Fairfax 2024

[Viking]

1 hour ago, Maxwave28 said:

Not to be too bullish, but would an ancillary benefit of share repurchases be that it extends the runway of potential compounding at FFH. By returning capital to shareholders it limits the size of the company’s capital base and allows FFH to continue to invest in smaller and perhaps higher returning opportunities and therefore delay the drag a larger capital base has on its investment universe as Buffett has warned about for years? 

I think this is a great point. Especially if Fairfax wants to remain primarily a P/C insurer (and not morph into a conglomerate). Aggressively buying back undervalued shares as the hard market ends is such a good decision/use of excess capital.
 

It also means Fairfax/Prem is not focussed on empire building. Fairfax is instead clearly focussed on making decisions that build long term shareholder value. Very encouraging.

[StubbleJumper]

1 hour ago, Hamburg Investor said:

FFH realized a cagr of book value of 18% over 38 years. That 18% is the average after the worst decade in its history; before that bad years kicked in, the cagr was of course higher. That was a cagr of 26% from 1985 to 2009. 26% over a quarter century. Being in the top 1% (0.1%?) over a century - was that luck or skill? If you think (like me), 26% over 24 years has to be skill - how likely is it, that a value investor after that totally looses his skills?
 

 

I don't think that there's much question about whether it was luck or skill.  Nor do I think that there's any question about those skills suddenly disappearing.  But, it *is* definitely fair to question whether 1985-2009 can be replicated, and even whether the record of the entire 38 year period can be replicated on a going-forward basis.  Let's just say that I find that proposition to be dubious at best.  If it does happen, I'll be a happy guy, but there's a big difference between buying your first small insurance company and doubling its size 4 or 5 times and doing that when you already have net written of $23 billion.  Let's just say that I am a bit skeptical that they will routinely meet their 15% target for growth in BV.

 

2 hours ago, Hamburg Investor said:

Those foolowing bad years in my view had at least something to do with the low bond yields; you could say the reason for the bad decade was only one factor (Prem doing bad). Than it would just be a coincidence, that a lot of other insurers did bad (although not that bad) in those years too, like MKL or BRK. But than: What’s your reasoning about those managers, as they at least haven’t outperformed the S&P500 over that decade too: Have Buffett and Gayner lost it too? 

 

I must confess that I don't pay much attention to Gayner, so I won't offer a view on that.  Buffett hasn't lost it, but he has certainly had to change his approach to enable the returns that BRK has had.  The size challenge has been a real problem for BRK, particularly for investments.  Thank heavens that Todd or Ted put him onto Apple, or the past decade might have been pretty mediocre.

 

2 hours ago, Hamburg Investor said:

What’s your scenario for a hefty and longlasting downturn at FFHs roe after - looking from the standpoint in 3 or 4 years - 41 years with a cagr of around 18% roe? What makes you think, that the roe would go down to - say - 10% after 41 years with 18% on average? Low bond yields over the next 20 years? If that happens - okay, I go with you. It should get lower a bit, as FFH grows and gets bigger. Okay. But apart from external and from size factors, what should happen? Prem getting irrational? Loosing his skills after 41 years (again, if you’d see the last decade as a result of only one factor - Prem - and you think, that he‘s not anymore able of learning from mistakes - than that makes sense somehow; bit is that likely?!)? How reasonable is that - a value investor, who understood the power of float and having Bernard on his site - loosing all his skills after 4 decades of outperformance? 

 

The scenario is the math of operating an insurance sub.  Take a careful look at the disclosure that Prem provides in his annual letter which describes cost (benefit) of float, sovereign debt returns, and the resulting financing differential.  We have been in an unusually favourable situation for the past two or three years.  But, what that means is that either FFH has discovered the secret sauce which enables it to write a CR of 94 and buy treasuries at 5% and nobody else can do that, or it means that there is no secret sauce and other people can do that too.  If it's the former, then FFH shares a worth a fortune.  If it's the latter, capital will flow into the industry and those favourable returns will abate.  It is very rare to get BOTH a good underwriting profit AND strong sovereign debt returns.  My take is that the insurance market will turn, as it always does, so enjoy it while it lasts!

 

 

SJ

[Hektor]

1 hour ago, StubbleJumper said:

My take is that the insurance market will turn, as it always does

I guess when it turns, people will continue to buy sporting goods, get married, eat at restaurants, fly in/out of airport, travel/vacation, bank, lease ships to ship goods, insure etc., and Prem (and his team) will do what they have done all along, and then insurance will turn again. Do you agree?

