Maverick47 Posted January 28, 2024 Posted January 28, 2024 13 hours ago, Viking said: I think Buffett’s greatest strength might be his patience. Viking — Thanks so much for sharing your thoughts in this latest post. And I think it dovetails well with musings of others regarding how large a position Fairfax should make of one’s portfolio. Temperament/patience are areas where small individual investors might well have an advantage over professional traders/portfolio managers. Fifteen years ago when I had a much smaller non retirement portfolio, I made the mistake of treating my investments as if they were bets in a casino. When two of my small investments began to perform well I sold off half when they had doubled, telling myself I was now “playing” with house money. I did keep the half stakes — one has turned into a 10 bagger after 15 years, while the other is a 14 bagger. But neither decision would have made a material difference to me now since the initial amounts were rather small. I would only be concerned personally with Fairfax or other investments making up a large portion of my current portfolio if I believed there was a reasonable chance it might go to zero, like Enron. Part of Prem’s history makes me think that is unlikely. The struggles against short sellers when he faced a concerted attack betting that the company would go to zero or thereabouts in the early 2000’s had the benefit for me now, I believe, of making Prem more cautious about a financial situation that would ever put the company in such a position again. I think he and his investment folks really hit the ball out of the park with their credit default swaps at the time of the 2008 financial crisis. The profits on that allowed them to buy back the portions of their subsidiaries that they had to sell off to make it through the short selling attacks (was that both Odyssey Re and Northbridge?). I only got into the stock myself around the 2010 time frame. Then the lesson they learned from that macro bet was that they should make another one (the lost years thereafter betting on deflation, and hedging their equity investments). I think you have laid out very well that the latest lesson they have learned is not to make such huge macro bets in the future, and for roughly the last 4 or 5 years their actions have matched what they have said in that regard. I think one sign that an insurance/investment platform company is taking the long view, allowing compounding to work its exponential magic, can be seen by examining whether they have a net deferred tax liability on their balance sheet or not. Those only get built up with years of unrealized capital gains, generally on equity investments. It takes a lot of patience and a long term view on the part of a CEO to do this. The power of compounding of this deferred tax liability only makes a material difference after about 25 or 30 years. Berkshire is a shining example of this — basically they are allowing an interest free loan of well over $10 billion from the government compound on behalf of their owners. Companies with net deferred tax assets are actually doing the reverse — making an interest free loan to the government. Fairfax has a net deferred tax liability of about $1 billion. Other US companies with net deferred tax liabilities are Markel and Cincinnati Financial, which is why I have some positions in those companies as well. I like companies that make decisions that pay off over the same long term that I have in mind for my retirement time frame of 30 years or so, and that’s what I see in all of these companies.
Viking Posted January 28, 2024 Posted January 28, 2024 21 minutes ago, Maverick47 said: Viking — Thanks so much for sharing your thoughts in this latest post. And I think it dovetails well with musings of others regarding how large a position Fairfax should make of one’s portfolio. Temperament/patience are areas where small individual investors might well have an advantage over professional traders/portfolio managers. Fifteen years ago when I had a much smaller non retirement portfolio, I made the mistake of treating my investments as if they were bets in a casino. When two of my small investments began to perform well I sold off half when they had doubled, telling myself I was now “playing” with house money. I did keep the half stakes — one has turned into a 10 bagger after 15 years, while the other is a 14 bagger. But neither decision would have made a material difference to me now since the initial amounts were rather small. I would only be concerned personally with Fairfax or other investments making up a large portion of my current portfolio if I believed there was a reasonable chance it might go to zero, like Enron. Part of Prem’s history makes me think that is unlikely. The struggles against short sellers when he faced a concerted attack betting that the company would go to zero or thereabouts in the early 2000’s had the benefit for me now, I believe, of making Prem more cautious about a financial situation that would ever put the company in such a position again. I think he and his investment folks really hit the ball out of the park with their credit default swaps at the time of the 2008 financial crisis. The profits on that allowed them to buy back the portions of their subsidiaries that they had to sell off to make it through the short selling attacks (was that both Odyssey Re and Northbridge?). I only got into the stock myself around the 2010 time frame. Then the lesson they learned from that macro bet was that they should make another one (the lost years thereafter betting on deflation, and hedging their equity investments). I think you have laid out very well that the latest lesson they have learned is not to make such huge macro bets in the future, and for roughly the last 4 or 5 years their actions have matched what they have said in that regard. I think one sign that an insurance/investment platform company is taking the long view, allowing compounding to work its exponential magic, can be seen by examining whether they have a net deferred tax liability on their balance sheet or not. Those only get built up with years of unrealized capital gains, generally on equity investments. It takes a lot of patience and a long term view on the part of a CEO to do this. The power of compounding of this deferred tax liability only makes a material difference after about 25 or 30 years. Berkshire is a shining example of this — basically they are allowing an interest free loan of well over $10 billion from the government compound on behalf of their owners. Companies with net deferred tax assets are actually doing the reverse — making an interest free loan to the government. Fairfax has a net deferred tax liability of about $1 billion. Other US companies with net deferred tax liabilities are Markel and Cincinnati Financial, which is why I have some positions in those companies as well. I like companies that make decisions that pay off over the same long term that I have in mind for my retirement time frame of 30 years or so, and that’s what I see in all of these companies. @Maverick47 i always appreciate your comments. You have areas of expertise that are different from mine. Thank you for sharing your thoughts on the tax liability. I will file that away. I think there is merit to your comments about Fairfax going through adversity. And learning the right lesson on the other side. I agree with you - Fairfax has been making much better decisions in recent years - i put it at about 6 years (since about 2018). It looks to me like Fairfax has been slowly improving the quality of their businesses over the years. - insurance seems to have always been moving in that direction since Andy Barnard took over in 2011. I liked the sale of Riverstone UK (runoff) in 2020/21 although it appeared to be well run. More recently, Fairfax has talked about how they have reduced property cat exposure at Brit (who had been underperforming in recent years). - equities is where you can really see the improvement in quality the last 5 years. Having higher quality insurance and equity holdings should also provide some buffer should adversity strike. ————— I continue to believe that something changed internally at Fairfax around late 2017 or early 2018 with how they were managing the equity bucket at Hamblin Watsa. It’s almost like someone very senior said ‘enough of this bullshit’. And from that day equity holdings were told: 1.) they had to stand on their own two feet financially. Fairfax hold co was no longer going to be piggy bank for poorly run operations 2.) they had to run themselves. Fairfax HO did not have the resources to be a turnaround shop. Two other things were decided: 1.) New money would only go to the best opportunities. 2.) New equity purchases must have very strong CEO’s/management/leadership. The amount of (good) change that has happened at Fairfax since 2018 has been breathtaking. The quality of the equity holdings (looked at as a group) has improved dramatically. And i don't think Fairfax is done.
