Fairfax 2024

[SafetyinNumbers]

7 minutes ago, juniorr said:

how does the capital gains inclusion rate change Fairfax Investments 

 

My guess is it should increase the deferred tax liability all else being equal by the increase in the inclusion rate. Anyone have a better idea?

 

If my estimate is right it would increase the deferred tax liability by ~$412m or ~$18/share. 

[Maverick47]

From an economic standpoint, as long as Fairfax continues to prefer to hold equity investments for the long term and allow the gains to compound on the balance sheet unrealized, there should be no dramatic reduction in reported after tax income.  But if as you’ve noted, the deferred tax liability would increase by $18 per share, the book value ought to drop by an equal amount.

 

However, in my opinion, that is a somewhat misleading effect.  A deferred tax liability is an interest free loan from the government which has to be paid back only when gains are realized.  And a deferred tax asset is an interest free loan to the government that only is  paid back to the company as future income is generated and able to be shielded from taxes because of the prepaid tax asset.

 

Neither of these are present valued on the balance sheet.  An asset that earns no interest is not worth as much in my opinion as a similar amount invested in 5% government bonds.  Similarly, a no interest loan that might not have to be paid off until years in the future is not as large a liability as a similar amount borrowed by means of a 6% interest 10 year bond issue.

 

Fairfax has about a $1 billion net deferred tax liability (interest free loan from the taxing authority) on the balance sheet at year end 2023.  That is a sign of a savvy insurance company in my opinion, and if the liability grows to $1.4 billion after a tax change, it just makes the comparison with peer insurance companies that often record net deferred tax assets on their balance sheets that much more favorable.

[Daphne]

From the perspective of share price, there may be a rush to take capital gains before the new rate kicks in on June 25.

[Xerxes]

Medical question:

 

Anyone understood what medical test Prem Watsa was talking about in the AGM ? that he makes available for everyone in the company. Related to the heart.

 

I recall few years before Covid, I think his CFO passed away. I wonder if that was the reason why this initive was started.

[Xerxes]

21 hours ago, petec said:

But 5 years ago FFH was a Faberge egg, with value inside value inside value. 

 

Plan within plans within plans.

This is right out of Frank Herbert's Dune.

 

[valueseek]

16 minutes ago, Xerxes said:

Medical question:

 

Anyone understood what medical test Prem Watsa was talking about in the AGM ? that he makes available for everyone in the company. Related to the heart.

 

I recall few years before Covid, I think his CFO passed away. I wonder if that was the reason why this initive was started.

Calcium score for over 45 i think

[petec]

11 hours ago, Viking said:

1.) If investors understand the facts so well today why does Fairfax trade at a P/BV of 1.1 x (ext. March 31 book value) and a PE of 6.7 x (est 2024 earnings)?

 

Unlike you, I don't see that as super cheap. It is certainly good value, and allows for solid compounding from here, but insurance companies don't generally sustain multiples *much* higher than this. I mean, it's not like they trade at 2x or 3x book long term. 1.4-1.5x, maybe.

 

11 hours ago, Viking said:

2.) If investors understand the facts so well why are so many people thinking/discussing selling down their position? 

 

For me it's just because FFH has gone from a deep, deep value to a compounder-type value. As the share price has closed on IV, so my position size has doubled, despite the rest of the portfolio doing well. So it is now less good value and a much bigger position. That warrants action so long as there I have other good ideas. But I emphasise that I am not selling much. I am topping the position on share price spikes but I retain most of what I owned at the low in 2020, because I DO see strong performance from here.  I am a *very* long term holder of this stock (16 years so far and hoping for I'm only a quarter of the way through).

 

BTW one area where you and I slightly differ, as we have discussed before, is on how much execution has improved. It definitely HAS improved, and there was a big focus on this after years of investment underperformance. But the things that have really moved the needle are outside management's control: higher interest rates (drives earnings on float and Eurobank's NIM), lower combined ratio (which is clearly and I think mostly driven by higher interest rates because rates have impacted BV at most other insurers and because capital is no longer flooding into the industry in sidecars etc.), and higher commodity prices (which helps a lot of the investment book). All of these things were valuable options 4 years ago; today they are realities and are increasingly (but not fully) priced in. But improved execution hasn't affected these things. In fact, the *really* good execution was *before* these changes happened, when FFH kept the bond portfolio short, kept their underwriting discipline in the soft market, invested in undervalued commodity stocks (much to the chagrin of many here), and waited while Eurobank slowly dealt with their NPLs. Their patience *then* is what is driving today's earnings, more than their execution *now*, it's just that they didn't get credit *then*, but now they do because the market can see the benefits. I see much greater continuity in management's decision-making than you do, and I think this affects how we think about the stock today: you see great execution as something that is likely to continue, whereas I saw FFH *partly* as a bundle of undervalued macro options 4 years ago, and those options are less undervalued now.

