Fairfax 2024

[Daphne]

On 1/16/2024 at 6:17 PM, Parsad said:

 

I thought he was already in there!  This is long overdue.  Congratulations Prem!  Cheers!

 

Edited January 25, 2024 by Daphne
Old content

[Daphne]

Berkeley year end
 

Fourth Quarter Return on Equity of 23.6% and Operating Return on Equity of 23.2%;

Record Quarterly and Annual Pre-Tax Underwriting Income and Net Investment Income

[gfp]

BMO raises target price to C$1550 from C$1400

[MMM20]

WSJ: Insurers Rake In Profits as Customers Pay Soaring Premiums

 

https://www.wsj.com/finance/insurance-companies-profits-stock-ebae7fd1?

 

[Hoodlum]

National Bank mentioned a few of the driving factors for stock price increase this year.  It looks like analyst are starting to catch on to what has already been mentioned here.

 

https://www.theglobeandmail.com/investing/markets/inside-the-market/article-fridays-analyst-upgrades-and-downgrades-for-jan-26/

 

Quote

National Bank analyst Jaeme Gloyn once again named Fairfax Financial Holdings Ltd. his top pick for 2024 in his Diversified Financials coverage universe.

 

The Toronto-based holding company was also selected a year ago and saw its shares jump 52 per cent in 2023 (versus a gain of 9 per cent for the S&P/TSX Capped Financial Index).

 

In a report released Friday, Mr. Gloyn said he picked Fairfax based on three potential catalysts:

 

1. Operating Income guidance upgrade.

“In the first three quarters of 2023, Fairfax hit their annual operating income expectation of $3.0-billion,” he said. “We expect management will raise the bar on this outlook to upwards of $5-billion.”

 

2. Valuation.

“We believe consistent low to mid-teens operating ROE [return on equity] performance will drive a re-rating of the shares,” he said. “At the current trading valuation of 1.05 times, the market is pricing FFH like a 7-per-cent ROE business. We expect interest and dividend income ALONE to drive 7-percentage-points of ROE. FFH peers such as MKL and BRKa also trade at higher valuations of 1.4 times to 1.5 times P/ B.”

 

3. S&P/TSX 60 Index inclusion:

“FFH is top candidate for inclusion in the S&P/TSX 60 Index, which could drive estimated demand equivalent to 6 days of FFH average daily volume,” he said. “This will turn an under-owned financial into a core holding.”

Mr. Gloyn also sees the property and casualty (P&C) insurance sector remaining “well-positioned for 2024, regardless of a soft landing or changes in interest rates.”

 

“What if interest rates move lower? Lower rates could be neutral/positive for FH,” he said. “First, Fairfax’s extended duration of fixed income assets protects them from a near-term decline in rates. Second, Fairfax has the ability to purchase higher yield corporate debt. Third, lower rates drive gains in fixed income assets, flowing to net income, ROE and book value growth.

 

“What if the insurance cycle softens? We don’t see a softer insurance market as a significant concern because; i) Fairfax has proven its ability to deliver mid-90s combined ratios in soft market conditions, ii) Fairfax has the ability to release recently built up excess capital at subsidiaries, iii) underwriting income represents 20 per cent of our operating income forecast in 2024/2025.”

Maintaining an “outperform” rating for Fairfax shares, he hiked his target to a Street-high $2,000 from $1,800. The current average is $1,648.87.

 

[Masterofnone]

Should Fairfax get included in the index does anyone think they might use this as an opportunity to exit a portion of the TRS? There's a big wad of shares owned by the counter party.

[SafetyinNumbers]

2 hours ago, Hoodlum said:

National Bank mentioned a few of the driving factors for stock price increase this year.  It looks like analyst are starting to catch on to what has already been mentioned here.

 

https://www.theglobeandmail.com/investing/markets/inside-the-market/article-fridays-analyst-upgrades-and-downgrades-for-jan-26/

 

 

It’s a really good note. Hopefully makes it harder for those funds underweight vs the benchmark to ignore! 

[Luke]

On what does FFH inclusion in the TSX 60 depend? 

[Viking]

46 minutes ago, Masterofnone said:

Should Fairfax get included in the index does anyone think they might use this as an opportunity to exit a portion of the TRS? There's a big wad of shares owned by the counter party.

 

Valuation will likely be the driver of what they do with the TRS position.

 

Of all the analyst reports I have read over the past 18 months National Bank has consistently been the best - and by the best I mean they get into the weeds and provide a very thorough and thoughtful build of all of their assumptions. Their estimate 12 months ago was the most accurate. I don't think it was luck.

