Fairfax 2024

[Cigarbutt]

2 hours ago, StubbleJumper said:

If you assess the long-term ROE high enough and you believe that FFH can reasonably reinvest at that ROE, you can easily make the argument that the company is worth 1.5x BV.  But, when doing that exercise, it is important to remain mindful of the financing differential table and the growth in BV table that Prem publishes every year in his annual letter.

SJ

Then, why such a big discount to the 1.5x BV numbers these days?

The graph needs some recent update..

The reason i'm asking is because, evidently, the float liability needs to be discounted and, presently, given the potential for profitable growth in float, maybe the required discount on the float liabilities suggest a higher P/B than 1.0.

i'm asking also because an example of the junk presentation by recently attacking shorts concerns the Riverstone-Barbados entity, a transaction involving two sophisticated parties exchanging an entity in run-off (where the insurance liabilities will clearly need to be paid out and maybe more than written in the books) for a P/B of about 1.0.

Isn't FFH now worth more than Riverstone-Barbados then, from a P/B value point of view?

[StubbleJumper]

34 minutes ago, Cigarbutt said:

Then, why such a big discount to the 1.5x BV numbers these days?

The graph needs some recent update..

 

To be worth 1.5x BV, effectively, you need to argue that the long-term ROE on a going-forward basis will be high enough.  We know that the first dozen years of FFH's existence were characterised by an absolutely ridiculous run of consistently high growth in BV (see the table on page 20 of Prem's annual letter from last year).  But following that start-up phase that began in 1986 and ended a dozen or so years later, there has been a period of about 20 years with much less convincing growth in BV.   And then there's been the past 3 or 4 years. 

 

It's really interesting to take that table that Prem publishes every year and monkey around with it a bit.  Erase 1986 and 1987 on the argument that you can't "start up" twice and then recalculate compound annual growth.  Break the series into the growth phase from 1986-99 and the lacklustre phase from 2000-2019 or 2020, and calculate the compound growth rates for each of those phases.  When you do this exercise, you might view the 17.7% historical average growth in BV on that table in a somewhat different light and you should certainly question whether that series can be replicated going forward.

 

That then leaves the really difficult task of guessing what all of that means for the future.  My take is that the economics of the insurance industry will not allow FFH to routinely achieve its bogey of 15% growth in BV on a going forward basis.  I'd be happy if they could grow BV by 12%, but suspect that it may be more like 10% over the long term.  That's not a knock on FFH, it's just a tough industry.  If they actually do routinely achieve that 15% goal, I'll be the happiest guy around.

 

But, turning to valuation, if you pay 1.5x BV for something that grows its book by 15%, you are basically getting a 10% earnings yield with relatively rapid growth.  But, if you paid 1.5x BV and FFH grows BV by 10%, you are getting a 6.7% earnings yield and decent growth...and I'd say you'd have slightly overpaid, but not terribly so if the earnings are rock-solid, regular and predictable (in other words all of the things that the insurance industry is not!).  At this point it's trading at a shade over 1x BV, which means that the market finally figures that FFH is worth more alive than dead (ie, if it trades at <1x BV, in theory it's worth more dead than alive, so just break it up, sell off the pieces or run them off, and give the proceeds to the shareholders!).  I'd say that it's definitely worth 1.2x but I guess we'll see over the coming months whether the market agrees with that.  Maybe it'll rattle off 8 or 10 years of fabulous returns that will make me think it's worth 1.5x?  Time will tell....

 

 

SJ

[TwoCitiesCapital]

15 hours ago, Haryana said:

 

I see it as a simple thesis that Fairfax is better than cash because that cash is in Treasuries with better than free leverage.

 

 

Just be careful applying this in practice. 

 

Fairfax owned a ton of cash/short duration bonds in 2020. The stock still was down over 50+% from the peak despite that. 

 

This was also demonstrated in 2008 where the stock of Fairfax was falling even while it's CDS were printing money. 

 

In a panic, it'll trade like a stock regardless of how well it's underlying assets are doing.

[Cigarbutt]

29 minutes ago, StubbleJumper said:

 

To be worth 1.5x BV ... Time will tell....

SJ

Your post is helpful. But there's room between a p/b of 1.0 and 1.5 or more.

The likelihood of seeing intrinsic value (can use book value as proxy) is somewhat elevated over the next few years but it's less clear if this will be recognized in the marketplace with a higher p/b?