 

That said, I also see FFH *partly* as an excellent management team which I want to compound with forever. And I do recognise that in certain key areas execution has transformed, most notably eschewing broad hedging and finding ways out of losing investments rather than holding them forever (although even here, few things have actually been monetised - the bigger thing has simply been positions getting smaller as the portfolio grows).

 

Sorry - longer post than I intended.

 

 

Edited April 17, 2024 by petec

[jfan]

On 4/15/2024 at 9:09 PM, Cigarbutt said:

The prospective measure you're looking for may be an elusive goal. The diagonal measure you describe could reveal some info but IMO not more than the current accident year combined ratio and the ratio you compute could be influenced by recent growth in premiums written which, in itself, would increase the ratio as the payment curve is not bell-shaped with more payments early on and then a long tail to the right. Example:

The idea is to try, for each years and trend-wise, to identify a deviation from the expected trajectory. This is not easy and insurers may be slow to recognize developing issues. For example, look at the following which is a significant pattern that started to develop in the late 90s for medical malpractice claims:

Over time, it became clear that developing trends would become very costly. BTW, this cumulative payment curve is sort of representative for the average long-tail type of lines that FFH carries (duration and shape).

Up to 2013, FFH reported accident year reserve development and that was helpful but it's not a requirement and is no longer reported by them. It's possible to figure it out but it takes some effort.

 

 

Thanks @Cigarbutt. Your post was very helpful. I came across a blog (only glanced at it) discussing converting calendar year to accident year which I've linked below:

Calculating an insurer’s accident year and calendar year reserves | kitchensinkinvestor (wordpress.com)

At my stage (can only trust but not yet verify), I can only take Prem's words that they are underwriting conservative and consistently with the goal to survive. From a top down view, the following "soft" items suggest this is taking place:

1) Not letting go of employees when there is a soft market

2) Not acquiring turnaround insurance operations

3) allowing insurance subs to operate in a decentralized manner to flatten barriers to information flow

4) facilitating fun competitions to innovate between organizations, to share best practices

5) tenure of insurance presidents in the organization

6) cautiousness in entering new territories ie cybersecurity (small exposure, recognizing Cat-like behaviours)

7) the obvious data trends for combined ratio/loss ratio, net premium written:surplus ratios, reserve triangle patterns

 

Last but not least,  the kindness of the CoBF board to scrutinize Fairfax

 

 

[UK]

Is it fair to conclude that their duration of insurance liabilities decreased quite substantially in last six years, from this info bellow?

 

 

Edited April 17, 2024 by UK

[vinod1]

6 hours ago, petec said:

 

Unlike you, I don't see that as super cheap. It is certainly good value, and allows for solid compounding from here, but insurance companies don't generally sustain multiples *much* higher than this. I mean, it's not like they trade at 2x or 3x book long term. 1.4-1.5x, maybe.

 

 

For me it's just because FFH has gone from a deep, deep value to a compounder-type value. As the share price has closed on IV, so my position size has doubled, despite the rest of the portfolio doing well. So it is now less good value and a much bigger position. That warrants action so long as there I have other good ideas. But I emphasise that I am not selling much. I am topping the position on share price spikes but I retain most of what I owned at the low in 2020, because I DO see strong performance from here.  I am a *very* long term holder of this stock (16 years so far and hoping for I'm only a quarter of the way through).