 

Today? They have updated their models and have upped their price target to C$2,000. This is not a crazy number. It is based on Fairfax trading at a 1.3 multiple which is reasonable. 

 

Fairfax is still cheap. And it would be easy to argue that it is crazy cheap. Why would they exit the TRS when the set-up is so favourable (not just valuation but also the near-term outlook)?

 

Buffett said 12 'truly good decisions' made over 60 years (one every 5 years) is what generated his significant outperformance versus the S&P 500. You make the big money by holding your best ideas for years - decades in Buffett's case. My guess is Fairfax is holding the TRS to make the big money.

 

“They say you never grow poor taking profits. No. you don’t. But neither do you grow rich taking a four point profit in a bull market.” Reminiscences of a Stock Operator

Edited January 26, 2024 by Viking

[Masterofnone]

Just thinking that the created demand of 6 days worth of volume plus likely run-up in anticipation of this demand could possibly create that favorable valuation.

[Viking]

36 minutes ago, Masterofnone said:

Just thinking that the created demand of 6 days worth of volume plus likely run-up in anticipation of this demand could possibly create that favorable valuation.

Here is what Prem said in the 2020AR after they put the position on: “We think this will be a great investment for Fairfax, perhaps our best yet!” 
 

My view is the FFH-TRS is a ‘punch-card’ type of investment for Fairfax. A ‘truly good decision.’ Exceedingly rare. One that comes along perhaps once every 5 years or so. And Fairfax knows how to value this investment.

 

Why would you sell something that is likely going to compound at a high rate for the next 5 years? You would be a dummy to sell it even at fair value. And Fairfax is nowhere near fair value today.

 

Cutting your flowers and watering your weeds is never a smart thing to do. Inevitably, the proceeds go into an inferior idea. Most people sell because they think they can find something as good or better. That isn’t what happens when you sell the ‘truly good decisions’. I think it is mental flaw that lots of investors have. And it leads to sub-par returns.

 

i know this because i see a guy in the mirror every day who has repeatedly made this mistake over the years  

Edited January 26, 2024 by Viking

[MMM20]

44 minutes ago, Viking said:

Cutting your flowers and watering your weeds is never a smart thing to do.

I think most of us agree, but we also know survivorship bias is real and context matters. Yes, the valuation on normalized earnings hasn’t really changed over the past 3-4 years even as the stock has 3-4x’d, and we know book value understates economic reality. But let’s say someone bought this back then at 0.5-0.6x book and has let it grow to nearly half their retirement portfolio or kids college fund or whatever and now the risk inherent in such concentration is keeping them up at night - let’s say the risk of The Big One, or of Prem keeling over tomorrow, or that Eurobank is a big fat fraud, or some true black swan. Would you blame them for cutting this in half this year if it keeps running up? Investing is never easy, right? Asking for a friend.
 

Edited January 26, 2024 by MMM20

[Luke]

6 minutes ago, MMM20 said:

I think most of us agree, but we also know survivorship bias is real and context matters. Yes, the valuation on normalized earnings hasn’t really changed over the last 3-4 years even as the stock has 3-4x’d, and we know book value understates economic reality. But let’s say someone bought this back then at 0.5-0.6x book and has let it grow to nearly half their retirement portfolio or kids college fund or whatever, and now the risk inherent in such concentration is keeping them up at night - let’s say the risk of The Big One, or of Prem keeling over tomorrow, or that Eurobank is a big fat fraud, or some true black swan. Would you blame them for cutting this in half this year if it keeps running up? Investing is never easy, right? Asking for a friend.
 

In what would that person invest the proceeds, what businesses at this kind of quality and reasonable prices can one find? Everything else is expensive now...

[Viking]

2 hours ago, MMM20 said:

I think most of us agree, but we also know survivorship bias is real and context matters. Yes, the valuation on normalized earnings hasn’t really changed over the past 3-4 years even as the stock has 3-4x’d, and we know book value understates economic reality. But let’s say someone bought this back then at 0.5-0.6x book and has let it grow to nearly half their retirement portfolio or kids college fund or whatever and now the risk inherent in such concentration is keeping them up at night - let’s say the risk of The Big One, or of Prem keeling over tomorrow, or that Eurobank is a big fat fraud, or some true black swan. Would you blame them for cutting this in half this year if it keeps running up? Investing is never easy, right? Asking for a friend.

I would love to hear other board members thoughts: how do you handle position sizing? Especially when the winning/oversized position is likely just getting started?

@MMM20 that is a great question. I also have a friend who is looking for an answer.