[nwoodman]

9 hours ago, gfp said:

After a brief technical delay, the NAIC website is functioning again and the Q1 reports are trickling out.  . 

Thanks,  these are always fascinating.

 

Micron turned out to be a good trade, although they left a bit of money on the table. 

 

Date of Disposition: March 26, 2024
Number of Shares Sold: 572,934
Total Consideration: $60,018,937
Book/Adjusted Carrying Value: $48,894,188
Realized Gain: $29,262,819
Average Sale Price per Share: Approximately $104.76

 

Edited May 15 by nwoodman

[SafetyinNumbers]

51 minutes ago, nwoodman said:

Thanks,  these are always fascinating.

 

Micron turned out to be a good trade, although they left a bit of money on the table. 

 

Date of Disposition: March 26, 2024
Number of Shares Sold: 572,934
Total Consideration: $60,018,937
Book/Adjusted Carrying Value: $48,894,188
Realized Gain: $29,262,819
Average Sale Price per Share: Approximately $104.76

 

 

I guess they don't think of it as quality which makes sense. It will be interesting if they are patient on buying quality and then sitting on their hands. 

Edited May 15 by SafetyinNumbers

[nwoodman]

13 minutes ago, SafetyinNumbers said:

 

I guess they don't think of it as quality which makes sense. It will be interesting if they are patient on buying quality and then sitting on their hands. 

True, I thought it was a move in the right direction though 

[StubbleJumper]

12 hours ago, Hektor said:

I guess when it turns, people will continue to buy sporting goods, get married, eat at restaurants, fly in/out of airport, travel/vacation, bank, lease ships to ship goods, insure etc., and Prem (and his team) will do what they have done all along, and then insurance will turn again. Do you agree?

 

Without a doubt, but the math of it can be a bit nasty.  If the insurance market turns and the CR bounces up to even 98 from the current 94, it would hurt a fair bit.  On $23B of float net written, that would be nearly $1B hit income, pre-tax.  You'd need to sell a lot of chicken dinners at St Hubert to offset that!  And a situation where it's possible to simultaneously write a CR of 98 and buy sovereign debt at 5% would still be an unusually good financing differential...

 

 

SJ

Edited May 15 by StubbleJumper
generally sloppy composition

[Hektor]

7 minutes ago, StubbleJumper said:

Without a doubt, but the math of it can be a bit nasty.  If the insurance market turns and the CR bounces up to even 98 from the current 94, it would hurt a fair bit. 

Agree. However, what would be the likely duration of this situation? It could be a long time if there is a once in a 50 or a 100 year event, I would think. I guess FFH is better organized now than in the past to at least tide over such a period, if not take advantage of it (I don't know how, though )

[Hektor]

12 minutes ago, StubbleJumper said:

And a situation where it's possible to simultaneously write a CR of 98 and buy sovereign debt at 5% would still be an unusually good financing differential...

How like is such a situation, where CR goes up and a %5 debt opportunity exists? 

[Hamburg Investor]

12 hours ago, StubbleJumper said:

 

I don't think that there's much question about whether it was luck or skill.  Nor do I think that there's any question about those skills suddenly disappearing.  But, it *is* definitely fair to question whether 1985-2009 can be replicated, and even whether the record of the entire 38 year period can be replicated on a going-forward basis.  Let's just say that I find that proposition to be dubious at best.  If it does happen, I'll be a happy guy, but there's a big difference between buying your first small insurance company and doubling its size 4 or 5 times and doing that when you already have net written of $23 billion.  Let's just say that I am a bit skeptical that they will routinely meet their 15% target for growth in BV.

 

I don't think, you'll find a lot of people here, who are looking for 18% or 26% returns when investing in Fairfax. As I have already explained here, I don't do that. You describe the challenge very well: it is much easier to achieve extraordinary returns when you are smaller.

 

12 hours ago, StubbleJumper said:

I must confess that I don't pay much attention to Gayner, so I won't offer a view on that.  Buffett hasn't lost it, but he has certainly had to change his approach to enable the returns that BRK has had.  The size challenge has been a real problem for BRK, particularly for investments.  Thank heavens that Todd or Ted put him onto Apple, or the past decade might have been pretty mediocre.

Together with Markel, Berkshire is my second largest investment. As happy as I am about Apple's performance, even that is only a small part of Berkshire as a whole. Berkshire would be worse off without Apple, but it wouldn't be in a completely different league. However, my general thesis is that the investment decisions at Berkshire, Markel and Fairfax will never be so bad in the long run that they use up the advantage of the float. Whereby the float advantage is greater at Fairfax than at Markel and Berkshire (which also uses other levers, such as tax deferral) due to the greater leverage. In any case, Prem can make even more stupid investments than Gayner and still Fairfax will do better.