There are reversible factors for this but there are also irreversible factors, such as their unusual ability to perform atypical transactions such as the monetization of the runoff sub mentioned before. This approach (is great in a way but) leaves them vulnerable to less enthusiasm from the market, to reasonable criticism and, unfortunately, to junk/mud attacks.

The sale of Riverstone-Barbados was a great way to monetize an asset in times of need but included aspects which had costs from a risk management and quality of earnings point of view. The CVR tied to the deal effectively was equivalent to an adverse reserve development cover (liability side of the transaction) sold by FFH as part of the deal and the guarantee on the asset side was effectively an off-balance sheet arrangement reported through a derivative-type of disclosure which corresponded to, effectively, FFH buying a total return swap on the underlying common stocks held in exchange for some kind of cash flow streams, while FFH continued to "guarantee" the value of the underlying securities to the buyer. Now this aspect of the transaction has become much smaller and manageable but it was quite large at the time of the sale..

Anyways, Fairfax is Fairfax and will continue to be, i guess, to a large degree and potentially in a lumpy way..

[Viking]

1 hour ago, StubbleJumper said:

 

To be worth 1.5x BV, effectively, you need to argue that the long-term ROE on a going-forward basis will be high enough.  We know that the first dozen years of FFH's existence were characterised by an absolutely ridiculous run of consistently high growth in BV (see the table on page 20 of Prem's annual letter from last year).  But following that start-up phase that began in 1986 and ended a dozen or so years later, there has been a period of about 20 years with much less convincing growth in BV.   And then there's been the past 3 or 4 years. 

 

It's really interesting to take that table that Prem publishes every year and monkey around with it a bit.  Erase 1986 and 1987 on the argument that you can't "start up" twice and then recalculate compound annual growth.  Break the series into the growth phase from 1986-99 and the lacklustre phase from 2000-2019 or 2020, and calculate the compound growth rates for each of those phases.  When you do this exercise, you might view the 17.7% historical average growth in BV on that table in a somewhat different light and you should certainly question whether that series can be replicated going forward.

 

That then leaves the really difficult task of guessing what all of that means for the future.  My take is that the economics of the insurance industry will not allow FFH to routinely achieve its bogey of 15% growth in BV on a going forward basis.  I'd be happy if they could grow BV by 12%, but suspect that it may be more like 10% over the long term.  That's not a knock on FFH, it's just a tough industry.  If they actually do routinely achieve that 15% goal, I'll be the happiest guy around.

 

But, turning to valuation, if you pay 1.5x BV for something that grows its book by 15%, you are basically getting a 10% earnings yield with relatively rapid growth.  But, if you paid 1.5x BV and FFH grows BV by 10%, you are getting a 6.7% earnings yield and decent growth...and I'd say you'd have slightly overpaid, but not terribly so if the earnings are rock-solid, regular and predictable (in other words all of the things that the insurance industry is not!).  At this point it's trading at a shade over 1x BV, which means that the market finally figures that FFH is worth more alive than dead (ie, if it trades at <1x BV, in theory it's worth more dead than alive, so just break it up, sell off the pieces or run them off, and give the proceeds to the shareholders!).  I'd say that it's definitely worth 1.2x but I guess we'll see over the coming months whether the market agrees with that.  Maybe it'll rattle off 8 or 10 years of fabulous returns that will make me think it's worth 1.5x?  Time will tell....

 

SJ

Great conversation @StubbleJumper and @Cigarbutt . I think trying to model ROE more than 5 years out is largely a fools errand (i.e. the next 10 or 15 years). However, i think ROE can be modelled over the next 3 years and perhaps over the next 5 years with some accuracy. This is true for any company, including Fairfax. 

 

My guess is Fairfax has an excellent opportunity to deliver 15% ROE (on average) for each of the next 5 years. Why?

1.) As Buffett teaches us with the Aesop fable, the size, timing and certainty of cash flows are the three key variables. Fairfax will be earnings an enormous amount over the next 5 years ($20 billion?) - and we now have a high degree of certainty on this.  

2.) Fairfax is on a 6 year ‘hot streak’ when it comes to capital allocation. Financial markets have experienced wicked volatility over the past 4 years - active management matters a lot in this environment. Please re-read 1.) and add the effects of compounding. 

3.) It looks to me like Fairfax has been upgrading the quality of its insurance businesses. This suggest underwriting profit is likely to surprise to the upside moving forward (like it has in 2022 and 2023). 
4.) Fairfax has been aggressively upgrading the quality of their massive $17 billion equity portfolio for the past 6 years and the benefits of this are just starting to hit earnings. Historical numbers don’t help with this bucket - they misinform an investor.
5.) Fairfax’s $43 billion fixed income portfolio is perfectly positioned for the next few years and the benefits of this are flowing into earnings.