 

BTW one area where you and I slightly differ, as we have discussed before, is on how much execution has improved. It definitely HAS improved, and there was a big focus on this after years of investment underperformance. But the things that have really moved the needle are outside management's control: higher interest rates (drives earnings on float and Eurobank's NIM), lower combined ratio (which is clearly and I think mostly driven by higher interest rates because rates have impacted BV at most other insurers and because capital is no longer flooding into the industry in sidecars etc.), and higher commodity prices (which helps a lot of the investment book). All of these things were valuable options 4 years ago; today they are realities and are increasingly (but not fully) priced in. But improved execution hasn't affected these things. In fact, the *really* good execution was *before* these changes happened, when FFH kept the bond portfolio short, kept their underwriting discipline in the soft market, invested in undervalued commodity stocks (much to the chagrin of many here), and waited while Eurobank slowly dealt with their NPLs. Their patience *then* is what is driving today's earnings, more than their execution *now*, it's just that they didn't get credit *then*, but now they do because the market can see the benefits. I see much greater continuity in management's decision-making than you do, and I think this affects how we think about the stock today: you see great execution as something that is likely to continue, whereas I saw FFH *partly* as a bundle of undervalued macro options 4 years ago, and those options are less undervalued now.

 

That said, I also see FFH *partly* as an excellent management team which I want to compound with forever. And I do recognise that in certain key areas execution has transformed, most notably eschewing broad hedging and finding ways out of losing investments rather than holding them forever (although even here, few things have actually been monetised - the bigger thing has simply been positions getting smaller as the portfolio grows).

 

Sorry - longer post than I intended.

 

 

 

Terrific post. 

 

Jerome Powell should get nearly as much credit as anyone else for Fairfax improved performance. 

 

Board members are very thoughtful and intelligent and I am not suggesting they fall for these things but there a terrific book that shines light on some of these things.

 

https://www.amazon.com/The-Halo-Effect-Phil-Rosenzweig-audiobook/dp/B002C0CG2Q/?_encoding=UTF8&pd_rd_w=7FDQE&content-id=amzn1.sym.cf86ec3a-68a6-43e9-8115-04171136930a&pf_rd_p=cf86ec3a-68a6-43e9-8115-04171136930a&pf_rd_r=144-1873670-4288829&pd_rd_wg=jNneC&pd_rd_r=f125960c-d014-425f-a302-19a2dd4c96f4&ref_=aufs_ap_sc_dsk

 

Vinod

[MMM20]

1 hour ago, vinod1 said:

Jerome Powell should get nearly as much credit as anyone else for Fairfax improved performance. 

 

The test of a first-rate intelligence is the ability to hold two opposed ideas in the mind at the same time and still retain the ability to function.

 

1) Fairfax management has executed and upgraded the quality of the business - yet the stock still trades around 1.1x book and 7x p/e and even after a monster run still seems like an absolute and relative bargain.

 

2) Interest rates normalizing off all-time lows was a huge tailwind and made them look even better - if that hadn't happened (yet), it might still trade at $500.

 

Edited April 17, 2024 by MMM20

[giulio]

FFH did not need higher interest rates to work out well as an investment in 2020-2021.

If you held everything the same, the stock was easily worth 2x.

When I was building my position the market cap was around $10B and I thought that in 5 years time FFH's shares of Atlas + Digit + FIH could easily be worth $5B. I was able to get ALL the rest for $5B.

IT WAS A NO BRAINER.

The subsequent outperformance was surely due to not just one factor but multiple ones working in the same direction:

• no more shorts,/hedges
• fih investments surfacing value
• equities portfolio recovering from covid
• better uw results
• hard market
• buybacks
• higher interest on fixed income portfolio

and I am sure I am missing others.

 

4-5% rates are not an anomaly. 0-1% was! My assumption in 2021 was rates would go back to 2019 levels, 2% at best. Still, FFH was so undervalued.

 

To say that FFH worked out as an investment ONLY because JPow hiked rates is UNFAIR to the great work done by Watsa and the team.

 

G

 

 

[Xerxes]

9 hours ago, petec said:

 

All of these things were valuable options 4 years ago; today they are realities and are increasingly (but not fully) priced in.

Pete,

 

Going on same theme of embedded call option getting good value in recent years for FFH, do you see a similar “step-change” in Berkshire history in the 90s and 2000s, where it was the optionally that got fully valued more than anything else. 
 

Is Berkshire being ready for the disaster that GFC was, counts in your opinion as the same as FFH being ready for a major re-rating ?

[Xerxes]

12 hours ago, valueseek said:

Calcium score for over 45 i think

thank you. will look into this. 

Those few words could end up be the most important part of this investment/insurance AGM.  