Viking Posted January 28, 2024 Posted January 28, 2024 (edited) Capital Allocation - Is the Management Team at Fairfax Best-In-Class? Of all the posts that I have done on Fairfax over the past year, this one on capital allocation is the most important. Below is an update with some new material. My view is over the past 6 years, the management team at Fairfax has delivered best-in-class results. Do you agree? Please share your thoughts. ————— Capital allocation is the most important responsibility of a management team. Why? Capital allocation decisions are what drive the long-term performance of a company and important metrics like reported earnings, growth in book value and return on equity. These metrics in turn drive the multiple given to the stock by Mr Market - and finally the share price and investment returns for shareholders. Capital allocation is especially important for P/C insurance companies. And that is because of something called float – which provides low cost (sometimes free) leverage (see Chapter 4 of my PDF called ‘Fairfax-Hiding in Plain Sight’ for more information on float). https://thecobf.com/forum/topic/20253-fairfax-financial-60-of-the-best-posts-all-in-one-document/#comment-526661 When done well, capital allocation does two important things: Delivers a solid return. Improves the quality of the business. Therefore, the fundamental task of an investor is to determine if management, over time, is making intelligent decisions regarding capital allocation. What is capital allocation? Capital allocation is the process of determining how capital is raised, managed and disbursed by a company. Capital allocation decisions often play out with a lag, sometimes years in length. Recognizing this, an investor needs to take a multi-year approach with their analysis. What are the sources of capital for Fairfax? Fairfax has three sources of capital: equity, debt and float. The largest bucket is its $31 billion in float (as of Dec 31, 2022) which has a cost of less than zero - because they earn an underwriting profit (over the past 10 years they have averaged a CR of 95.6%). Fairfax also utilizes some debt, which has an average cost of about 5%. All together Fairfax has total capital of about $58.1 billion working for shareholders, or about $2,500/share. This capital has been obtained at a very low average cost. How does Fairfax do capital allocation? Internal capabilities: Capital allocation at Fairfax is managed by the senior leadership team, led by CEO Prem Watsa. Insurance: Since 2011, the insurance business has been led by Andy Barnard. In early 2023, Brian Young was promoted and now shares oversight responsibilities with Andy Barnard over all of Fairfax’s insurance and reinsurance operations. Brian is also still CEO of Odyssey. Investments: The investment business is managed by the large team at Hamblin Watsa. The fixed income team is led by Brian Bradstreet, who has been with Fairfax from the beginning. The equities team is led by Wade Burton, who joined Fairfax in 2009 from fund manager Cundill Investments, and Lawrence Chin, who also joined from Cundill in 2016. In India, Fairfax has Fairbridge, a boots-on-the-ground investment team. Fairfax also leverages the knowledge of the many CEO’s who manage their vast collection of equity holdings across the globe. “Since 1985, investments have been centrally managed for all of the Fairfax group companies by Hamblin Watsa Investment Counsel Ltd. (www.hwic.ca), a wholly-owned subsidiary of Fairfax. Hamblin Watsa emphasizes a conservative value investment philosophy, seeking to invest assets on a total return basis, which includes realized and unrealized gains over the long-term.” Fairfax web site Fairfax has a large internal team with expertise across many different asset classes and geographies. They are a long-tenured group with experience managing through many different market cycles. They are also a battle tested team. They have established a strong long-term track record of success. Below is a slide from the AGM (April 2023) that summarizes Fairfax’s internal investment team. External capabilities: Fairfax has been actively cultivating relationships with a large network of individuals/companies in the investment world for decades. The company has established partnerships and expertise across many different asset classes (real estate, private equity, commodities) and geographies (India, Greece, Africa, the Middle East). These external partnerships have been an important source of ideas and diversification while also delivering solid returns to Fairfax over the years. This important external capability allows Fairfax to leverage the knowledge and skills of a much larger group of people and organizations. Summary: Over decades, Fairfax has built out a large team and network of highly skilled internal and external capital allocators. In a world where active management is back, this has become a significant competitive advantage. Fairfax is well positioned at exactly the right time. In general, what are the basic capital allocation options available to management? Reinvest in the business - grow organically: support the slow and steady growth of existing operations. Acquisitions/mergers - higher risk, but can be transformative. Asset sales - lower risk, opportunity to take advantage of Mr Market’s mood swings. Pay down debt: the most predictable option, as the cost of repaid debt is known. Pay dividends: although tax-inefficient, usually indicates a financially healthy, shareholder-friendly company. Share buybacks: impactful, if purchased below intrinsic value, by improving per-share financial metrics like earnings per share and book value per share. What has Fairfax done? The management team at Fairfax has been extremely active on the capital allocation front. Every year they typically make between five to ten meaningful decisions. So much has been happening on the capital allocation front in recent years it is hard for shareholders to keep up - especially understanding the impact on current and future business results. Below we are going to take a quick look at 16 of Fairfax’s bigger decisions made in recent years to see what we can learn. Reinvest in the business: 1.) 2019-2023, hard market in insurance. Net premiums written have increased 79% over the past four years from $13.3 million in 2019 to an estimated $23.7 million in 2023, a CAGR of 15.5% per year. Fairfax is poised to deliver an estimated record underwriting profit of $1.37 billion in 2023 (CR of 94%). 2.) In 2017, seeded start-up Go Digit in India at a cost of $154 million and a fair value today of $2.3 billion. This investment has turned into a home run, with a possible IPO coming in 2024 (bringing more potential gains). Acquisitions/sales: insurance: 3.) In 2017, purchased Allied World, with the help of minority partners, for $4.9 billion (at 1.3 x book value). The price paid was not an overpay. Net written premiums have increased from $2.37 billion in 2018 to $4.46 billion in 2022, an increase of 88% in 4 years. With the onset of hard market in 2019, the timing of this purchase was perfect. 4.) In 2017/2019, sold ICICI Lombard for $1.7 billion: realized a $1 billion pre-tax investment gain. Due to regulations in India, Fairfax had to sell down its position in ICICI Lombard to be able to invest in Digit. This action was a brilliant strategic shift of Fairfax’s insurance business in India. 5.) In 2020/2021, sold Riverstone UK (runoff) for $1.3 billion (plus $236 million CVI). At a time when they needed the cash, Fairfax sold their UK run-off business at a much higher price than expected at the time. By shrinking the size of the runoff group, this sale also improved the overall quality of the remaining P/C insurance businesses. 6.) In 2022, sold the pet insurance business to JAB Holding Co. for $1.4 billion. This action resulted in a $1 billion after-tax gain. This sale was a home run for Fairfax as the business was sold for a much higher price than anyone thought possible (most people didn’t even know Fairfax owned this business). 