6.) Fairfax has been incubating holdings on its balance sheet for years (and decades). These will be monetized at the appropriate time and the company will book significant one time gains. Lumpy. But lumpy doesn’t mean they don’t exist. 

None of the 6 points above are being reflected in the current multiple. I think that’s crazy. As an investor, i love it.

If you want to look out more than 5 years you are really making a call on management and their capital allocation skills. Are they good? If so, how good?

 

Today most people on this board are now saying “yes, earnings look good for the next 3 or 4 years BUT it can’t possibly continue over the long term.”
 

With the stock trading so cheaply today it suggests Fairfax’s ROE will be poor in 2024, 2025, 2026 and every year after. IMHO, that is a massive disconnect from reality.

Edited February 17 by Viking

[MMM20]

5 hours ago, StubbleJumper said:

To correct a couple of points in your post, float does show up on the balance sheet as investments (ie, we take policy holders' premiums and invest them and that's where the float goes) and as policy liabilities.  What is more, float is not always at zero-cost or better, as there have been many years when the CR exceeded 100.  But life is definitely grand when that zero-cost or better situation prevails!

I disagree with your corrections. 
 

1) Yes of course the assets show up with an offsetting liability. But that’s missing something: the structural excess delta between the return on those investments and the cost of that financing. FFH doesn’t have to borrow at 6-8% because they can borrow at 0% by underwriting to breakeven. And that shows up in the income statement in higher earnings but not fully and properly on the balance sheet. That piece of the whole thing is an intangible asset that the accountants understate and our job as analysts to fix that. Right? I make a conservative assumption for that delta and capitalize it. Isn’t that the accurate way to handle it?
 

2) I’m talking about the ability to underwrite to breakeven or slightly better in the long run through cycles and volatility. The year to year volatility shouldn’t factor into the assessment of intrinsic value given sufficient discipline and quality on the insurance side - and they’ve proven that at this point IMHO. 

 

Does that make sense? What am I still missing?

 

Edited February 17 by MMM20

[valueventures]

Apologies if this has already been discussed in detail, but does anyone have updated thoughts around FFH's possible inclusion in the S&P/TSX 60 this year? Seems like the most mechanical means of facilitating more institutional involvement in the stock and driving up P/B.

 

I believe FFH already qualifies for the index based on its size, so curious to hear what is holding it back. Thanks!

[Maverick47]

@MMM20 Your point about float appearing on the balance sheet in an overstated manner that an analyst ought to adjust does, I think, also apply to the difference between deferred income tax liabilities and assets.  Fairfax has about $1 billion more deferred tax liabilities than assets on their balance sheet.  That net liability is akin to an interest free loan from the tax authorities.  Not as valuable as float generated at a negative cost with positive underwriting profits, but more favorable than debt or preferred stock issuances.

[SharperDingaan]

22 hours ago, Ghost said:

 

This situation that FFH is currently in (attack by short sellers) reminds me of the Gamestop saga, except of course FFH today is actually undervalued. 

 

It's way more lethal when 'institutions' are mocking you. MW has erred badly, and it has entangled them in a growing tar baby. They have a weak hand, their network is reassessing them, time is ticking, and they need a way out (Reddit). There is a much higher risk adjusted payoff to simply staying put.

 

The smart thing would be for MW to cut bait, and fold. Question is, does their network let them?

Bought the popcorn, expecting a show.

 

SD

Edited February 18 by SharperDingaan

[Hoodlum]

6 minutes ago, SharperDingaan said:

 

It's way more lethal when 'institutions' are mocking you. MW has erred badly, and it has entangling them in a growing tar baby. They have a weak hand, their network is reassessing them, time is ticking, and they need a way out (Reddit). There is a much higher risk adjusted payoff to simply staying put.

 

The smart thing would be for MW to cut bait, and fold. Question is, does their network let them?

Bought the popcorn, expecting a show.

 

SD

I know MW says they are still shorting but I wouldn’t trust anything they say.  Do we know they didn’t cover over a week ago?  Maybe @sleepydragon is able to see that. 

[nwoodman]

1 hour ago, valueventures said:

Apologies if this has already been discussed in detail, but does anyone have updated thoughts around FFH's possible inclusion in the S&P/TSX 60 this year? Seems like the most mechanical means of facilitating more institutional involvement in the stock and driving up P/B.

