns over the next couple of years are not guaranteed, but the $150/Year for the next couple of years looks to be reasonable. From 2026 forward, we’re only guessing. What we do know is that they will be playing from a position of strength with a VERY large balance sheet, a solid insurance operation and a demonstrated acumen in asset allocation. As an investor, I like my chances at that point.

 

-Crip
 

[Thrifty3000]

7 hours ago, petec said:

Apologies if this has been discussed upthread, but how do people feel about Fairfax at USD900 if rates fall from here?

 

In my view rising rates have been the most significant driver of earnings over the last few years. I do not mean to detract from all the other good things that have happened, but higher earnings on the bond portfolio AND premium growth AND lower combined ratios have transformed operating earnings. All three are largely driven by rates: bond earnings obviously are, and I suspect premium growth and lower CRs are too since rates drive tourist capital in and out of the industry.

 

If so, then a return to significantly lower rates would cause operating earnings to drop back down, possibly significantly. The next 3 years of earnings are somewhat locked in (especially in bonds) but the three years after that could look very different. Book value will probably be in the $1300 range by then, but the stock has clearly traded below book when interest rates are low.

 

How does the stock react if the 10y goes back to say 2% over the next year or two (regardless of how likely you think that is)?

 

 

 

If you want a doomsday scenario where cash and bonds collectively earn less than 1%, and the rest of the portfolio earns less than 8%, you're looking at EPS in the neighborhood of $90 pre-tax. After taxes and overhead/expenses would put it around $40 EPS.

 

Add or subtract what you want for insurance earnings. I'd expect at least $25 to $50 EPS in that type of rate environment.

[Thrifty3000]

Here is a historical chart showing average portfolio returns:

 

Edited December 19, 2023 by Thrifty3000

[Thrifty3000]

2 hours ago, Thrifty3000 said:

Here is a historical chart showing average portfolio returns:

 

 

From 2011-2016 5-year treasuries yielded around 1.5%, and the portfolio only yielded 2.3% because of the equity hedges.

 

From 2017-2022 5-year treasuries were extremely volatile, but appear to have averaged around a 1.75% yield. However, the portfolio returned 4.8% thanks to the equities, etc.

 

I think the last decade shows us that a 4.5%+ portfolio return is reasonably achievable even in an environment with sub 2% treasury yields.

 

Therefore, $100+ per share portfolio earnings (after taxes/expenses) seems plenty reasonable 4 years from now and beyond.

Edited December 19, 2023 by Thrifty3000

[Xerxes]

1 hour ago, Thrifty3000 said:

 

From 2011-2016 5-year treasuries yielded around 1.5%, and the portfolio only yielded 2.3% because of the equity hedges.

 

From 2017-2022 5-year treasuries were extremely volatile, but appear to have averaged around a 1.75% yield. However, the portfolio returned 4.8% thanks to the equities, etc.

 

I think the last decade shows us that a 4.5%+ portfolio return is reasonably achievable even in an environment with sub 2% treasury yields.

 

Therefore, $100+ per share portfolio earnings (after taxes/expenses) seems plenty reasonable 4 years from now and beyond.

The whole “not locking in duration” decision also had an impact on market share that FFH could grab at the right time as its peers got walloped. 
 

Would that increase in market share show up anywhere other than now larger pool of gross insurance premiums. 
 

Is there a positive scale factor in for such a non-centralized entity ? 

[Viking]

7 hours ago, Thrifty3000 said:

Here is a historical chart showing average portfolio returns:

 

In terms of return on their total investment portfolio, I have Fairfax tracking at 8.2% for 2023. And 7.2% for 2024 and 2025.
 

For both 2024 and 2025 i am modelling nothing for large realized gains: items like selling pet insurance or Ambridge. Or revaluing of GIG (this should drop into 2023). I think it is highly likely Fairfax will do something meaningful to surface value in 2024 or 2025. So i think my 7.2% estimate is conservative. 
 

What about 2026? And further out? That is simply a bet on management. And their capital allocation skills. Fairfax has been putting on a clinic the past 5 years when it comes to capital allocation. Volatility is a tailwind for Fairfax - not a headwind. Why do people expect they are going to all of sudden get stupid? From my perspective that approach is not being conservative. 