7.) In 2023, purchased KIPCO’s 46% stake in Gulf Insurance Group for $740 million fair value consideration, as it is payable over 4 years. Fairfax paid a premium to get a control position in a quality business. This is a great strategic purchase that will solidify Fairfax’s presence in MENA region for insurance. This deal closed in late December 2023. Acquisitions/sales: investments: 8.) In 2018, made initial investment in Poseidon/Atlas/Seaspan. Fairfax partnered with David Sokol (formerly Buffett’s heir apparent at Berkshire). Today Fairfax owns a 45.5% stake in this company valued at $2 billion. Poseidon will see significant growth in 2024 as it takes delivery of a large number of container ships and completes the final leg of its multi-year new-build strategy. 9.) In late 2018, purchased 13% of Stelco for $193 million. Fairfax partnered with Alan Kestenbaum. This investment has already delivered more than $300 million in in total gains (as of Dec 31, 2023). Today, Fairfax now owns 23.6% of Stelco (having invested no new money). 10.) In 2020/21, initiated a total return swap position giving them exposure to 1.96 million FFH shares at an average cost of $372/share. With Fairfax’s stock closing at $1,013/share (Jan 26, 2024), this investment has already delivered a cumulative gain of about $1.26 billion (before carrying costs). This action was very creative and opportunistic and has become in three short years one of Fairfax’s best investments ever. 11.) In Dec 2021, reduced the average duration of its $37 billion bond portfolio to 1.2 years (as interest rates bottomed). This action saved the company billions in bond losses, protected the company’s balance sheet and allowed the insurance subs to be aggressive in growing their business in the hard market. 12.) In Oct 2023, increased the average duration of its $41 billion bond portfolio to 3.1 years (as interest rates were peaking). This locks in record interest income, currently running at about $2 billion annually, for the next 3 or 4 years. The string of decisions executed by the fixed income team over the past 24 months was brilliant and has delivered billions in value to Fairfax’s shareholders with much more to come. 13.) In 2020 and 2023, expanded partnership with Kennedy Wilson. Phase 1, in 2020, was the establishment of a $3 billion real estate debt platform. Phase 2, in 2023, was the purchase of $2 billion of PacWest loans yielding a fixed rate to maturity of 10%. Fairfax, through long term partner Kennedy Wilson, took advantage of a temporary market dislocation. 14.) In 2022, sold Resolute Forest Products for $626 million (plus $183 million CVR) at the top of the lumber cycle. Fairfax opportunistically sold at a premium price what had been one their large chronically underperforming equity holdings. This sale also improved the overall quality of the remaining basket of equity holdings. 15.) In 2023, sold Ambridge Partners for $379 million, delivering a $259 million pre-tax investment gain. Dividend: In January 2024, Fairfax increased their annual dividend 50% to $15/share. It had been $10/share going all the way back to 2011. Share buybacks: Effective shares outstanding have decreased an estimated 17.1% over the past six years from 27.8 million in 2017 to an estimated 23.0 million in 2023, an average decline of 2.9% per year. 16.) in 2021, re-purchased 2 million shares at $500/share. This was 7.6% of shares outstanding at the time. Fairfax’s share price recently closed at $1,013. Fairfax’s significant share purchase was done at an incredibly attractive price - which makes it very beneficial for the company and shareholders. This was another financial home run. The list above captures only the largest capital allocation decisions made by Fairfax in recent years. We could easily add another 15 smaller examples of transactions that are also proving to be of a material benefit to Fairfax. --------- For a comprehensive list of many of Fairfax’s capital allocation decisions going back to 2010 (sorted by year) go to the Appendix in my PDF called ‘Fairfax-Hiding in Plain Sight’. https://thecobf.com/forum/topic/20253-fairfax-financial-60-of-the-best-posts-all-in-one-document/#comment-526661 ---------- The importance of properly sizing your bet A lesson from Stan Druckenmiller: position sizes really matter https://moneyweek.com/investments/investment-strategy/605020/stan-druckenmiller-position-size-really-matters “Sizing is 70% to 80% of the equation. Part of the equation is seeing the investment, part of the investment is seeing myself in a good trading rhythm. It’s not whether you’re right or wrong, it’s how much you make when you’re right and how much you lose when you’re wrong,” says Druckenmiller. Position size matters. A lot. If you don’t believe Druckenmiller, just ask Buffett. Now take a close look at the 16 examples I cited above. What jumps out? The size of gain from each of the decisions. My math says 9 delivered a $1 billion or more gain to Fairfax and its shareholders over time. In recent years, Fairfax has been not only making very good decisions - it has been sizing them exceptionally well. The benefits to the company and shareholders have been massive - with much more to come. Fairfax’s market cap is only $25 billion. A $1 billion gain is a needle mover for the company. A bunch of them stacked one on top of the other? That is called ‘escape velocity’ for operating earnings. More on this point later in the post. Asset sales Asset sales is one part of capital allocation that separates Fairfax from its peers like Berkshire Hathaway and Markel. In selling an asset, Fairfax is essentially trading a stream of future cash flows for a lump sum today. Why should a company sell an asset? Sometimes another company - who is willing to pay up - values an asset at a much higher value than you do. The sale of the pet insurance business is a great example of this. There also can be important strategic reasons to sell an asset. For instance, if a sale allows the company to better focus on other parts of its business, selling an asset can lead to improved financial results. Selling APR to Atlas is perhaps a good example of this. Selling lower quality assets is also a good way to improve the overall quality of the remaining holdings. Selling Riverstone UK (runoff) and Resolute Forest Products are two good examples of this. Put simply, asset sales have been a very important part of Fairfax’s capital allocation framework, realizing significant value for Fairfax and its shareholders over the years. Improving the quality of the two businesses - insurance and investments Over the past 6 years Fairfax has done a great job of improving the overall quality of both its insurance and equity holdings. Equities was where the heavy lifting needed to be done - and after years of effort Fairfax has made considerable progress with many underperforming holdings (sales, mergers, take-private). Other holdings, like Eurobank, always well managed, have been greatly assisted by external events (economic pivot in Greece). Higher quality businesses are able to deliver higher and more stable earnings. And that is what we are starting to see. Analysts have been slow to recognize this change, which is one reason why their estimates were usually too low in 2023. Is Fairfax’s capital allocation record perfect? No, of course not (no company is perfect on this front). I see two notable misses: Taking until late 2020 to exit the last short position (and not exiting earlier). Not finding a way to unload Blackberry during the WallStreetBets mania that caused the share price to spike for a very short period of time in 2021. Fairfax says they were unable to act due to being in a blackout period at the time. Looking at everything they have done over the past five or so years, it is clear that Fairfax has been executing exceptionally well. "In this business if you're good, you're right six times out of ten. You're never going to be right nine times out of ten." Peter Lynch Looking at Fairfax’s track record over the past five years, I would argue that the company has been right with their capital allocation decisions at a rate much higher than 6 out of 10. In Druckenmiller parlance, Fairfax has been on a multi-year “hot streak”. Or in Buffett parlance, Fairfax has been hitting the ball like Ted Williams for the past couple of seasons. Has Fairfax simply been lucky? Did Prem give the team at Fairfax a sip of ‘liquid luck’ back in 2018? Some luck likely has been involved. But I like this definition of luck: “Luck is what happens when preparation meets opportunity.” Roman philosopher Seneca What have we learned? Here are the words I would use to describe Fairfax’s approach to capital allocation: Flexible - use the full suite of options available. Opportunistic - take advantage of