 

12 hours ago, StubbleJumper said:

 

The scenario is the math of operating an insurance sub.  Take a careful look at the disclosure that Prem provides in his annual letter which describes cost (benefit) of float, sovereign debt returns, and the resulting financing differential.  We have been in an unusually favourable situation for the past two or three years.  But, what that means is that either FFH has discovered the secret sauce which enables it to write a CR of 94 and buy treasuries at 5% and nobody else can do that, or it means that there is no secret sauce and other people can do that too.  If it's the former, then FFH shares a worth a fortune.  If it's the latter, capital will flow into the industry and those favourable returns will abate.  It is very rare to get BOTH a good underwriting profit AND strong sovereign debt returns.  My take is that the insurance market will turn, as it always does, so enjoy it while it lasts!

 

 

SJ

I think there are insurance companies that have the secret sauce. Geico is one of them, RLI too, Markel was also doing very well for many years; unlike Fairfax. But since 2011, Fairfax's combined ratio has regularly improved massively compared to Markel and the PC market as a whole. So I do believe that Fairfax has found a bit of the special sauce.
 

The interesting thing is that Fairfax achieved the CAGR of 26% at a time when the combined ratios were not particularly good compared to the market. Now the insurance business is structurally better (since Andy Barnard has been there; he started as COO in 2011). So while Fairfax grows and that surely depresses the outlook, the improved insurance gives tailwind.
 

I think you have to differentiate between two things: The structural change that Fairfax has gone through: The Fairfax insurance portfolio is much better today than it was in 2011, but not as good as, say, RLI. Also, the many new smaller insurance companies scattered around the world will improve the learning curve and provide opportunistic opportunities. And on the other hand, we have had and continue to have exceptionally good times in recent years (hard market). But I think that with interest rates above 4%, insurance companies in general will benefit, and the good insurers even a bit more of course. And if interest rates go down again? Then things will be worse. And if they rise to 8%? Then insurance companies will fare much better than the market. And where are interest rates going now? Well, nobody knows. But just because they were so low now doesn't mean they have to go there again. That would be the first time they went back to a point just because they were already there, wouldn't it?
 

In the end, the question is whether or not one interprets the combination of 1. favourable float (which Fairfax did not have in the past, but now has in my opinion), 2. the willingness to invest one's own equity in shares and companies and 3. having a value investor from Graham and Doddsville as CEO is a corporate advantage. If this is a clear advantage, then outperformance against an average company should be possible. If 10% roe is the average, then Berkshire, Markel and Fairfax should outperform. If Fairfax doubles twice times from here, then I am also sceptical as to whether 15% will be achievable in the long term. But until then I think it is absolutely possible. You can already see that Fairfax is focussing more on quality than Berkshire. Fairfax should therefore be able to follow the path outlined in the "Buffett Alpha" study, i.e. investing in large quality companies.

[MMM20]

8 minutes ago, Hamburg Investor said:

In the end, the question is whether or not one interprets the combination of 1. favourable float (which Fairfax did not have in the past, but now has in my opinion), 2. the willingness to invest one's own equity in shares and companies and 3. having a value investor from Graham and Doddsville as CEO is a corporate advantage. If this is a clear advantage, then outperformance against an average company should be possible. If 10% roe is the average, then Berkshire, Markel and Fairfax should outperform. If Fairfax doubles twice times from here, then I am also sceptical as to whether 15% will be achievable in the long term

 

Nice summary. ~12% per share compounding should be achievable with these structural advantages and rounds to a ~10x return over a couple decades. That's why I'm here. I hope they drop the ~15% goal as they get larger and just tell investors that as value investors they'll take what the market gives them.

[petec]

On 5/15/2024 at 1:52 AM, StubbleJumper said:

It is very rare to get BOTH a good underwriting profit AND strong sovereign debt returns.  My take is that the insurance market will turn, as it always does, so enjoy it while it lasts!

 

+1

 

Exactly correct. 

[petec]

15 hours ago, Hamburg Investor said:

In the end, the question is whether or not one interprets the combination of 1. favourable float (which Fairfax did not have in the past, but now has in my opinion), 2. the willingness to invest one's own equity in shares and companies and 3. having a value investor from Graham and Doddsville as CEO is a corporate advantage.

 

The only thing that really matters in the long term is culture. Fairfax has that in spades. That's the advantage of having a controlling shareholder. And it is the moat.