[Santayana]

10 hours ago, petec said:

But the things that have really moved the needle are outside management's control: higher interest rates

Being positioned to take advantage of the higher rates was completely in management's control, and there was really only one direction rates could move.

[Viking]

11 hours ago, petec said:

Unlike you, I don't see that as super cheap. It is certainly good value, and allows for solid compounding from here, but insurance companies don't generally sustain multiples *much* higher than this. I mean, it's not like they trade at 2x or 3x book long term. 1.4-1.5x, maybe.

 

@petec I really appreciate the opportunity to discuss/debate Fairfax. 

 

One of the keys to valuing Fairfax today is your assessment of two things:

1.) How good is their insurance business?

- Is it average or above average (compared to peers)? 

2.) How good is their investment team at Hamblin Watsa?

- Is it average or above average (compared to peers)?

 

Here is my quick assessment:

 

I think the insurance business is above average (compared to peers). Not best-in-class yet but definitely better than average. Importantly it appears to be improving in quality; trend is important when looking forward.

 

I think their investment team (at Hamblin Watsa) is best-in-class (compared to peers). Especially in a high interest rate environment (versus a zero interest rate environment) with lots of volatility in financial markets. This is important because Fairfax generates about 80% of their income streams from investments and only 20% from insurance underwriting. (I think most insurers are about 55-60% from investments and 40-45% from insurance underwriting - don't quote me on this split). 

 

Fairfax is currently earnings about 7.5% on its investment portfolio and this is significantly more than P/C insurance peers. This outperformance will likely continue for the next couple of years (one reason being the average duration of the fixed income portfolio has been extended to about 3 years). There is a very good chance Fairfax's average ROE over the next three years will be 15% or higher (it could easily be in the high teens).

 

Fairfax has been the best performing P/C insurance company over the past 5 years (in terms of BV growth). It also has the best prospects looking out three years (given its significant leverage to investments and their current positioning). And it is by far the cheapest today.  

 

It is within this context that I think Fairfax trading today at a P/BV = 1.1 is crazy cheap. Especially when compared to P/C insurance peers today. Most trade at a P/BV of 1.4 x or higher. The set-up today at Fairfax looks an awful lot like a much younger Berkshire Hathaway. In that context I think a P/BV multiple of 1.1 x is nuts. 

[petec]

47 minutes ago, Viking said:

 

@petec I really appreciate the opportunity to discuss/debate Fairfax. 

 

One of the keys to valuing Fairfax today is your assessment of two things:

1.) How good is their insurance business?

- Is it average or above average (compared to peers)? 

2.) How good is their investment team at Hamblin Watsa?

- Is it average or above average (compared to peers)?

 

Here is my quick assessment:

 

I think the insurance business is above average (compared to peers). Not best-in-class yet but definitely better than average. Importantly it appears to be improving in quality; trend is important when looking forward.

 

I think their investment team (at Hamblin Watsa) is best-in-class (compared to peers). Especially in a high interest rate environment (versus a zero interest rate environment) with lots of volatility in financial markets. This is important because Fairfax generates about 80% of their income streams from investments and only 20% from insurance underwriting. (I think most insurers are about 55-60% from investments and 40-45% from insurance underwriting - don't quote me on this split). 

 

Fairfax is currently earnings about 7.5% on its investment portfolio and this is significantly more than P/C insurance peers. This outperformance will likely continue for the next couple of years (one reason being the average duration of the fixed income portfolio has been extended to about 3 years). There is a very good chance Fairfax's average ROE over the next three years will be 15% or higher (it could easily be in the high teens).

 

Fairfax has been the best performing P/C insurance company over the past 5 years (in terms of BV growth). It also has the best prospects looking out three years (given its significant leverage to investments and their current positioning). And it is by far the cheapest today.  

 

It is within this context that I think Fairfax trading today at a P/BV = 1.1 is crazy cheap. Especially when compared to P/C insurance peers today. Most trade at a P/BV of 1.4 x or higher. The set-up today at Fairfax looks an awful lot like a much younger Berkshire Hathaway. In that context I think a P/BV multiple of 1.1 x is nuts. 

 

I don't disagree with any of that. I perhaps ought to clarify that when I say 1.1x isn't crazy cheap, what I mean is I don't necessarily expect the market to value it a whole lot higher. However I do think that at 1.1x (and even 1.5) FFH can compound at a very attractive rate for a long time (which I define as 5 years minimum and really 10+ years).