dislocations/opportunities as they arise. Countercyclical - act contrary to prevailing investment trends. Speed - act quickly when necessary. Conviction (position sizing) - go big when risk/reward is highly compelling/asymmetrical. Creative - be open minded during the process. Long term focus – goal is to generate above-market returns. Accepting of volatility. Strategic - make the company stronger - both insurance and investments. Rational - capital goes to the best (risk adjusted) opportunities. Equally capable in executing across both insurance and investment businesses. What has been the financial impact of Fairfax’s capital allocation decisions? Operating Income: Let’s start by looking at operating income given it is viewed by analysts as the most important part of an insurance company’s total earnings. Operating income at Fairfax is the sum of three things: underwriting profit, interest and dividend income and share of profit of associates. For the 5-year period from 2016-2020, operating income at Fairfax averaged $1 billion per year or $39/share. Compared to the 5-year averaged from 2016-2020: in 2021, operating income doubled to $1.8 billion or $77/share. in 2022, operating income tripled to $ 3.1 billion or $132/share. in 2023, operating income is on track to quadruple to $4.4 billion or $190/share. in 2024, operating income is estimated to quintuple to $4.6 billion or $202/share. The run rate for operating income per share in 2023 ($190/share) is 4.9 times larger than the average from 2016-2020 ($39). What is the reason for the spike higher? The dramatic increase is due in large part to the exceptional capital allocation decisions made by the management team at Fairfax over the past 6 years. Importantly, the gains in operating income are durable as they have been driven by improving fundamentals (not one time items). Investment Gains: The other important part of earnings is investment gains. This lumpy part of earnings has historically been a strength for Fairfax - the pet insurance and Resolute sales in 2022, and the Ambridge Partners sale in 2023, being three recent examples. We should expect Fairfax to continue to deliver solid (but lumpy) investment gains moving forward. My current estimate has Fairfax on track to deliver record earnings of around $170/share in 2023. Return On Equity: For the 5-year period from 2016-2020, ROE averaged about 6.0% per year. For the period 2021-2024, ROE is tracking to average 16.6%. That is a marked improvement. Important: I have use 'average equity' to calculate ROE. Some P/C insurers (like WRB) use 'beginning year equity' in their calculation. If I used 'beginning year equity' my ROE for Fairfax would be higher. Driven by strong capital allocation decisions, all important financial metrics at Fairfax have been materially improving in recent years. This strong performance looks set to continue in 2024. How is the strategic positioning of Fairfax’s businesses? Insurance: Significant expansion by acquisition 2015-2017 - build out of global platform is complete. Significant expansion by organic growth 2019-2023 - hard market Ongoing bolt-on acquisitions, like Singapore Re, has further strengthened the business. Ongoing buy-out of minority partners, like Eurolife in 2021 and Allied World in 2022, and majority partner KIPCO (GIG) in 2023, has further strengthened the business. The quality of the insurance businesses has rarely looked better. The business is delivering record net premiums written and record underwriting profit. Investments - fixed income: 2021: shortened duration of portfolio to 1.2 years and shifted to primarily government bonds in late 2021, to protect the balance sheet. 2023: extended duration to 3.1 years in October 2023, to lock in much higher rates. 2023: capitalizing on dislocations in financial markets to lock in even higher rates - with KW, purchased $2 billion in PacWest real estate loans yielding a total return of 10%. The positioning of fixed income portfolio has rarely looked better. The portfolio is delivering record interest and dividend income. Investments – equities: Total return swaps, giving exposure to 1.96 million Fairfax shares, looks well positioned. Eurobank - balance sheet is fixed, earnings are strong. Greece is expected to be a top performing economy in Europe in the coming years. Purchase of Hellenic Bank will be a catalyst in 2024. Poseidon / Atlas - is currently in rapid growth mode. Investments in India (Fairfax India/BIAL etc) look well positioned given India is expected to be a top performing global economy in the coming decade. The rest of the company’s portfolio looks well positioned. The quality of the portfolio of equities owned has rarely looked better. The portfolio is delivering record share of profit of associates and sold investment gains. Summary: The strategic positioning of each of Fairfax’s three economic engines (insurance, fixed income and equities) has been steadily improving for the past five years. Conclusion Fairfax has a strong management team. They have been executing exceptionally well over the past 6 years. They are now delivering record financial results. Both businesses - insurance and investments - appear very well positioned. Fairfax is delivering on the dual core objectives from capital allocation: Deliver good/great returns on capital deployed Improve the quality of each of the businesses (insurance and investments) over time As a result, I think we can fairly conclude that the management team at Fairfax have demonstrable best-in-class capital allocation skills, and not just within their peer group in P/C insurance. And with the company producing record operating earnings (and an estimate of around $4 billion in earnings) this best-in-class team is going to get the opportunity to deploy billions each year moving forward into new opportunities. Record, sustainable and growing earnings + exceptional capital allocation + compounding + time = exponential growth ---------- Fairfax is trading today at a P/BV of about 1.05 (using my estimated 2023YE BV). That is a very low valuation - it suggests Fairfax is a poorly run P/C insurer with poor prospects. If Fairfax is best-in-class at capital allocation how can it also be poorly run with poor prospects? The answer is simple - it can’t be both at the same time. If Fairfax is above average at capital allocation then future earnings growth should be solid. This will lead to an above average ROE. As Mr Market comes to understand Fairfax better - and that the company is an above average P/C insurer, then we should see multiple expansion. The trifecta for a stock: Growing earnings + growing multiple + lower share count = much higher share price. 'Time is the friend of the wonderful business.' Warren Buffett Edited January 29, 2024 by Viking
MMM20 Posted January 28, 2024 Posted January 28, 2024 (edited) 2 hours ago, Viking said: asset sales have been a very important part of Fairfax’s capital allocation framework, realizing significant value for Fairfax and its shareholders over the years So my friend with the big FFH position decided to take a cue from Fairfax and create his own dividend (and sell his last share if the stock triples tomorrow). FFH’s earnings yield is ~15-18% these days, and they pay out ~1/10th of it as a dividend. So selling ~6-7% of your position basically amounts to taking out about half your share of earnings to reinvest yourself and leaving the other half to get reinvested by the great capital allocators at Fairfax. Right? This is some mix of: “The first rule of compounding is never to interrupt it unnecessarily.” - Charlie Munger “One of my smartest friends in venture capital is constantly getting huge clumps of stocks at nosebleed prices. And what he does is he sells about half of them always. That way, whatever happens, he feels smart. I don't follow that practice. I don't criticize it either." - Charlie Munger I figured this might be a good middle ground / regret minimization framework for others in a similar situation. Edited January 28, 2024 by MMM20
KFS Posted January 29, 2024 Posted January 29, 2024 On 1/26/2024 at 8:15 PM, 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've received the same notification from Fidelity. 0.25% obviously isn't much, but could amount to a couple hundred extra bucks per month if you have significant holdings. What exactly is the downside to enrolling? (If there is one.) Is this easy money with no downside?