Edited December 20, 2023 by Viking

[Haryana]

I am counting on at least one large realized gain or monetization or revaluation per year in guessing 200/year.

 

1. Digit IPO is in the pipeline

2. BIAL IPO is in the pipeline

3. New items will get added in the pipeline with their opportunism

4. They buy a small portion of an existing asset that revalues it upwards

5. They sell a small portion of an existing asset that revalues it upwards

6. They sell some unknown/insignificant position for an significant/outsized valuation

7. They sell some debt earning high interest for large gain when interest rates lower

8. Some of their distressed assets like BB or FDGE produce unexpected value

9. Fairfax India gets revalued to book value for whatever turn of events

 

[OCLMTL]

11 hours ago, Thrifty3000 said:

The investment portfolio will probably be closing in on $70 bil in 3 years. Bonds and cash will probably make up 60% of the portfolio. A blended 4.5% return, or $3.2 bil, should net around $100 per share.

 

If the bonds are only earning 2% then the rest of the portfolio has to earn 8% to maintain the $100 per share bogey. I don’t think that’s too big of a hurdle for the investment team.

 

I also think if interest rates are 2% that it’s not far-fetched to assume sub-100 combined ratios, which should help FFH stay in the neighborhood of $150 EPS through the cycle.  

To me that’s the biggest « hidden » upside. A lot of people are worried about rates heading lower and the potential impact to EPS/FCF in 3 years. It’s totally legitimate if you ask me. The problem though is that if we look at Viking’s earnings expectations, for example, and we see that $4B of earnings PER YEAR gets added to BV, and slap an incremental ROE on that $4B of 10%, you’re talking about a LOT of earnings power in years 4+ simply on the added equity we’ve built in the last few years. 

 

Am I completely wrong to think that incremental ROE of 10% is achievable on each tranche of $4B of earnings per year the company adds? Am I seeing this in a way that is overly simplistic? Thanks for all the feedback. Trying to humbly contribute to this dialogue. 

[Xerxes]

If that famous constant $150 per share per annum earning builds up against 2024 equity, as that equity goes up and accumulates then ROE would drop in year 3, as equity now has a larger base. 
 

So there is a case for FFH not trade at a premium multiple in the out year. 

[Viking]

52 minutes ago, OCLMTL said:

To me that’s the biggest « hidden » upside. A lot of people are worried about rates heading lower and the potential impact to EPS/FCF in 3 years. It’s totally legitimate if you ask me. The problem though is that if we look at Viking’s earnings expectations, for example, and we see that $4B of earnings PER YEAR gets added to BV, and slap an incremental ROE on that $4B of 10%, you’re talking about a LOT of earnings power in years 4+ simply on the added equity we’ve built in the last few years. 

 

Am I completely wrong to think that incremental ROE of 10% is achievable on each tranche of $4B of earnings per year the company adds? Am I seeing this in a way that is overly simplistic? Thanks for all the feedback. Trying to humbly contribute to this dialogue. 

@OCLMTL great add. I think what you are getting at is the power of compounding - earnings on earnings. It cracks me up that we have a bunch of value investors on this board who seem to be ignoring this ‘8th wonder of the world’ when they look at Fairfax and the significant earnings that is rolling in each quarter.
 

Yes, we don’t know exactly what Fairfax is going to do. But does this mean we assign it a value of zero? Expecting Fairfax to earn 10% on reinvested earnings (on average) makes sense to me.
 

Related, the size and timing of earnings matter. A lot. Well, at least that’s what Buffett says. Companies that get the cash flow up front are supposed to be valued higher. Especially if it outsized.
 

Fairfax has been generating record operating earnings starting back in 2022. New record in 2023. Likely a new record in 2024. Outlook for 2025 and 2026 is good. This is a massive amount of earnings coming over a 5 year period. 
 

This pile of gold has been/will be reinvested each year. Those investments are/will grow new earnings streams. Which, over time, will grow into rivers. So in 5 years time guess what? 

 

The idea that earnings at Fairfax will flatline at $150/share for the next two years and then drop from there makes no sense to me. At least based on what we know today. 

 

Edited December 20, 2023 by Viking

[Viking]

44 minutes ago, Xerxes said:

If that famous constant $150 per share per annum earning builds up against 2024 equity, as that equity goes up and accumulates then ROE would drop in year 3, as equity now has a larger base. 
 