 

Position size has two components:

1.) when you buy

2.) what happens over time

 

Position sizing is exceptionally difficult. Probably because it is more art (gut) than science (brains). Unlike the ‘brain’ type, the ‘gut’ type of decisions can’t easily be explained.

 

My comments in earlier posts today were meant to be quite general in nature. As an example, i have owned Berkshire Hathaway stock many times over the years. I always sold it after a decent move higher. With hindsight, i should have simply held my position. And been adding to it on weakness. 
 

Now there is another situation… and i think this is what you are getting at… i am going to make up some number. What if you backed up the truck with Fairfax a year ago and made it 33% of your total portfolio. Concentrated, but not a crazy number. Today, Fairfax might now be 50% of your total portfolio. At what point does it get too big?

 

I’m a big believer in the ‘sleep well at night’ rule of position sizing (that you reference). If your weighting is keeping you up at night, that is telling you something. I suspect there are a few people on this board in this boat. Yes, great problem to have. 
 

Another way to look at it might on a risk / return adjusted basis:

- What do you think Fairfax is going to return over the next couple of years?

- What will the index averages return over the next couple of years?

- What is the chance something is going to happen to materially impact Fairfax’s valuation (a 30% or more permanent drawdown) over the next couple of years? 
 

My view is you only want to be highly concentrated if the opportunity is materially better than putting the money in a broad based market index (you expect 1.5x or better outperformance). But you have to be wired the right way for this to work (to hold a very concentrated position).
 

My guess is quite a few Berkshire Hathaway shareholders have achieved generational wealth holding the stock for decades. What did these shareholders do when confronted with the same question? My guess is the ones who built the greatest fortunes didn’t sell a share. 

Edited January 26, 2024 by Viking

[LC]

4 minutes ago, Viking said:

I would love to hear other board members thoughts: how do you handle position sizing? Especially when the winning/oversized position is likely just getting started?

 

I trimmed <3.3% of my FFH a week ago thinking:

OK this is getting a big chunk of the portfolio now,

So let's take some eenie-meenie little profits,

And given FFH's volatility maybe I can buy it back in a few days/week.

 

That was $60 dollars per share ago. I can't help but get in my own way sometimes. That said the position is still close to 40% weighted. 

 

Quote

Everything else is expensive now...

 

Luca, haven't I seen you posting in the "What are you buying" thread on a very regular basis?

[Luke]

7 minutes ago, LC said:

Luca, haven't I seen you posting in the "What are you buying" thread on a very regular basis?

Ok, I still find some value in China but i am already very overweight, and yeah then cloning pabrai with coal...still i find it hard to find sth where i could put fairfax money where it is AS well invested as with FFH

[SafetyinNumbers]

3 hours ago, Luca said:

On what does FFH inclusion in the TSX 60 depend? 

There is a committee (4 people from S&P & 3 from TMX) that decides. Generally the TSX 60 (XIU) tries to mimic the sector weights of the TSX Composite (XIC) while also trying to beat it. Historically, they have replaced components when they go under 20bp but I don’t think it’s a rule. 
 

Financials are already overweight in XIU vs XIC so that might make the hurdle higher for FFH to get in. IFC took a long time to go in for that very reason. When IFC was announced in to XIU in March 2022, its weight at the end of Feb was 104bp and it was the 25th biggest company in the XIC. It was almost inevitable that IFC was going to get into XIU given its above average growth. Now its weight is ~124bp and it’s the 20th biggest weight in the XIU. They would have been better off putting it in sooner.

 

I would argue FFH is a good analog for what happened with IFC. Given the high certainty of near term earnings, FFH’s weight in XIC is only going to increase. Today, I estimate, it jumped from 29th to 27th biggest passing GIB and TRI. Its weight is probably close to 101bp. At the end of 2022, FFH was #41 and 65bp. It’s like a freight train and if the committee can see that, they may want to get it in soon so they don’t lose ground to XIC.
 

I estimate, AQN is only ~21bp in XIU after today’s trading so it’s flirting with the historical replacement precedent of 20bp. Please correct me if I’m wrong but I believe they will use Feb 29 as the measurement date. Presumably, it will be a live every quarter going forward or if a member of XIU is acquired. Recently ABX was rumoured to be interested in FM. If that transaction was consummated, it would open up a spot for FFH as well. 
 

Of course, they could always skip FFH and go to TFII but it’s less than half the weight. 
 

The biggest impact of Scotia and now NBF socializing the idea of FFH going in XIU is that shareholders who really want to take profits for risk management or because they are afraid of a drawdown might hold on instead. This is important, because most buying is institutional and it’s usually done on a % of volume. It’s a constraint placed by investors on asset managers to protect against them manipulating share prices.