dartmonkey Posted January 29, 2024 Posted January 29, 2024 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've received the same notification from Fidelity. 0.25% obviously isn't much, but could amount to a couple hundred extra bucks per month if you have significant holdings. What exactly is the downside to enrolling? (If there is one.) Is this easy money with no downside? I would say, yes, easy money with no downside. Interactive Brokers also pays shareholders who have agreed to allow them to lend their shares, in their case, half of the borrow fee. The borrow fee for Fairfax is low, around 0.5% as far as I can tell, so in this case, they pay similarly. The broker takes a risk, lending out shares to a short seller, because the broker obviously has a legal obligation to return them to their owner, so I can see how they earn their fee. But for me, the share owner, I can't see how there's any risk at all, and so I can't see why I would want to turn down a 0.25% payment, small as it may be, when there's no risk to me. Some people have an objection to short selling in general, and especially of short selling of the shares of a company they are invested in, but it seems to me that this is irrational emotion getting in the way of increasing one's investment return.
LC Posted January 29, 2024 Posted January 29, 2024 It's essentially riskless, but yes theoretically it could be. You agree to lend your shares out, there is a chance the ultimately counterparty(s) may fail to deliver to the central clearing house (DTCC/NSCC). For anyone who cares about the plumbing: https://www.researchgate.net/publication/228260887_Naked_Short_Sales_and_Fails_to_Deliver_An_Overview_of_Clearing_and_Settlement_Procedures_for_Stock_Trades_in_the_US
Dinar Posted January 29, 2024 Posted January 29, 2024 There is a tax angle that is not being discussed. When a dividend gets paid and you own shares, in the US, it can be a qualified dividend, which puts you either into a 15% or 20% federal tax bracket on dividends + 3.8% Obama tax. If you had lent out your shares, then it is NOT a qualified dividend, but instead payment in lieu of dividend, and can be taxed as high 37.8% + Obama tax.
Xerxes Posted January 29, 2024 Posted January 29, 2024 https://podcasts.apple.com/ca/podcast/the-acquirers-podcast/id1454112457?i=1000642465517
Munger_Disciple Posted January 29, 2024 Posted January 29, 2024 53 minutes ago, Dinar said: There is a tax angle that is not being discussed. When a dividend gets paid and you own shares, in the US, it can be a qualified dividend, which puts you either into a 15% or 20% federal tax bracket on dividends + 3.8% Obama tax. If you had lent out your shares, then it is NOT a qualified dividend, but instead payment in lieu of dividend, and can be taxed as high 37.8% + Obama tax. This is a big deal.
Parsad Posted January 29, 2024 Posted January 29, 2024 On 1/27/2024 at 8:02 PM, cwericb said: 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 Well said! Cheers!
Santayana Posted January 29, 2024 Posted January 29, 2024 On 1/28/2024 at 9:59 AM, Viking said: 16.) in 2021, re-purchased 2 million shares at $500/share. This was 7.6% of shares outstanding at the time. Fairfax’s share price recently closed at $1,013. Fairfax’s significant share purchase was done at an incredibly attractive price - which makes it very beneficial for the company and shareholders. This was another financial home run. To me, this move was the biggest of all because of how they raised the money to do it. What's the current carrying value on Odyssey?
SafetyinNumbers Posted January 30, 2024 Author Posted January 30, 2024 2 hours ago, Santayana said: To me, this move was the biggest of all because of how they raised the money to do it. What's the current carrying value on Odyssey? I’m not sure but I think with these agreements they buy back at the same multiple they sold at which in Odyssey’s case was 1.9x BV.
OCLMTL Posted January 30, 2024 Posted January 30, 2024 6 hours ago, Santayana said: To me, this move was the biggest of all because of how they raised the money to do it. What's the current carrying value on Odyssey? Funny you say that because that’s when I decided to buy Fairfax shares for the first time in my life. The arb was so big between the sale at 1.8-1.9x BV and $1B buyback at 0.8x and it was so bold, it cannot have been ignored. It was a HUGE signal Prem was sending to the markets. After that, I started buying, too small at first, and now I’m hugely OW (a lot would say irresponsibly so) and sleeping extremely well at night at these levels.
cwericb Posted January 30, 2024 Posted January 30, 2024 22 hours ago, Parsad said: Well said! Cheers! Thank you. 15 hours ago, OCLMTL said: ... now I’m hugely OW (a lot would say irresponsibly so) and sleeping extremely well at night at these levels. Ditto this. 1
NormR Posted January 30, 2024 Posted January 30, 2024 I've parked the lineup for Fairfax Lollapalooza 2024 on a public webpage over here ... https://www.stingyinvestor.com/FairfaxWeek2024.html If I've missed anything, please let me know.
MMM20 Posted January 30, 2024 Posted January 30, 2024 (edited) On 1/24/2024 at 8:36 PM, MMM20 said: I demand attribution for my super original and incredible chart, Mr. Tidefall Capital And you left out the best part - the green arrow. It's looking roughly right so far! Edited January 30, 2024 by MMM20
hardcorevalue Posted January 30, 2024 Posted January 30, 2024 haha I did totally copy you. but still screwed up the tweet so I look stupid anyways!