 

In other words, I kind of expect this to stay "cheap", and that's one of the things I like about it, because I think that allows it to compound nicely for me.

[petec]

52 minutes ago, Viking said:

The set-up today at Fairfax looks an awful lot like a much younger Berkshire Hathaway.

 

This will be a controversial post, but I have 5 core holdings which make up 60% of my liquid net worth. One is Berkshire itself. One is Microsoft. Three are things that I think one way or another look like younger Berkshires: FFH, PSH, and BN. I'm just waiting for the silver fox to buy and insurance company 

[petec]

4 hours ago, giulio said:

To say that FFH worked out as an investment ONLY because JPow hiked rates is UNFAIR to the great work done by Watsa and the team.

 

That is certainly not what I meant. What I said was that FFH in 2020 had macro options embedded within it. In other words, IF rates rose it would benefit mightily. The price reflected nothing for this, but it seemed highly likely to me. 

 

As a result, it is fair to say that rising rates NOT management action has driven much of the recent increase in earnings. 

 

Management action, however, has determined earnings POWER over time. In particular their willingness to wait rather than chase premiums and yield. They deserve a TON of credit for that. But those decisions were taken years ago.

[petec]

2 hours ago, Santayana said:

Being positioned to take advantage of the higher rates was completely in management's control, and there was really only one direction rates could move.

 

Exactly. The money they are making now was earned years ago, when everyone thought they were idiots.

[Viking]

What do people on the board feel are the biggest risks when investing in Fairfax today? Let’s spend some time discussing/debating these as a group - it is important that we live in the real world. So please post your thoughts. 

 

When I was at Fairfax’s AGM a number of people I talked to identified interest rates/lower bond yields as a big risk. So let’s start here. 

 

Fairfax risk: “What if interest rates/bond yields are much lower in 4 or 5 years time. Causing interest income to fall precipitously?”

 

Interest rates/lower bond yields were a watch out for me at Fairfax when the average duration of the fixed income portfolio was 1.6 years at the end of 2022. But in Q1 2023 we learned Fairfax had pushed this out to 2.5 years. And in Q4 2023 we learned Fairfax had pushed it out again, this time to about 3 years. 

 

Fairfax has locked in interest income of about $2 billion for each of the next 3 to 4 years. Significantly extending duration is a big deal. So ‘much lower’ interest rates/bond yields, if that happens, is really a potential problem looking out 4 or 5 years. 

 

Predicting macro

 

Trying to predict macro looking out 1 year is pretty tough… buy trying to predict macro looking out 4 or 5 years? Good luck with that. 

 

I think we will see persistently higher inflation in the coming years. Perhaps an average of around 3% to 3.5% per year. As a result, i think Fairfax will be given lots of opportunities in the coming years to keep the average duration of their fixed income portfolio at around 3 years if that is what they want to do. Just like what we are seeing today (mid-April), where bond yields have spiked and Fairfax is being given a nice opportunity to extend duration if they want. 

 

Alignment

 

When investing in Fairfax over the last 2 decades, i find it is helpful to be aligned with the positioning of their investment portfolio (it allows that ‘sleep well at night’ thing). From around 2011 to 2018 i did not like how Fairfax was positioned with their investment portfolio so i did not own the stock. Today? I like how Fairfax is positioned with their investment portfolio; it is a good fit for me.
 

Given i think it likely that inflation remains higher than expected in the coming years:

• Fixed income: I like that they have extended the average duration to 3 years. And i am comfortable they will be able to reinvest at an acceptable rate in the coming years.
• Equities: I like the exposure to commodities and industrials.

I think paying attention to macro is useful mostly at inflection points. The rest of the time, it is probably best to just ignore it.

Edited April 17, 2024 by Viking

[TwoCitiesCapital]

5 hours ago, giulio said:

FFH did not need higher interest rates to work out well as an investment in 2020-2021.

If you held everything the same, the stock was easily worth 2x.

 

I agree with this. I was one of the few pounding the table on FFH back in 2020/2021 after having sold out in 2018. 

 

Fairfax didn't recover with the rest of the market, DIGIT has done superbly well over the prior 2-years, and it became clear FFH was incredibly cheap even with very modest assumptions. I was guestimating $500-600 USD/share was a reasonable valuation, but it was reading for like $250-450 USD for much of that time. 