 

I believe FFH already qualifies for the index based on its size, so curious to hear what is holding it back. Thanks!

@SafetyinNumbers seems to be the resident expert here.  However from what I can gather it is in the hands of the committee because as, as you rightly point out, they meet the following criteria:

 

1. Market Cap

2. Liquidity and Trading Volume

 

other things that will be considered by the committee are

 

3. Public Float

4. Financial Health

5. Sector and Industry Representation

6. Compliance and Governance

 

Not sure how the Muddy Water shenanigans affects the process, it shouldn’t but who knows.  I will say one thing though the TSX60 has been a real laggard.

 

The demand from Index inclusion would make ideal conditions for unwinding the TRS position.

 

 

 

 

 

 

Edited February 17 by nwoodman

[StubbleJumper]

1 hour ago, MMM20 said:

1) Yes of course the assets show up with an offsetting liability. But that’s missing something: the structural excess delta between the return on those investments and the cost of that financing. FFH doesn’t have to borrow at 6-8% because they can borrow at 0% by underwriting to breakeven. And that shows up in the income statement in higher earnings but not fully and properly on the balance sheet. That piece of the whole thing is an intangible asset that the accountants understate and our job as analysts to fix that. Right? I make a conservative assumption for that delta and capitalize it. Isn’t that the accurate way to handle it?
 

 

I would say that what you are describing is the business.  The actual asset is the statutory capital that the insurance company maintains on its balance sheet, and it is that asset which enables the insurance company to write policies.  That definitely is an asset.  The float itself and the financing differential is the mechanism to generate profit from that statutory capital.  If you want to argue that $100m of statutory capital is actually worth $150m or $200m as long as the business is a going-concern, then I guess that's okay as it's akin to arguing that an insurer should trade above book.

 

1 hour ago, MMM20 said:

) I’m talking about the ability to underwrite to breakeven or slightly better in the long run through cycles and volatility. The year to year volatility shouldn’t factor into the assessment of intrinsic value given sufficient discipline and quality on the insurance side - and they’ve proven that at this point IMHO. 

 

 

You are assuming that underwriting will be profitable across a cycle.  That is not always the case for insurers, and hasn't always been the case with FFH.  Certainly we hope that they will be able to experience underwriting profits over, say, a 10 year period but that is not always the case.

 

 

SJ

[StubbleJumper]

1 hour ago, Viking said:

Great conversation @StubbleJumper and @Cigarbutt . I think trying to model ROE more than 5 years out is largely a fools errand (i.e. the next 10 or 15 years). However, i think ROE can be modelled over the next 3 years and perhaps over the next 5 years with some accuracy. This is true for any company, including Fairfax. 

 

 

No, I would never be so brave as to try to model things out past a few years for a company like FFH.  You've been pretty courageous to construct your forecasts for even a few years!  The purpose of making observations about the long-term ROE or long-term rate of growth in BV is that this is really the question that puts a boundary on valuation.  Personally, I figure FFH might be worth 1.2x or 1.3x as a going-concern, but others figure it might merit a much richer valuation.  Well, that view needs to be informed by the type of BV growth rate that would be required to justify the higher valuation.  And that table that Prem publishes every year in his letter should be a bit of a reality check on how enthusiastic we ought to be!

 

2 hours ago, Viking said:

My guess is Fairfax has an excellent opportunity to deliver 15% ROE (on average) for each of the next 5 years

 

Well, you are braver than me if you are going out five years!  Every year that FFH shoots the lights out it becomes more difficult to attain the 15% bogey because capital accumulates and needs to be reinvested in something that will provide roughly a 15% ROE if they want to continue to make that bogey.  With the rapidly growing book, it's been pretty easy for the insurance subs to soak up pretty much all of the capital provided from their annual earnings and reinvest it in writing more business.  But, 2023 is a bit concerning because that process growing the book seems to have slowed, meaning that we will likely see a fair bit of excess capital in those subs when the annual report comes out next month.  Unless there's a quick turnaround in underwriting, that capital will need to be deployed elsewhere.  So the usual thing would be to dividend it to the holdco which would then do something like buy a new business, repay debt, repurchase shares or, as was done, increase the dividend.  Most of those options strike me as having a lower return than expanding the book has provided over the past 3 or 4 years!  Compounding is great as long as your flow of investment opportunities is attractive.  In the end, I hope you are correct about 15% for the next five years, but it won't be easy.