 

The side effect of that is, sellers set the price. Knowing there is likely a significant amount of buying coming sometime in the next year at a time when the company is growing incredibly fast might decide to at least lift their offers. Some shareholders might even hold on and see if they can get a better price when there is an indiscriminate time constrained buyer and reported BV is likely somewhat higher. 
 

The float in FFH is relatively tight and underowned by Canadian institutions who are benchmarked to XIC. If shareholders start believing what NBF is telling them, the multiple expansion could be significant. P/B could get out of hand.
 

It’s happened before from 95-98, a period when FFH put up 20%+ ROE for 4 years in a row. Maybe 2023 was year 1. P/B went over 3 back then before coming back to earth. It seems more likely to happen in this kind of market (meme stocks etc..) but it might take analysts starting to believe FFH can grow earnings consistently as some quants also set prices. Morningstar coming around would be a huge signal. I don’t expect that to happen but it’s possible. 

 

 

 

[Tommm50]

Yeah, I'm hugely over-weighted in Fairfax. I've owned it for over twenty years. It's finally moving as I knew it eventually would. I was waiting for it to crack $1,000 U.S. to pull some of the investment into treasuries. Today it did. My plan is to wait for the year end results and start to siphon money out. Having said that I will keep a large position because I think the market is just starting to catch on and it has a long way to run yet.

 

I believe Buffett once said "If you want to make a fortune, concentrate. If you want to keep a fortune, diversify."

[Viking]

5 minutes ago, SafetyinNumbers said:

There is a committee (4 people from S&P & 3 from TMX) that decides. Generally the TSX 60 (XIU) tries to mimic the sector weights of the TSX Composite (XIC) while also trying to beat it. Historically, they have replaced components when they go under 20bp but I don’t think it’s a rule. 
 

Financials are already overweight in XIU vs XIC so that might make the hurdle higher for FFH to get in. IFC took a long time to go in for that very reason. When IFC was announced in to XIU in March 2022, its weight at the end of Feb was 104bp and it was the 25th biggest company in the XIC. It was almost inevitable that IFC was going to get into XIU given its above average growth. Now its weight is ~124bp and it’s the 20th biggest weight in the XIU. They would have been better off putting it in sooner.

 

I would argue FFH is a good analog for what happened with IFC. Given the high certainty of near term earnings, FFH’s weight in XIC is only going to increase. Today, I estimate, it jumped from 29th to 27th biggest passing GIB and TRI. Its weight is probably close to 101bp. At the end of 2022, FFH was #41 and 65bp. It’s like a freight train and if the committee can see that, they may want to get it in soon so they don’t lose ground to XIC.
 

I estimate, AQN is only ~21bp in XIU after today’s trading so it’s flirting with the historical replacement precedent of 20bp. Please correct me if I’m wrong but I believe they will use Feb 29 as the measurement date. Presumably, it will be a live every quarter going forward or if a member of XIU is acquired. Recently ABX was rumoured to be interested in FM. If that transaction was consummated, it would open up a spot for FFH as well. 
 

Of course, they could always skip FFH and go to TFII but it’s less than half the weight. 
 

The biggest impact of Scotia and now NBF socializing the idea of FFH going in XIU is that shareholders who really want to take profits for risk management or because they are afraid of a drawdown might hold on instead. This is important, because most buying is institutional and it’s usually done on a % of volume. It’s a constraint placed by investors on asset managers to protect against them manipulating share prices.

 

The side effect of that is, sellers set the price. Knowing there is likely a significant amount of buying coming sometime in the next year at a time when the company is growing incredibly fast might decide to at least lift their offers. Some shareholders might even hold on and see if they can get a better price when there is an indiscriminate time constrained buyer and reported BV is likely somewhat higher. 
 

The float in FFH is relatively tight and underowned by Canadian institutions who are benchmarked to XIC. If shareholders start believing what NBF is telling them, the multiple expansion could be significant. P/B could get out of hand.
 

It’s happened before from 95-98, a period when FFH put up 20%+ ROE for 4 years in a row. Maybe 2023 was year 1. P/B went over 3 back then before coming back to earth. It seems more likely to happen in this kind of market (meme stocks etc..) but it might take analysts starting to believe FFH can grow earnings consistently as some quants also set prices. Morningstar coming around would be a huge signal. I don’t expect that to happen but it’s possible. 

@SafetyinNumbers that was very informative. Thank you for taking the time to lay it out in some detail. What if investors decide Fairfax is a buy and hold type of stock again? And not just a trade? When i read reports like National Bank (well done) i think we are getting to a sentiment inflection point. We will see. Fairfax’s AGM this year is setting up to be quite the event. 