 

But it WAS interest rates that changed things. Interest going from 0 to 5.5% allowed Fairfax to capture billions in interest income in 2022/2023/2024 and lock that in with visibility for the next 3-4 years.

 

That, paired with float exploding in a hard market, are what we're thinking game changers to justify the move to $1000 and still make it look like a reasonable value here. 

 

5 hours ago, giulio said:

To say that FFH worked out as an investment ONLY because JPow hiked rates is UNFAIR to the great work done by Watsa and the team.

 

It's what made a 2-3x and 4-7x. Prem deserves credit, but it's not without luck. 

There was no guarantee, or foresight, that we'd have a hard market this strong for this long. Also, the fastest rate hikes in history was basically on nobodies bingo card in 2021. 

 

The team executed very well on it, but that doesn't mean that the environment/beta wasn't the huge portion of the tailwind. 

 

2 hours ago, Santayana said:

Being positioned to take advantage of the higher rates was completely in management's control, and there was really only one direction rates could move.

 

It was - but if you're going to give them credit for that then you also have to ding them for the opportunity cost of sitting at 0 for 5-years waiting for it and missing the turn in 2019/2020 when rates reverted back to 0. 

 

How many billions were left on the table from 2016 - 2021 as we waited in short-bonds earnings practically nothing? What would those billions have compounded into if redeployed at covid lows? Or used to increase share repurchases? Or invested into treasuries that could've been sold at massive premiums near the covid lows? 

We'll never know - but there was a huge cost to shareholders for waiting.

 

Perhaps it paid off - but it paid off because we got lucky with the steepest hiking cycle in history paired with an incredibly strong insurance markets allowing a greater weight of portfolio to be reinvested at high rates versus what was invested/missing interest at low rates. Those didn't have to happen in tandem and isn't what Fairfax was prepared for when they went to 0 (you'll recall they did it under Trump expecting higher rates due to economic growth - not inflationary animal spirits under Biden). 

 

 I'm happy with the outcome. But I'm not judging the process by the outcome. Ultimately they got one interest rate call wrong and then they got one right. And it just so happened the portfolio was significantly larger for the right call then the wrong one which is the only reason that panned our so well. And that portfolio size was luck

Edited April 17, 2024 by TwoCitiesCapital

[Viking]

25 minutes ago, petec said:

 

That is certainly not what I meant. What I said was that FFH in 2020 had macro options embedded within it. In other words, IF rates rose it would benefit mightily. The price reflected nothing for this, but it seemed highly likely to me. 

 

As a result, it is fair to say that rising rates NOT management action has driven much of the recent increase in earnings. 

 

Management action, however, has determined earnings POWER over time. In particular their willingness to wait rather than chase premiums and yield. They deserve a TON of credit for that. But those decisions were taken years ago.

@petec perhaps were you and i differ: i agree with you that rising interest rates was a big opportunity for Fairfax. But opportunity means nothing without proper execution. And the execution at Fairfax has been excellent. And as a result we now have $2 billion a year of interest income.

 

I think it is incredibly difficult to do what Fairfax did with their fixed income portfolio over the past 3 years. 
1.) they took the average duration down to 1.2 years in Q4 2021. Sold a bunch of corporate bonds at a yield of 1%. 
2.) they were then super disciplined as interest rates started to rise - they waited all through 2022. It wasn’t until Q1 2023 that they started to meaningfully extended the average duration (to 2.5 years). And having the discipline to wait until Q4 to get really aggressive extending duration (to 3 years) was, in hindsight, sheer brilliance.
 

I remember when everyone thought the 10 year US Treasury yield would peak at 3%. The fact the fixed income team did not meaningfully extend duration earlier and at much lower yields is amazing. 

[Hamburg Investor]

54 minutes ago, Viking said:

 

@petec I really appreciate the opportunity to discuss/debate Fairfax. 

 

One of the keys to valuing Fairfax today is your assessment of two things:

1.) How good is their insurance business?

- Is it average or above average (compared to peers)? 

2.) How good is their investment team at Hamblin Watsa?

- Is it average or above average (compared to peers)?

 

Here is my quick assessment:

 

I think the insurance business is above average (compared to peers). Not best-in-class yet but definitely better than average. Importantly it appears to be improving in quality; trend is important when looking forward.