 

2 hours ago, Viking said:

With the stock trading so cheaply today it suggests Fairfax’s ROE will be poor in 2024, 2025, 2026 and every year after. IMHO, that is a massive disconnect from reality.

 

With FFH trading near adjusted-book, the market is basically saying that there's not much value to the company being a going-concern.  It's basically saying that shareholders would be equally well off to break up the company, sell off the parts at their carrying value (or run off the business), pay off the debts and distribute the cash.  I'd say that's a little too pessimistic :-).  FFH definitely has more value as a going-concern than it does as a collection of assets.

 

The easiest thing to do at this stage is what we did all throughout 2023.  Don't worry about valuation too much because at 1x BV it's probably undervalued anyway.  Just take your estimate of earnings for 2024 and maybe 2025, add it to current BV and decide whether you'd be satisfied if the stock price were at your forecast BV for 2024 and 2025.  In the short term, it looks like an adequate return can be obtained with no growth in valuation.  And if there is an expansion to 1.2x or 1.3x, so much the better.

 

 

SJ

 

 

PS, Our friend, Brett Horn, who figures it's worth CAD$970 per share, but for some reason hasn't recommended liquidation even though BV is ~30% higher than that.  Strange, that. 

[SafetyinNumbers]

59 minutes ago, nwoodman said:

@SafetyinNumbers seems to be the resident expert here.  However from what I can gather it is in the hands of the committee because as, as you rightly point out, they meet the following criteria:

 

1. Market Cap

2. Liquidity and Trading Volume

 

other things that will be considered by the committee are

 

3. Public Float

4. Financial Health

5. Sector and Industry Representation

6. Compliance and Governance

 

Not sure how the Muddy Water shenanigans affects the process, it shouldn’t but who knows.  I will say one thing though the TSX60 has been a real laggard.

 

The demand from Index inclusion would make ideal conditions for unwinding the TRS position.

 

 

 

 

 

 

 

I think it qualifies for the S&P/TSX 60 but additions and deletions are subject to committee as @nwoodman pointed out and historically they don’t act unless there is an opening via M&A or a constituent goes below 20bps.
 

Currently, there is no opening but there is usually some turnover annually so presumably it’s just a matter of time. Given the built in growth at Fairfax its weighting is only going higher, it’s possible the committee acts and deletes an constituent above the 20bp historical precedent or deletes a smaller financial to help with the sector representation. 
 

I spoke to a few fund managers this week and to me seems like a logical approach given valuation and catalysts (Digit IPO, Eurobank dividend, BIAL IPO etc…) is to stay overweight until at least the week of 60 add. It will probably be a mistake to sell then as well in the long term but that will depend on the multiple and prospects at the time.

[Cigarbutt]

2 hours ago, MMM20 said:

I disagree with your corrections...
... But that’s missing something: the structural excess delta between the return on those investments and the cost of that financing...That piece of the whole thing is an intangible asset that the accountants understate and our job as analysts to fix that. Right? I make a conservative assumption for that delta and capitalize it. Isn’t that the accurate way to handle it?
...

Does that make sense? 

What you describe is the whole (main) point as to why insurers may be worth more than book value.

For FFH, some adjustments (less discounting of the reserves) need to be made to the potential delta effect that you mention.

Also, to avoid double counting, i think you need to recognize that some of the intangible asset aspect has already been recognized when subs were acquired:

[Haryana]

6 hours ago, TwoCitiesCapital said:

 

Just be careful applying this in practice. 

 

Fairfax owned a ton of cash/short duration bonds in 2020. The stock still was down over 50+% from the peak despite that. 

 

This was also demonstrated in 2008 where the stock of Fairfax was falling even while it's CDS were printing money. 

 

In a panic, it'll trade like a stock regardless of how well it's underlying assets are doing.

 

Volatility can be good for those who understand their hold and stay for the long term.

The danger is if they go out of business but then your cash holding bank can also fail.

"All I want to know is where I’m going to die, so I’ll never go there." - Charlie Munger

 

[Haryana]

12 hours ago, Spooky said:

 

... Buffett’s returns appear to be neither luck nor magic, but, rather, reward for the use of leverage combined with a focus on cheap, safe, quality stocks. ...

 

 

 

This is why I emphasize the following:

1. Buffett Brainwash Syndrome {Buffett = Oracle/Prophet;}

2. The method can be copied by someone with the right temperament

 

[TwoCitiesCapital]

1 hour ago, Haryana said:

 

Volatility can be good for those who understand their hold and stay for the long term.

The danger is if they go out of business but then your cash holding bank can also fail.