[Blugolds]

Logged into my Fidelity account and saw something at the top of the screen telling me that I am eligible for additional income by lending shares of a security. Happened to be Fairfax…Anyone else see this? 

 

I didnt enroll, but have never seen that before….thoughts? Not necessarily as to if I should, but why they are doing it? Due to daily volume? 

 

 

 

[Dinar]

8 minutes ago, Blugolds11 said:

Logged into my Fidelity account and saw something at the top of the screen telling me that I am eligible for additional income by lending shares of a security. Happened to be Fairfax…Anyone else see this? 

 

I didnt enroll, but have never seen that before….thoughts? Not necessarily as to if I should, but why they are doing it? Due to daily volume? 

 

 

 

I have seen it many times.  I never enrolled for regular accounts because of adverse tax treatment, but may make sense for IRAs.  IBKR tried to get me enrolled, but they promised 5 basis points a year in lending income, so I passed

[Parsad]

2 hours ago, Dinar said:

I have seen it many times.  I never enrolled for regular accounts because of adverse tax treatment, but may make sense for IRAs.  IBKR tried to get me enrolled, but they promised 5 basis points a year in lending income, so I passed

 

That's pretty low interest, so the short demand is not that high.  I remember seeing offers of 15-18% for OSTK shares when they were being shorted intensely.  I'm pretty sure when the hedgies were attacking Fairfax back in 2003, brokers were offering double digit interest then too.  Cheers!

[Viking]

How does an investor make the big money?

 

To state the obvious, outperforming the market averages is very difficult. Especially over a longer timeframe like 10 or 20 years. So why manage your own investments? Investors usually do it for the opportunity to make the big money - to materially outperform the market averages.

 

How can an investor do that? That is what we are going to explore in this post.

 

The post has been broken into the following sections:

 

1.) Learning from the master: how did Buffett do it?

2.) Time, compounding and exponential growth

3.) What do investors actually do?

4.) How to make the big money

5.) Berkshire Hathaway shareholders - a special breed?

6.) Fairfax Financial

 

—————

Warren Buffett - Berkshire Hathaway 2022AR

 

“In 58 years of Berkshire management, most of my capital-allocation decisions have been no better than so-so…

 

“Our satisfactory results have been the product of about a dozen truly good decisions – that would be about one every five years.

 

“The lesson for investors: The weeds wither away in significance as the flowers bloom. Over time, it takes just a few winners to work wonders. And, yes, it helps to start early and live into your 90s as well.”

—————

 

Part 1: Learning from the master: How did Buffett do it?

 

Warren Buffett has been able to significantly outperform the market averages since 1965. Over the past 58 years (to YE 2022), Berkshire Hathaway stock has had a CAGR of 19.8%, which is about 2 times the CAGR of the S&P 500 of 9.9% (including dividends). Yes, Buffett has earned ‘big money’ for Berkshire Hathaway shareholders.

 

 

But here is what is really interesting. Buffett readily admits most of his capital allocation decisions over this 58-year time period were ‘so-so.’

 

He goes on to explain that his significant outperformance was driven by a small number of ’truly good decisions’. Buffett puts the number at 12, or one about every 5 years.

 

This looks like it could be important. Let’s explore this further.

 

What is Warren Buffett’s greatest attribute?

 

Yes, this is kind of  dumb thing to ask. Let’s do it anyway. What is it about Warren Buffett that has allowed him to consistently generate such outstanding results over the past 58 years?

• Intellect?
• Work ethic?
• Thirst for knowledge?
• Temperament?
• Character?
• Self awareness?
• Management skills?

Obviously, all of the above attributes are important and will help investors achieve success. But lots of investors have many of these attributes - and yet they still underperform the market averages over time (let alone outperform to the degree that Buffett did).

 

Is there something else, not listed above, that perhaps explains Buffett’s significant outperformance?

 

I think there is something else…

 

I think Buffett’s greatest strength might be his patience.

 

Before you throw your phone/tablet in disgust, let me explain. We need to peel the layers back.

 

Buffett’s holding period is not months. Or years. For his ‘truly good decisions,’ the investments that become needle movers for Berkshire Hathaway, his holding period can be measured in decades. And that is very different from almost any other investor out there. That is something Buffett does than pretty much no one else does. (Please name another successful investor who did it this way… i can’t think of another one.)

 

After patience, i think Buffett’s next greatest strength might be how he sizes his positions, especially his best ideas. And not just at the time of purchase - but also over time. How to size a position is exceptionally difficult to do and is a topic that requires its own post - so we will not explore it further here.