MMM20 Posted January 30, 2024 Posted January 30, 2024 (edited) 2 hours ago, hardcorevalue said: haha I did totally copy you. but still screwed up the tweet so I look stupid anyways! It’s just crazy that after this run it still trades at a discount. I figured your point was that FFH should trade at a premium to BRK and MKL by the time this hard market ends… which seems like a good bet. Edited January 30, 2024 by MMM20 typo
Viking Posted January 30, 2024 Posted January 30, 2024 (edited) 54 minutes ago, MMM20 said: It’s just crazy that after this run it still trades at a discount. I figured your point was that FFH should l trade at a premium to BRK and MKL by the time this hard market ends… which seems like a good bet. What we are learning is Fairfax WAS building considerable value from 2010-2020. It was masked by all the one-time losses (primarily the equity hedges/short positions and later by poorly performing equity holdings). The one-time losses ended. Headwinds became tailwinds. Since 2018, Fairfax has been on a capital allocation hot streak. Weave it all together - Fairfax became a coiled spring that got released in October of 2022. The crazy thing is we are still learning what ‘normalized earnings’ looks like. Because fundamentals just keep getting better. And there are lots of catalysts lurking (Digit IPO, Anchorage IPO, equity revaluations - where CV is well under FV, what they are going to do with $4 billion/year in earnings etc). Edited January 30, 2024 by Viking
MMM20 Posted January 30, 2024 Posted January 30, 2024 (edited) 1 hour ago, Viking said: What we are learning is Fairfax WAS building considerable value from 2010-2020. It was masked by all the one-time losses (primarily the equity hedges/short positions and later by poorly performing equity holdings). The one-time losses ended. Headwinds became tailwinds. Since 2018, Fairfax has been on a capital allocation hot streak. Weave it all together - Fairfax became a coiled spring that got released in October of 2022. The crazy thing is we are still learning what ‘normalized earnings’ looks like. Because fundamentals just keep getting better. And there are lots of catalysts lurking (Digit IPO, Anchorage IPO, equity revaluations - where CV is well under FV, what they are going to do with $4 billion/year in earnings etc). Obviously I agree with your assessment. I can’t borrow your conviction but I can borrow your 250+ page book to help build my own and my family is grateful for that. Now let’s see if the TSX 60 inclusion arbitrage crowd (and closet/ indexers themselves) drive it to fair value. Edited January 30, 2024 by MMM20
treasurehunt Posted January 31, 2024 Posted January 31, 2024 Chubb reported Q4 results today - P&C combined ratio of 85.5%, consolidated net premiums written up 13.4% YoY, P&C premiums up 12.5%. The press release had this bit: "In the quarter, continuing the trend we experienced all year, commercial P&C rates and price increases across the majority of our global portfolio were strong and exceeded loss costs, which were stable. Pricing in our P&C lines was up 12.4% in North America and 10.1% in our international retail business, while financial lines pricing globally continued to decrease led by public D&O." Augurs well for Fairfax.
Viking Posted February 4, 2024 Posted February 4, 2024 (edited) Multiple expansion - a deep dive This post is broken into the following parts: Part 1 - Introduction: Drivers of a share price Part 2 - Multiple Part 3 - Turnarounds Part 4 - The turnaround is complete - the caterpillar has transformed into a butterfly Part 5 - Narrative change and multiple expansion Part 6 - Multiple expansion - What does the math look like? Appendix - Is growth in book value a good measure of quality? ————— Part 1 - Introduction Three things drive a share price: Earnings Multiple Share count In buying a stock, an investor is buying a stream of future earnings. The multiple is simply the price an investor is willing to pay for the stream of future earnings. These are called ‘fundamentals’. Understanding the change in each of these items gives an investor great insight into the future path of a stock. It’s like being able to predict the future. Of course, the perfect sep-up for an investor is to find a company that is: Growing earnings Experiencing multiple expansion Reducing its share count Finding a company where one of these things is happening is usually pretty good. Finding a company where two are happening at the same time - that usually leads to market-beating returns. Finding a company where all three things are happening at the same time - well, that is how the big money is made - or multi-baggers in Peter Lynch parlance. Theory is great. But is it actually possible for an investor to find a stock that is poised to do all three at the same time? Aren’t markets supposed to be pretty efficient? Well grasshopper, let’s pivot to the real world and look at an unloved, scrappy P/C insurance company called Fairfax Financial. Yes, it is still unloved... we will show you why in this post. A real life example: Fairfax Financial Buybacks Let’s start with share buybacks because they are the easiest. Over the last 4.75 years Fairfax has spent $1.94 billion and reduced effective shares outstanding by 4.12 million or a total of 15.1% (3.2% per year). This is a material reduction in share count. The average cost was $470/share. With shares closing Friday at $1,030, the shares were purchases at an average cost well below their intrinsic value. This is an example of great capital allocation on the part of management at Fairfax. Share count has been materially coming down for the last 4.75 years at Fairfax. We can check off box three from our list above. Earnings Let’s move now to earnings. Earnings at Fairfax have spiked over the past 3 years. And because of the significant reduction in shares, per share earnings are up even more. When analyzing P/C insurance companies, analysts prefer to look at operating income. It removes the volatility tied to ‘icky’ investment gains. Ok, let’s play be their rules and only look at the ‘good stuff’ - operating income. Operating income at Fairfax averaged $1 billion ($39/share) per year for the 5-year period from 2016-2020. Over the next 3 years (2021-2023) it was like a goat going straight up a mountain. For 2023 my estimate is operating earnings will come in around $4.4 billion ($190/share). This is a 387% increase per share. My forecast is for operating income to come in around $4.6 billion ($202/share) in 2024. This higher level is durable and growing. Bottom line, we are seeing a significant increase in earnings at Fairfax. We can check off box 1 from our list above. Multiple What about multiple? Share count and earnings are relatively easy to understand - they are largely based on numbers. Multiple can be a more difficult nut to crack. Yes, it is based on numbers. But it is also steeped in psychology. To better understand multiple we are going to do a deep dive. First we will zoom out and look at the big picture. And then we will zoom in and apply what we have learned to Fairfax. Let’s get started. Part 2 - Multiple What is the multiple for a stock? A multiple is a quick and easy way to value a company. It is best used to compare valuations of companies in the same industry. A low multiple (when compared to peers) suggests a stock may be undervalued - a high multiple suggests the opposite. What determines the multiple a stock trades at? Two things primarily drive the multiple: Past results and events. The facts. We all know the axiom: “The best predictor of future behaviour is past behaviour.” Well, it appears the same holds true for financial results. Narrative. This is ‘the story,’ or how the facts have been interpreted. A large part of narrative is driven by psychology. Most companies are pretty predictable animals. They tend to have the same management team. Future earnings tend to follow in an arc consistent with their historical trend. A narrative - that is reasonably accurate - settles in over time for most companies. And it tends to remain largely the same, sometimes for decades. As a result, most companies tend to trade at a pretty stable multiple over the years (within a stable band). Let’s steer this discussion back to Fairfax. To do this we need to bring turnarounds into the picture. Part 3 - Turnarounds As part of his investment framework, Peter Lynch classified all stocks into six broad categories - one of which was turnarounds. With turnarounds, past results/events usually have been pretty bad. This usually results in a narrative that is quite negative. Lower earnings and a poor narrative tends to compress the multiple - often to extremes. This set-up usually causes the share price to crater. Why did Lynch like turnaround