So there is a case for FFH not trade at a premium multiple in the out year. 

That only makes sense if Fairfax puts the earnings under a mattress. 
 

Or if they allocate capital in a value destructive way. With each passing year, this is looking less and less likely. 

[Xerxes]

45 minutes ago, Viking said:

That only makes sense if Fairfax puts the earnings under a mattress. 
 

Or if they allocate capital in a value destructive way. With each passing year, this is looking less and less likely. 

Viking

while earning on earnings would be logical, they could simply choose to hold steady and build up capital and not go on risk curve with their annual “proceeds”.
 

Pre Covid, they have demonstrated their patience. 
 

Their investment “greatest hits” all revolve around accumulating drypowder for a big swing. I don’t think it is illogical to assume that the surplus won’t be re-invested with same market rate, either because (1) rate peaked or (2) credit spread didn’t blow out or (3) internal opportunities in insurance subs are less available. 
 

We just don’t know any of this. 
 

In absence of (1), (2) and (3), it would either accumulate dropping that ROE overtime or do a return of capital. 

 

[Viking]

1 hour ago, Xerxes said:

Viking

while earning on earnings would be logical, they could simply choose to hold steady and build up capital and not go on risk curve with their annual “proceeds”.
 

Pre Covid, they have demonstrated their patience. 
 

Their investment “greatest hits” all revolve around accumulating drypowder for a big swing. I don’t think it is illogical to assume that the surplus won’t be re-invested with same market rate, either because (1) rate peaked or (2) credit spread didn’t blow out or (3) internal opportunities in insurance subs are less available. 
 

We just don’t know any of this. 
 

In absence of (1), (2) and (3), it would either accumulate dropping that ROE overtime or do a return of capital. 

@Xerxes i really enjoy the back and forth. Writing is a great way to think and get ones thoughts straight. Here is a good thought exercise. Go back to Fairfax version 2019. Look at all the important metrics. Now look at Fairfax 2023 and look at those same metrics. Importantly, look at all the decisions made each year from 2019-2023. The company is unrecognizable today to the company that existed 4 years ago. But here is the key: Fairfax did all of this when they had much lower earnings!
 

Today Fairfax is earning gobs of money that is sustainable. Do people seriously think Fairfax in 2027 is going to resemble the Fairfax of 2023? Seriously? 

Edited December 20, 2023 by Viking

[Parsad]

3 hours ago, Viking said:

That only makes sense if Fairfax puts the earnings under a mattress. 
 

Or if they allocate capital in a value destructive way. With each passing year, this is looking less and less likely. 

 

Correct!  Cheers!

[steph]

You don't only pay a higher P/B multiple because of high expeced return on book.  You pay a higher multiple because of the notion of quality.  Quality company, quality management,... .  Fairfax got a low P/B because of distrust towards management and the idea that FFH was lower quality.  With what they have just done I sincerely do believe that the market will reward them again with a P/B more in line with quality competitors.  1.3 to 1.5 times would be reasonable.  So if after 2026 rates are lower and ROE will be somewhat lower I am convinced the P/B could be higher as long as they continue doing sensible things. 

[petec]

19 hours ago, MMM20 said:

 

You can argue that earnings in the out years would be lower (I'm skeptical) but don't forget that the fair multiple of those earnings would be higher - holding ERP constant at least.

 

 

In theory, but this is not what happened during the 2010s, in my view.

[petec]

19 hours ago, Tommm50 said:

 

I don't believe lower CR's are driven by higher interest rates, if fact, the opposite. If an insurance company is not making income on the investment side it is forced to try to make it on the underwriting side i.e. lower CR's. I'm not sure the relationship to growth but growth is not as important as profit.

 

Sure - but if investors can't make reasonable returns in fixed income they go looking elsewhere, driving capital into all sorts of things including insurance. lower rates did NOT drive a hard market in the 2010s - why would the extend this one?

[petec]

9 hours ago, Viking said:

Why do people expect they are going to all of sudden get stupid?

 

I happen to agree with this entirely, but don't forget this is the same board that KNEW that Prem was stupid from about 2011 to 2021, so sentiment can shift