 

There are a couple of lessons here.

1. Really, really good investment opportunities are exceptionally rare. Over his lifetime, Buffett points to 12 that worked out for him - or one about every 5 years.
2. But finding a great investment is not enough on its own. Great patience is also required. It can take a decade or more for some investments to fully bloom.

Of the two skills (finding a great investment and having great patience with it) the second is the one that is incredibly rare today.

 

Part 2: Time, compounding and exponential growth

 

What is the greatest advantage of an investor?

 

It is time.

 

Why time?

 

Time is what allows compounding to work its magic.

 

Compounding is simple to explain but wicked difficult for most people to actually understand. I like the description below. It is ‘boring’ for years and then very ‘exciting’.

 

Given enough time, compounding inevitably results in exponential growth. Or at least the is what one would think. More on this later.

 

The goal of all investors is to get their portfolio to the ‘exciting’ part of compounding curve (the hockey stick part) - because it is life changing when it happens.

 

Buffett’s genius?

 

It is understanding that patience and time are two sides of the same coin. Together, they allow an investor to fully maximize the benefits of compounding. This in turn, can lead to exponential growth.

 

Patience: this is how the big money is made.

 

Compound Interest (drawing by Carl Richards)

 

 

—————

 

Let’s take a quick trip into the archives

 

One of my favourite all time books on investing is Reminiscences of a Stock Operator. It was first published all the way back in 1923 (in serial form over two years in The Saturday Evening Post).

 

Of all the memorable quotes in this book the following might be my favourite:

 

“And right here let me say one thing: After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight! It is no trick at all to be right on the market. You always find lots of early bulls in bull markets and early bears in bear markets. I've known many men who were right at exactly the right time, and began buying or selling stocks when prices were at the very level which should show the greatest profit. And their experience invariably matched mine - that is, they made no real money out of it. Men who can both be right and sit tight are uncommon. I found it one of the hardest things to learn. But it is only after a stock operator has firmly grasped this that he can make big money…” 

 

The lesson: Finding a great investment is hard. Holding the investment for years, perhaps decades - that is much more difficult. Should we be surprised that Buffett is in a league of his own?

 

—————

 

Part 3: What do investors actually do?

 

“Selling your winners and holding your losers is like cutting the flowers and watering the weeds.” Peter Lynch.

 

Warren Buffett liked this quote so much he contacted Peter Lynch and asked him if he could use it.

 

What is the average holding period for retail investors?

 

I think it is around 5.5 months. And falling over time.

 

Retail investors are like Edward Scissorhands. The flowers in their garden don’t stand a chance.

 

Actually, we probably need to update Peter Lynch’s quote: these days, retail investors are so active buying and selling stocks in their portfolio - it’s like they completely raze their garden every year or two. What’s the chance the flowers are getting cut? Probably 100%. Should we be surprised that most retail investors achieve such poor results over time?

 

What about the professional/smart money?

 

The performance of professional/smart money is measured by investors quarterly… so they can’t be patient with their holdings. Sub-par results over a couple of quarters and retail investors start to pull the plug. The professional/smart money has to chase short-term performance if they want to stay in business (or get paid their bonus) - which usually means owning whatever are the most popular stocks at a given time (the list of which is always changing).

 

The bottom line, ‘patience’ is not a word that is part of retail and professional investors vocabulary or in their toolbox.

 

Patience is primarily the stomach part of investing. Not the brain part. This also probably tells us something…

 

Ben Carlson has a good article on the subject of holding period

 

Buy & Hold is Dead, Long Live Buy & Hold (Feb 2023)

• https://awealthofcommonsense.com/2023/02/buy-hold-is-dead-long-live-buy-hold/

 

(As an aside, ‘The Compound’ has become one of my favourite podcasts to listen to. Ben, Josh, Michael and guests are great. They have a bunch of different formats depending on what you are interested in.)

 

Taking profits

 

Why do retail investors turn their portfolio over so much? Lot’s of reasons. To buy something they think is better. To get rid of a mistake. To try and time the market. Macro call. Hot tip. I could list another +20 ‘good’ reasons.

 

Let’s be optimistic. We are told taking profits is a sensible thing to do. Yes?

 

But remember, in this post, we are trying to learn how to make the big money.

 

Here is another great quote from the book ‘Reminiscences of a Stock Operator’:

 

“They say you never grow poor taking profits. No. you don’t. But neither do you grow rich taking a four point profit in a bull market.”