plays so much? Lynch loved turnarounds because of their potential to become big winners - sometimes 5 and even 10 baggers. Another benefit is the returns are usually not correlated with the overall market. Why are successful turnarounds so lucrative for investors? When investing, your starting point matters. Buy low. The stocks of lots of turnaround plays have been left for dead by investors - often you can buy them at crazy low prices. For successful turnarounds, two things happen. But usually along two very different time-frames: Short term (1 to 2 years): earnings turn. Medium term (3 plus years): multiple expansion. Of course, higher earnings tends to lead to a higher stock price. Facts are facts. But multiple expansion? This usually takes years to happen. Why? The multiple is largely driven by the looking through the rear view mirror - a narrative that has been constructed from past events. For successful turnarounds it often takes years for the narrative to get updated. Why does it take so long? There are a couple of reasons. Most turnarounds are under-followed. For the most part these are companies that have disappointed investors for years. Analysts? Investment professionals? Losing your clients money year after year by recommending a shitty stock is never a good career move. As a result, most turnarounds become hated companies. Lack of coverage results in an information disadvantage. Of course, some turnarounds actually turn around. And guess what? Pretty much no one notices - because no one is following the company anymore. And if no one is following the company it is impossible for the old narrative to change - even after the fundamentals have turned. There is a second reason it takes a long time for narratives to change and it is very powerful. Holding on to an old (wrong) narrative requires no work. After all, people are busy. Updating a narrative? Now that is hard. It requires a lot of work. And in the beginning almost everyone around you is going to think you are an idiot. But over time (sometimes years in length), as it becomes obvious to more and more people that the turnaround has actually happened, the ‘story’ around a stock gets to an inflection point. And those clinging to the old narrative are the ones who start to sound like idiots. And do you want that ‘crazy uncle’ managing your money? (Darwin at work on Bay and Wall Street.) Eventually, the narrative does get updated. And as that happens, we see multiple expansion. So what does all this have to do with Fairfax? Fairfax is a turnaround play. That has turned around. It actually started to turn around all the way back in late 2016 when it removed all the equity hedges (Trump getting elected was a great event for Fairfax shareholders). It picked up steam in 2018 and 2019 when the company got to work fixing its poor quality equity portfolio. We probably could say the turnaround was largely done at the end of 2020 when Fairfax covered its last short position. For sure, the turnaround was done by the end of 2021 - that is when all the positive changes from the previous years started to show up in much higher (record) operating income. Bottom line, the turnaround at Fairfax was completed years ago. Yes, I know… shocker! Fairfax has transformed itself over the past 6 years into a high quality insurance company. And that matters a lot when it comes to multiple. This is what we are going to explore next. Part 4 - The turnaround is complete - the caterpillar has transformed into a butterfly How do we know Fairfax has transformed itself into a high quality insurance company? To help us answer this questions we are going to look at something called return on equity (ROE). Return on equity (ROE) Return on equity is a measure of how profitable a company is. The bigger the number - the higher the quality. We are also going to look at operating income ROE (which I will call OI-ROE). This is viewed by the P/C industry as being a higher quality measure of ROE. Operating Income ROE at Fairfax For the 5-year period from 2016-2020, the OI-ROE averaged 9%. For the 3-year period from 2021-2023, the OI-ROE averaged 19%. My estimate for 2024 is 20%. OI-ROE has doubled from 9% to 19%. That is a massive increase. OI-ROE of 20% is top-tier performance among P/C insurers. Fairfax is tracking in 2024 to deliver its 4th year in this range. That is exceptional performance and a material increase from what it delivered in the past. I can hear the naysayers yell out as they are reading this post… “Ya, but it’s not sustainable!” To which I would answer: 3 years in a row at an average OI-ROE of 19.5% is in the books (well, should be when Fairfax reports Q4 results). A 4th year at 20% looks likely. Is 4 years in a row not the beginning of a trend? Maybe not 20%. But even something in the high teens range over the next 5 years would put Fairfax among the top tier of P/C insurers. I could also bring up investment gains. This is something we have completely ignored but is a clear strength of Fairfax (when compared to peers). Pet insurance? Sold in 2022 for a $1 billion after-tax profit. The FFH-TRS position (providing exposure to 1.96 million Fairfax shares) is up $1.3 billion (pre-tax) over the past 37 months. I could go on. Volatile? Yes. But smoothed out over a few years, the average number is a significant contributor to Fairfax’s regular ROE calculation. Just something to keep in mind. But to help us answer the question of whether or not the high OI-ROE is sustainable, let’s peel the onion back one more layer. What is the best predictor of long term results for a company? The best predictor of long term results for a company is the management team and their capital allocation skills. This is especially true for P/C insurance companies because of something called float (which can be larger in size than shareholder’s equity). The quality of the capital allocation decisions being made by management is likely the best leading indicator for future ROE for a P/C insurer. Of course, it takes years for good capital allocation decisions to show up in higher earnings and higher ROE. Especially for a turnaround like Fairfax. But that is exactly what we have been seeing in each of the past three years. But the story gets better. I wrote a very long post last week where I went into great detail on Fairfax’s capital allocation record over the past 6 years or so. The conclusion? Fairfax looks best-in-class in the P/C industry. If you have one of the best capital allocation teams in the industry, and they have been hitting the ball like Ted Williams over the past 6 years, what do you think ROE will look like in the coming years? Above average for sure. And probably even better than that. As a result, I think the facts and evidence points to Fairfax being a high quality insurance company. How is Mr. Market valuing Fairfax? Finally, we get to our answer! ROE and P/BV Return on equity (ROE) and price to book value (P/BV) are the preferred metrics used by investors to value P/C insurance companies. Looked at together, they tell investors a story about the company. Over time, a high and sustainable ROE inevitably results in a high P/BV multiple. The opposite is also true: a low ROE generates a low P/BV multiple. Return on equity Earlier we learned that OI-ROE at Fairfax is tracking to overage 20% from 2021-2024. That is top tier performance. Let’s now compare that to P/BV. Price to book value (P/BV) This measure tells us what Mr. Market thinks about the future prospects of the company. Or put another way, is ROE sustainable? Fairfax’s P/BV is about 1.11 (if we use estimated 2023 YE book value). Compared to peers, Fairfax’s P/BV is at the very bottom. A P/BV near 1 suggests the P/C insurer is both poorly run and has poor prospects. Fairfax has a very high ROE (with solid prospects). The company is high quality. Yet, its P/BV multiple is very low. This suggests Fairfax is very undervalued. What about PE? I know PE is not supposed to be used to value a P/C insurance company. But it is a useful measure for most companies so let’s see what it has to say. If we use Yahoo Finance’s current earnings estimate for Fairfax for FY 2023, we can see Fairfax is currently trading at a PE of 6x. That is crazy low. Both when compared to peers and the market in general. Summary Fairfax is a high quality company delivering top-tier ROE. Trading at what looks to be crazy cheap valuation as measured by both P/BV and PE. Is there anything that can explain this disconnect? Yes. The narrative surrounding the company is in need of an update. The part driven by psychology. Thanks for hanging in there. We’ve come full circle. Let’s finish connecting the dots. Part 5 - Narrative change and multiple expansion “Although expectations of the future are supposed to