"All I want to know is where I’m going to die, so I’ll never go there." - Charlie Munger

 

 

Absolutely. I agree. 

 

Except cash isn't volatile. Treating Fairfax as a cash equivalent because of the fixed income it owns will likely be a mistake in volatile environments - environments where cash would be expected to "gain" in relative value where Fairfax might be "losing" relative value

[MMM20]

16 hours ago, Cigarbutt said:

What you describe is the whole (main) point as to why insurers may be worth more than book value.

Agreed and I know I’m mostly preaching to the choir. My main point was that fair value is clearly well above accounting book value and mainly for this reason, however exactly you frame it. We can disagree how much above (for me quite clearly minimum 1.5x book), but how does it make any sense for this to still trade barely above liquidation value? I wonder if the market is actually still missing that main point or if I’m the one missing something stupid and getting lucky, in which case I need to cut this in half at least. Paranoia. 
 

Edited February 18 by MMM20

[MMM20]

12 hours ago, Haryana said:

This is why I emphasize the following:

1. Buffett Brainwash Syndrome {Buffett = Oracle/Prophet;}

2. The method can be copied by someone with the right temperament

I still don’t discount how difficult it was to actually execute that strategy over so many decades. It all looks so oblivious and easy in retrospect but Buffett still the GOAT even if leverage explains much of it. Luckily (for us) Prem had the same insight - and now the whole business is morphing toward quality, at least as a few of us value nerds define it. History doesn’t repeat but it does rhyme. Let’s debate it, Mr. Block

 

Edited February 18 by MMM20

[Haryana]

15 hours ago, TwoCitiesCapital said:

 

Absolutely. I agree. 

 

Except cash isn't volatile. Treating Fairfax as a cash equivalent because of the fixed income it owns will likely be a mistake in volatile environments - environments where cash would be expected to "gain" in relative value where Fairfax might be "losing" relative value

No, sure, you have a valid point there. 

Not saying from the point of financial planning or risk management but from the risk and value profile point of view.

Following from the BRK 2008 letter: 

[Additionally, the market value of the bonds and stocks that we continue to hold suffered a significant decline along with the general market. This does not bother Charlie and me. Indeed, we enjoy such price declines if we have funds available to increase our positions. Long ago, Ben Graham taught me that “Price is what you pay; value is what you get.” Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.] 

[Xerxes]

On 2/17/2024 at 6:12 PM, SafetyinNumbers said:

 

I think it qualifies for the S&P/TSX 60 but additions and deletions are subject to committee as @nwoodman pointed out and historically they don’t act unless there is an opening via M&A or a constituent goes below 20bps.
 

Currently, there is no opening but there is usually some turnover annually so presumably it’s just a matter of time. Given the built in growth at Fairfax its weighting is only going higher, it’s possible the committee acts and deletes an constituent above the 20bp historical precedent or deletes a smaller financial to help with the sector representation. 
 

I spoke to a few fund managers this week and to me seems like a logical approach given valuation and catalysts (Digit IPO, Eurobank dividend, BIAL IPO etc…) is to stay overweight until at least the week of 60 add. It will probably be a mistake to sell then as well in the long term but that will depend on the multiple and prospects at the time.

 

 

On Google Search, i simply typed:

 

"Tesla performance since s&p 500 inclusion"

 

Google Search answered the following as its first answer:

 

"Tesla shares closed around $232 on Dec. 18, 2020, the session before the company joined the S&P 500. Today they're about $247, a 6.7% increase based on closing prices. Meanwhile, the S&P 500 has climbed roughly 27%, led by mega-cap technology stocks such as Microsoft Corp., Apple Inc."

 

Who needs ChatGPT .. but that is beside the point.

My actual point would that index inclusion is sometimes more about the journey rather than end goal.

 

[Hamburg Investor]

On 2/17/2024 at 8:08 PM, StubbleJumper said:

 

To be worth 1.5x BV, effectively, you need to argue that the long-term ROE on a going-forward basis will be high enough.  We know that the first dozen years of FFH's existence were characterised by an absolutely ridiculous run of consistently high growth in BV (see the table on page 20 of Prem's annual letter from last year).  But following that start-up phase that began in 1986 and ended a dozen or so years later, there has been a period of about 20 years with much less convincing growth in BV.   And then there's been the past 3 or 4 years. 