 

I think their investment team (at Hamblin Watsa) is best-in-class (compared to peers). Especially in a high interest rate environment (versus a zero interest rate environment) with lots of volatility in financial markets. This is important because Fairfax generates about 80% of their income streams from investments and only 20% from insurance underwriting. (I think most insurers are about 55-60% from investments and 40-45% from insurance underwriting - don't quote me on this split). 

 

Fairfax is currently earnings about 7.5% on its investment portfolio and this is significantly more than P/C insurance peers. This outperformance will likely continue for the next couple of years (one reason being the average duration of the fixed income portfolio has been extended to about 3 years). There is a very good chance Fairfax's average ROE over the next three years will be 15% or higher (it could easily be in the high teens).

 

Fairfax has been the best performing P/C insurance company over the past 5 years (in terms of BV growth). It also has the best prospects looking out three years (given its significant leverage to investments and their current positioning). And it is by far the cheapest today.  

 

It is within this context that I think Fairfax trading today at a P/BV = 1.1 is crazy cheap. Especially when compared to P/C insurance peers today. Most trade at a P/BV of 1.4 x or higher. The set-up today at Fairfax looks an awful lot like a much younger Berkshire Hathaway. In that context I think a P/BV multiple of 1.1 x is nuts. 

That's a terrific discussion between both of you, @Viking and @petec, that really resonates to me.

I think both of you really hit it.

Fairfax was under pressure on several levels during the low-interest phase:
- Low interest rates are not good for the insurance business. BRK, MKL and FFH (also Geico) were not only stronger compounders in earlier years because they were smaller; interest rates were also higher. This discussion has been held many times and you can disagree.
- Low interest rates = low, eroding moats. I'll take Blackberry as an (absurd?) example. Blackberry was a bad idea (no discussion about it!). But in times of 10% interest rates, competitors would probably have invested less quickly and heavily in tech; Blackberry's moat and brand would have eroded more slowly; maybe it wouldn't have turned out so badly. Eurobank and other investments haven't exactly benefited economically from low interest rates either.
- Stock market valuations: = Growth beats value. Strong sales growth led to high stock market valuations in times of low interest rates, regardless of how profits developed. Was that exactly Prem's investment style? Probably not. So were FFH's stock market investments valued rather low on average during the low-interest phase? I think so.

And at the same time, this should not be overestimated: Prem made many mistakes. Hedges are one of them (he has sworn off them - I call that improvement) If you look at how Fairfax's CRs have developed compared to Markel or the PC market as a whole, you will see that Fairfax was a below-average profitable insurer until 2011. Since 2011, Fairfax has been catching up relative to Markel and the market; massively so. That is a difference in quality between then and now. India is new. TRS is new and smart etc.
 

I think FFH has gotten a really good bit better in recent years; there's good evidence of that. But they were also never as incredibly bad as they looked; they were just always "speculating" that interest rates would become "normal" (whatever that means; 0% doesn't mean it) and that growth wouldn't outperform value for all eternity.
 

But for me this also means: FFH was always better than it looked for many years after 2009; the visible compounding in these years always suffered from an unusually deep and long headwind; and not only from this, but - yes, of course - also from the mistakes of the management. But that's just it: Not only. Now it is more "normal": interest rates are more normal than they were at 0% to 2% for so long. The hard market is still a tailwind - but in contrast, "growth beats value" is still active, i.e. a headwind. One normal, the other a tailwind, the other a headwind - this is certainly not an extreme scenario but a balanced one altogether.

However - and that's what I want to add - I think that many still underestimate or have forgotten how well insurers like FFH (and BRK and MKL) can, indeed have compounded in normal times due to the "decade of headwinds". The combination of cost-free, growing float, a value investor at the top, diversification of corporate assets was a good idea and remains a good idea. But float was almost worthless and value was dead. But now interest rates are becoming normal. And there is the fact that the rest of the market is historically highly valued with a P/E ratio of 27 or so and we have higher interest rates; but insurers are historically rather lowly valued; so the spread is enormous. And Fairfax has gotten better. Yes, it's more about compounding now, but I can't find anything that should be 15+% (my best guess is more like 18%) compounding and buyable at a P/E below 7.

[MungerWunger]

@Viking Big fan of your fairfax posts! Just curious what % of your portfolio is allocated to the company if you don't mind sharing