be the driving force in the capital markets, those expectations are almost totally dominated by memories of the past. Ideas, once accepted, die hard.” Peter Bernstein Fairfax and narrative Fairfax had one analyst attend their Q3 conference call. Tom MacKinnon/BMO, you get a gold star from the teacher. The lack of interest in Fairfax in the analyst community suggests to me that the old narrative is still firmly in place. After all, it is Fairfax. That shitty little Canadian insurance company. Right? Even Rodney Dangerfield would be surprised at the lack of respect Fairfax still gets today - even though it is a top 20 global P/C insurer and now one of the top 30 Canadian companies in terms of market cap. Yes, but the stock is a dog! Woof! Right? Fairfax has probably been one of the best performing large cap stocks in Canada over the past three years (the best?). But, hey, don’t let the facts get in the way of a good narrative. To be fair, the quality of the research on Fairfax has been getting better, especially over the last year. I recently read Jaeme Gloin/National Bank’s Q4-2023 earnings preview for Fairfax and i had to wipe the tears from my eyes when i was done - it was that good. And not because he upped his price target to $C2,000. It was because of the facts and logic he provided readers - the detailed build - which he used to arrive at his conclusions (final earnings estimate, multiple and price target). It was clear Jaeme has actually put in the work to understand the Fairfax as it exits today (that doesn’t mean he is ignoring the past). But there is also, IMHO, still one piece of simply terrible stuff out there. ‘Crazy uncle’ bad. This one is so steeped in the past it reads like it was actually written 10 years ago. (Maybe it was…. I better check the date.) Anyone who follows Fairfax closely knows the report that I am referencing. Now when you can go unnamed - and yet people know who you are? Well, that’s pretty impressive. But is it really? The good news is the old narrative around Fairfax will eventually be laid to rest. And that’s because you can only ignore the facts and the fundamentals for so long. Multiple expansion My view is 2024 could well be the year when we get to an inflection point in the narrative for Fairfax. In fact it looks like it might have started as we begin 2024. In January the P/BV multiple has expanded from 1.0 to 1.1. As the narrative gets updated, Fairfax will shift from being valued as a poorly run company delivering poor results to being valued as a well run company delivering very good results. In turn, this should result in multiple expansion. Yes, Fairfax will need to do its part - and continue to deliver solid results. So with Fairfax today, it looks like we have a situation where: 1.) earnings are growing 2.) multiple is expanding 3.) share count is falling And all three happening at the same time? That is when the big money is made. Part 6 - Multiple expansion - What does the math look like? The example below is not intended to be a forecast. Rather it is intended to demonstrate to investors the power of multiple expansion (when it happens). Readers can overlay their own assumptions as they see fit. To keep our analysis simple we are going to use Dec 31, 2023 as our starting point. Let’s be conservative and assume Fairfax only earns $150 in 2023 (instead of the forecast of $170). Let’s also assume Fairfax continues to pay a $15 dividend. Let’s be conservative and assume Fairfax grows earnings at 6% per year. Now for the fun part. Let’s assume the P/BV multiple expands from 1x at Dec 31, 2023 (where it was) to 1.3x at Dec 31, 2026. A multiple of 1.3x would get Fairfax to the lower band when compared to peers - I think it is a conservative number. Given the inputs above, what is the return for investors over 3 years? The total increase is 100%. A double over 3 years. Of the total increase, about 50% is driven by earnings. And 50% is driven by multiple expansion. Yes, multiple expansion is rocket fuel to a stock. ————— Appendix - Is growth in book value a good measure of quality? I wasn’t able to find a good place to insert this into my post above. But I think it is important so I am including it here. The growth in book value over time is another way to assess the quality of a P/C insurance company. In some ways, it might be the best way. Because it includes all the ‘messy’ stuff that might not be included in ROE (like unrealized losses in bonds). How does Fairfax stack up when compared to peers like Markel, WR Berkley and Chubb? Over the past 5 years Fairfax’s has grown book value at a CAGR of 16.6%. None of the other 3 companies come close to that performance. It should be noted, Fairfax, WR Berkley and Chubb all pay a modest dividend. Markel does not. Yes, change in book value is just another important measure that points to Fairfax being a very high quality P/C insurance company. Edited February 4, 2024 by Viking
Maverick47 Posted February 4, 2024 Posted February 4, 2024 3 hours ago, Viking said: So with Fairfax today, it looks like we have a situation where: 1.) earnings are growing 2.) multiple is expanding 3.) share count is falling And all three happening at the same time? That is when the big money is made. @Viking, When I read your posts about Fairfax, I can’t help but hear the voice of my van pool driver from 30 years ago. He was sharing with his passengers the story of his summer job driving a delivery truck with a more experienced driver who would yell instructions to him from the loading dock as he was tasked with backing up to it. The instructions he recalled hearing were always the same: ”Keep comin’, Keep comin’, Keep comin’!!!’” CRASH! Hokayyy!!!!”
Crip1 Posted February 4, 2024 Posted February 4, 2024 (edited) On 1/24/2024 at 4:47 PM, Thrifty3000 said: So, for this simple look through earnings spreadsheet the most important fields I track are: Ticker # of Shares I Own Per Share Cost Basis Normalized Earnings Estimate Per Share Normalized Dividend Per Share Total Cost Basis (Cost Basis Per Share X # of Shares Owned) Total Normalized Earnings (Normalized EPS X # of Shares Owned Total Normalized Dividend Current Share Price Current Value of Investment (Current Share Price X # Shares Owned) Normalized Earnings Yield Normalized Dividend Yield Price to Normalized Earnings Multiple 10 Yr Estimated Growth Rate Year 10 Normalized Earnings Forecast (Based on current normalized earnings and my estimated growth rate) % of Portfolio Allocation Unrealized Gains % Unrealized Gains Normalized earnings is the field I focus most on getting right. I don't have a one size fits all approach for this one, though. I'm mostly focused on understanding what free cash flow will look like through a full economic cycle. I also try to understand and adjust for key risks - like super cats. For some investments I have to adjust for things like big, temporary, expenses - like major litigation costs/settlements that will take a few years to burn through (think post-GFC Bank of America). With some investments that have highly reputable managements I've learned that management forecasts are plenty reliable. So, if I'm really comfortable with a manager, I'll start with their forecast, try to poke holes in it, and adjust accordingly if I come up with anything. As far as making adjustments, I review my estimates annually at a minimum. However, anytime I learn about a material change, or think of a material risk, whether from company updates, CoBF, or otherwise, I immediately update my estimate. I probably make a handful of small adjustments to the model every quarter. I rarely have to make major adjustments at this point. I may make 1 or 2 major adjustments to the model each year. Usually, I get to just bump up the earnings estimate for the next year, which is fun. Since I started maintaining this spreadsheet in 2019 I've been able to increase my total normalized look through earnings by six figures every year just by replacing lower yielding investments with higher yielding ones whenever clear opportunities arise. @Thrifty3000 Thanks again for the time/effort to respond on this. It is something that I thought I should do but now really realize that I NEEDED to do this to better frame investment decisions. One other question...do you have any ETFs or mutual funds and, if so, how do you incorporate those into the analysis? About 70% of financial net worth is invested in individual stocks, but some money is in ETFs (for access to industries where I want to be but would prefer others with more knowledge pick out winners/losers) or Mutual Funds (401k accounts my wife and I pay into that do not offer self-directed stocks as investment options). -Crip Edited February 4, 2024 by Crip1
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