 

When investors sell their best ideas they are cutting the flowers in their portfolio. And because the really good ideas (that actually work out) are exceptionally rare (Buffett found one about every 5 years), the proceeds are recycled back into inferior ideas - investors water their weeds.

 

This is like throwing sand in the gears of the compounding machine we discussed earlier. And hurts investment results. Investors get stuck in the ‘boring’ stage (from the napkin drawing above). As a result, many investors never get to the ‘exciting’ stage - the hockey stick part of compounding that becomes life changing.

 

What does the investment industry have to say on this topic? I find it is helpful to follow the money. Incentives matter. A lot. How does everyone in the industry get paid? Fees. And fees generally come from activity. Action. Churn. Chasing short term performance. The exact opposite of patience.

 

Part 4: How to make the big money

 

Buffett’s very simple model:

• Step 1: identify a ‘truly good’ investment and size the position appropriately.
• Step 2: exercise great patience and let it grow undisturbed for decades.

Truly great investments (the needle movers) are exceedingly rare. When you discover one, you need to size it appropriately. And then you hang on to it. For a long, long time.

 

Do we have any real-life examples of ‘patience’ actually working out for a retail investor?

 

Yes. A company named Berkshire Hathaway.

 

Part 5: Berkshire Hathaway shareholders - a special breed?

 

Investors have known for decades that Berkshire Hathaway was run by one of the best capital allocators of all time. All an investor had to do was buy shares and watch the Buffett flower continue to bloom year after year… bigger, brighter and more beautiful.

 

Importantly, investors had years to watch (learn) and get their position sized right.

 

How many investors followed Berkshire Hathaway over the decades? Lots.

 

How many investors never bought shares? Lots.

 

How many investors bought shares and then sold them after a small gain? Lots.

 

How many investors bought shares and then held them for a decade or longer? Very few. But the few who did so built great wealth over time. These investors exercised great patience - and were richly rewarded.

 

These investors had a ‘truly great idea’ - buy Berkshire Hathaway stock. But their real genius - what separated them (and their returns) from all other investors - was their patience. They held the stock for the long-term.

 

Why didn’t these investors sell out? That is a great question. I don’t know. Because I sold my Berkshire Hathaway every time i ever owned it (after what i thought was a nice gain). With hindsight, i was an idiot. I was happy making a small profit. And i completely missed the big move - when it was staring me right in the face.

 

So what does all of this have to do with Fairfax? Maybe nothing. Maybe everything.

 

Part 6: Fairfax Financial

 

Similar to Berkshire Hathaway, Fairfax has an outstanding long-term track record. Fairfax has significantly outperformed the S&P 500 over the past 38 years (since the company was founded in 1985).

 

 

However, unlike Berkshire Hathaway, Fairfax had a pretty big stumble from about 2010-2017. The investing side of the business messed up (the insurance side of the business continued to perform well). Business results suffered. However, from about 2016 to 2020 the company got to work correcting its past mistakes. By 2021, the turnaround was largely complete.

 

Operating income has increased from a run rate of $1 billion/year from 2016-2020, to $1.8 billion in 2021, to $3.1 billion in 2022, to an estimated $4.4 billion in 2023. And it is poised to increase again in 2024 (my current estimate is $4.6 billion).

 

Since around 2018, Fairfax’s capital allocation decisions have been very good - best-in-class among P/C insurers. I have written about this extensively in other posts so i am not going to rehash things here.

 

Bottom line, the set-up at Fairfax today - with both insurance and investment businesses - has never looked better.

 

Now i generally hate comparing Fairfax with Berkshire Hathaway because they are such different companies. But i am going to break my rule in this post.

 

Here is what i am wondering - and i would love to hear your thoughts.

 

Does Fairfax today look like a much younger Berkshire Hathaway?

 

Here are some of the similarities i see between Fairfax today and a Berkshire Hathaway from 30 years ago:

1. Business model: built squarely on the P/C insurance / float model (Berkshire Hathaway has more of a conglomerate business model today)
2. Capital allocation: master capital allocator (Fairfax has been hitting the ball out of the park in this regard since 2018 - that is a pretty good timeframe to use to evaluate the current management team)
3. Significant, sustainable earnings: current estimates have Fairfax earning a record of more than $4 billion in 2023. And the future outlook is promising.
4. Size: Fairfax is still small in size - good capital allocation decisions move the needle in terms of financial results (earnings and book value growth)
5. All of the above + the power of compounding = opportunity for exponential growth over the next decade. ‘Time is the friend of the wonderful business’ to quote Warren Buffett.
6. Valuation: Fairfax’s stock is trading today at a very low valuation - both compared to P/C insurance peers and the overall stock market.