 

It's really interesting to take that table that Prem publishes every year and monkey around with it a bit.  Erase 1986 and 1987 on the argument that you can't "start up" twice and then recalculate compound annual growth.  Break the series into the growth phase from 1986-99 and the lacklustre phase from 2000-2019 or 2020, and calculate the compound growth rates for each of those phases.  When you do this exercise, you might view the 17.7% historical average growth in BV on that table in a somewhat different light and you should certainly question whether that series can be replicated going forward.

 

That then leaves the really difficult task of guessing what all of that means for the future.  My take is that the economics of the insurance industry will not allow FFH to routinely achieve its bogey of 15% growth in BV on a going forward basis.  I'd be happy if they could grow BV by 12%, but suspect that it may be more like 10% over the long term.  That's not a knock on FFH, it's just a tough industry.  If they actually do routinely achieve that 15% goal, I'll be the happiest guy around.

 

But, turning to valuation, if you pay 1.5x BV for something that grows its book by 15%, you are basically getting a 10% earnings yield with relatively rapid growth.  But, if you paid 1.5x BV and FFH grows BV by 10%, you are getting a 6.7% earnings yield and decent growth...and I'd say you'd have slightly overpaid, but not terribly so if the earnings are rock-solid, regular and predictable (in other words all of the things that the insurance industry is not!).  At this point it's trading at a shade over 1x BV, which means that the market finally figures that FFH is worth more alive than dead (ie, if it trades at <1x BV, in theory it's worth more dead than alive, so just break it up, sell off the pieces or run them off, and give the proceeds to the shareholders!).  I'd say that it's definitely worth 1.2x but I guess we'll see over the coming months whether the market agrees with that.  Maybe it'll rattle off 8 or 10 years of fabulous returns that will make me think it's worth 1.5x?  Time will tell....

 

 

SJ

 

I don‘t agree with your phases. It seems attractive at first sight, but it’s too simple:

 

Generally speaking a part of FFHs book value return has always been bound to the stock market. So it is no coincidence, that your first phase tracks the best bull market in history (started in 1987). In the following 10 years 2 of the 4 worst bear markets in over hundred years hit the stock market (tech bubble and financial crisis). Followed by the second best bull market in history, the recovery from the financial crisis with ultra low interest rates, that the world had never seen before.

I don’t disagree with the idea, that FFH will not be able to repeat the returns until 1999, as those returns had a lot to do with FFH being small, having a lot more float to assets than in the following years, being in a hard market and having wind from the back with the best stock market returns ever.

 

But by ignoring the tailwinds in the first phase you overestimate FFHs own ability in your first phase and underestimate it in your second (where much more headwind can be seen). Let‘s look at the second phase:

 

- 2000 until 2002: „9/11 and tech bubble crash: Welcome to reality“

These years were very special. Although Fairfax had own problems, the big points were the World Trade Centre (which hit the cr of FFH hard) and the collapse of the markets after the crash of the tech bubble and after 9/11 (so 9/11 hit FFH double, as it not only hit the cr but also hit stock prices) and a hard market (which ended 2003). This would be my second phase. 

- 2003 until 2009: „Good years again“

From 2003 (so after the bear market from 1999 to 2002) until 2009 (so over a full cycle) the returns of FFH are good, especially if you count in the drag by the soft market kicking in 2003 and lasting until 2010/2017). Prems returns weren‘t special until 2006, but with betting against the housing market became superb until 2009. That would be imho my third phase.

- 2009 until 2016: „Turning to black: The lost years“

In the years 2009 until 2011 a lot of things changed to the bad: Interest rates collapsed (so headwind for the insurance sector), the insurance market hardened a bit (only to get soft again some years later until 2017; on average it was a flat market in this phase), „growth outperforming value like never before“ (a drag for Prems stock returns, being a value investor; that ended 2020), bad hedge decisions of management started. This phase ended 2016. „The lost years“, partially through bad management decisions, as discussed here oftentimes - but there were a lot of headwinds to the insurance sector and Prems investment style in particular.

 

- 2016 until 2020: „The hidden turnaround years“

Still growth beat value, even more. But the insurance market began to harden. Management started to turn things around. Management performed maybe better than ever, growing insurance business and widening its international foot print, ending hedges, good investment decisions. But nobody sees it. The headwinds are too strong. Book value doesn‘t reflect, what’s happening under the surface.

 

- 2021 until????: „Fairfax shines again“

Rising interest rates and inflation kicked in, value beating growth again. The market is hard now. So these are again external factors, that gave and give a tailwind to the insurance sector and to FFH in particular. But again Management nailed it: Perfect management of bond portfolio.