The set up today for Fairfax looks - to me - an awful lot like a much younger Berkshire Hathaway. Fairfax is poised to become a compounding machine in the coming years. If that happens, Fairfax would become what Buffett would call a ‘truly good decision’ for investors.

 

Is Fairfax, once again, a buy and hold type of stock?

 

I am warming to this idea. I think 5 years is a good amount of time to evaluate a management team - and the team at Fairfax has done an exceptional job over the past 5 years. This topic is important - let’s give it the attention it deserves in a future post.

 

—————

Full quote by Warren Buffett from Berkshire Hathaway 2022AR

 

“At this point, a report card from me is appropriate: In 58 years of Berkshire management, most of my capital-allocation decisions have been no better than so-so. In some cases, also, bad moves by me have been rescued by very large doses of luck. (Remember our escapes from near-disasters at USAir and Salomon? I certainly do.)

 

“Our satisfactory results have been the product of about a dozen truly good decisions – that would be about one every five years – and a sometimes-forgotten advantage that favors long-term investors such as Berkshire. Let’s take a peek behind the curtain.

 

The Secret Sauce

 

“In August 1994 – yes, 1994 – Berkshire completed its seven-year purchase of the 400 million shares of Coca-Cola we now own. The total cost was $1.3 billion – then a very meaningful sum at Berkshire.

 

“The cash dividend we received from Coke in 1994 was $75 million. By 2022, the dividend had increased to $704 million. Growth occurred every year, just as certain as birthdays. All Charlie and I were required to do was cash Coke’s quarterly dividend checks. We expect that those checks are highly likely to grow.

 

“American Express is much the same story. Berkshire’s purchases of Amex were essentially completed in 1995 and, coincidentally, also cost $1.3 billion. Annual dividends received from this investment have grown from $41 million to $302 million. Those checks, too, seem highly likely to increase.

 

“These dividend gains, though pleasing, are far from spectacular. But they bring with them important gains in stock prices. At yearend, our Coke investment was valued at $25 billion while Amex was recorded at $22 billion. Each holding now accounts for roughly 5% of Berkshire’s net worth, akin to its weighting long ago.

 

“Assume, for a moment, I had made a similarly-sized investment mistake in the 1990s, one that flat-lined and simply retained its $1.3 billion value in 2022. (An example would be a high-grade 30-year bond.) That disappointing investment would now represent an insignificant 0.3% of Berkshire’s net worth and would be delivering to us an unchanged $80 million or so of annual income.

 

“The lesson for investors: The weeds wither away in significance as the flowers bloom. Over time, it takes just a few winners to work wonders. And, yes, it helps to start early and live into your 90s as well.”

Edited January 27, 2024 by Viking

[LC]

So interestingly enough the below article hit my inbox this morning:

https://specialsituationinvesting.substack.com/p/focus-and-investing?publication_id=903552&utm_campaign=email-post-title&r=1kl6gs

 

The author looked at some

of WB’s early partnership trading/investing behavior. His conclusion is not all too different than what you describe above, Viking. What really stood out to me was WB’s aggressiveness in minimizing opportunity cost:

 

Buffett focused completely on finding the next great opportunity and moving into it in as big a way as possible without regard for systems. He identified opportunities by spending the limited time he had studying what was knowable and important while largely ignoring the rest. He formulated a clear idea of intrinsic value in his mind and then refused to overpay. He then used opportunity cost as a framework to constantly move capital from his worst ideas into his best such that he could maximize his returns.

 

A lot of people (myself included) think concentration is 5 equally weighted positions. To Buffet I’d imagine that is 20% your best idea, and 80% worse ideas. So yes you are concentrated- but in sub-optimal ideas!

Anyways I think between the article and your post it provides a good spectrum of how WB achieved massive wealth and some points take away.

 

[cwericb]

Many Fairfax shareholders are now concerned about FFH being overweight in their portfolios. Obviously the reason we are overweight is primarily due to the excellent performance of the share price.

 

Unless one believes Fairfax shares are going to suddenly reverse direction, being overweight is not necessarily a bad thing. I have owned shares in Fairfax for 17 years, not sold a share and added over time.

 

Looking back over the years, yes there have been periods when the market surged and FFH shares did not. But people tend to forget that there were also quite a few periods when the market nosedived while FFH shares surged or maintained their value, and that often helped me sleep at night.

 

I am just a dumb average joe and by no means a sophisticated investor. Had I traded in and out of Fairfax over the years, there is no way I would have been able to predict when to have bought and sold to my advantage.

 

So for me at least, I am not going to sell my shares simply because the company is doing so well.

 

JMHO