Edited February 19 by Hamburg Investor

[StubbleJumper]

7 minutes ago, Hamburg Investor said:

 

I don‘t agree with your phases. It seems attractive at first sight, but it’s too simple:

- generally speaking a part of FFHs book value return has always been bound to the stock market. So it is no coincidence, that your first phase tracks the best bull market in history (started in 1987). In the following 10 years 2 of the 4 worst bear markets in over hundred years hit the stock market (tech bubble and financial crisis). Followed by the second best bull market in history, the recovery from the financial crisis with ultra low interest rates, that the world had never seen before.

I don’t disagree with the idea, that FFH will not be able to repeat the returns until 1999, as those returns had a lot to do with FFH being small, having a lot more float to assets than in the following years, being in a hard market and having wind from the back with the best stock market returns ever.

 

But by ignoring the tailwinds in the first phase you overestimate FFHs own ability in your first phase and underestimate it in your second (where much more headwind can be seen). Let‘s look at the second phase:

- 2000 until 2002 were very special. Although Fairfax had own problems, the big points were the World Trade Centre (which hit the cr of FFH hard) and the collapse of the markets after the crash of the tech bubble and after 9/11 (so 9/11 hit FFH double, as it not only hit the cr but also hit stock prices) and a soft market (which lasted until around 2010). This would be my second phase. 
- from 2003 (so after the bear market from 1999 to 2002) until 2009 (so over a full cycle) the returns of FFH are good, especially if you count in the drag by the soft market. Prems returns weren‘t special until 2006, but with betting against the housing market became superb until 2009. That would be imho my third phase. 
- In the years 2009 until 2011 a lot of things changed: Interest rates collapsed (so headwind for the insurance sector), the insurance market hardened a bit (only to get soft again some years later until 2017), „growth outperforming value“ (a drag for Prems stock returns, being a value investor), bad hedge decisions of management started. This phase ended 2016. „The lost years“, partially through bad management decisions, as discussed here othentimes - but there were a lot of headwinds to the insurance sector too.

- 2016 until 2020: „The hidden turnaround years“ Still growth beat value. But the insurance market began to harden. Management started to turn things around. Management performed maybe better than ever, growing insurance business and widening its international foot print, ending hedges, good investment decisions. But nobody sees it.

 

- 2021 till ????: „Fairfax shines again“

Rising interest rates and inflation kicked in, value beating growth again. The market is hard now.

 

So these are again external factors, that gave and give a tailwind to the insurance sector and to FFH in particular. But again Management nailed it: Perfect management of bond portfolio.

 

 

Well, you don't have to agree with how I've described the phases.  What's important is to not blindly take the historical 17.7 percent cumulative average growth in BV as something that would necessarily be indicative of FFH's future.  The first dozen or so years exert a great deal of leverage on the average outcome.   I've suggested that some of those were start-up years and are unlikely to be replicated...and you've taken the perspective that those were years with a small asset base and a particular set of circumstances that are unlikely to be replicated.  Okay.

 

I'm not sure that I underestimate FFH management's abilities in comments about the second phase.  I described it as lacklustre results which I viewed as a pretty charitable term given the numbers.  Lots of things went on during those years outside of FFH's control (as you said 9/11, the KRW year, and the four horsemen of the apocalypse) and there were a few unforced errors.  But, that's the insurance industry.  In the end, it was 20 years where BV growth fell short of the 15% annual bogey.  

 

If you get 3 or 4 years in a row of great underwriting conditions and good investing conditions, it is well worth going back and looking at the company's historical financing differential and its history of BV growth.  

 

 

SJ

[glider3834]

Looking at GIG transaction again, I believe based on fair value of acquisition consideration, Fairfax is effectively paying ~ P/B 2.2x for Kipco's stake. 

 

100% implied equity value for GIG based on below is ~US$1.63B & GIG's shareholder equity at 30 Sep-23 was ~US$742.5M, which works out to implied P/B multiple of 2.2x

 

 

US$756M fair value of acquisition consideration is lower than US$860M headline number for two reasons

 

1. Initial US$200M upfront, cash payment is to be reduced by dividends Kipco received after 1 Jan'23.

 

2. Fairfax also has a payment deed for four annual instalments of US$165M (or US$660M) in aggregate which Fairfax records at its fair value ie discounted present value.

 

At 30 Sep-23, Fairfax measured the fair value of acquisition price at US$740M - this has now increase slightly to US$756M at the time of closing. But the workings for how this US$740M is calculated is shown below & helpful.

 

 

 

 

 

 

Edited February 19 by glider3834