[Xerxes]

On 5/14/2024 at 8:16 PM, Viking said:

I think this is a great point. Especially if Fairfax wants to remain primarily a P/C insurer (and not morph into a conglomerate). Aggressively buying back undervalued shares as the hard market ends is such a good decision/use of excess capital.
 

It also means Fairfax/Prem is not focussed on empire building. Fairfax is instead clearly focussed on making decisions that build long term shareholder value. Very encouraging.

@Maxwave28

@Viking

 

Home Depot puts out sometimes +40% ROE, given its fully shrunk equity … thanks to the very large historical capital return. 

[Viking]

Capital allocation - Circle of Competence - Margin of Safety - Concentration

 

In this section we are going to explore the topic of capital allocation.

 

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. In turn, these metrics drive the multiple given to the stock by Mr. Market - and finally the share price and investment returns for shareholders.

 

When done well, capital allocation does two important things:

1. Delivers a solid return.
2. Improves the quality of the company.

Therefore, the fundamental task of an investor is to determine if management, over time, is making intelligent decisions regarding capital allocation.

 

How to be a good investor / capital allocator

 

Being a good investor is the same thing as being a good capital allocator.

 

Warren Buffett is a great teacher. In his 1996 shareholder letter, Buffett succinctly lays out what an investor needs to do to be successful. This is the same approach that Berkshire Hathaway has followed - quite successfully - for decades. We have included Buffett’s full quote below.

 

In his framework, Buffett introduces the concept of ‘circle of competence.’ Given its importance, we will explore it more fully in the next section.

 

Warren Buffett - 1996 Shareholder Letter

 

“Let me add a few thoughts about your own investments.  Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals.

 

“Should you choose, however, to construct your own portfolio, there are a few thoughts worth remembering. Intelligent investing is not complex, though that is far from saying that it is easy.  What an investor needs is the ability to correctly evaluate selected businesses. Note that word "selected":  You don't have to be an expert on every company, or even many.  You only have to be able to evaluate companies within your circle of competence.  The size of that circle is not very important; knowing its boundaries, however, is vital.

 

“To invest successfully, you need not understand beta, efficient markets, modern portfolio theory, option pricing or emerging markets. You may, in fact, be better off knowing nothing of these.  That, of course, is not the prevailing view at most business schools, whose finance curriculum tends to be dominated by such subjects. In our view, though, investment students need only two well-taught courses - How to Value a Business, and How to Think About Market Prices.

 

“Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now.  Over time, you will find only a few companies that meet these standards - so when you see one that qualifies, you should buy a meaningful amount of stock. You must also resist the temptation to stray from your guidelines:  If you aren't willing to own a stock for ten years, don't even think about owning it for ten minutes. Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio's market value.

 

“Though it's seldom recognized, this is the exact approach that has produced gains for Berkshire shareholders:  Our look-through earnings have grown at a good clip over the years, and our stock price has risen correspondingly. Had those gains in earnings not materialized, there would have been little increase in Berkshire's value.”

 

—————

 

Mental model: circle of competence

 

A mental model is simply a framework that helps us understand how something works. Mental models guide our behaviour and they help us solve problems.

 

“The more models we have, the better able we are to solve problems. But if we don't have the models, we become the proverbial man with a hammer. To the man with a hammer, everything looks like a nail. If you only have one model, you will fit whatever problem you face to the model you have” Charlie Munger

 

To guide investors, Warren Buffett introduces the concept of ‘circle of competence’ as a foundational mental model.

 

What is it?

 

‘Circle of competence’ is a subject area when you have an edge. It is a match with your skills and experiences.

 

To be successful at investing, stick to areas where you know more than other people. This might sound obvious. Few actually do it.

 

It allows you to answer the 3 fundamental questions:

1. Do you understand the business?
2. Is it run by competent management?
3. Does it sell for a price that is attractive?

 

Let’s revisit Buffett’s quote:

 

“You only have to be able to evaluate companies within your circle of competence.  The size of that circle is not very important; knowing its boundaries, however, is vital.” Warren Buffett 1996 Shareholder Letter

 

Buffett highlights a number of important points:

• Self awareness: You have to know what your circle of competence is.
• The size of the circle is not very important. Importantly, it can be expanded over time.
• Knowing the boundaries is ‘vital’. This is knowing what to avoid.

In the HBO documentary linked below, Buffett expands on ‘circle of competence’ and provides additional insight:

• Patience: wait for the right opportunity - one that is in your ‘sweet spot.’
• Think independently: don’t let the mood of Mr. Market influence what you are doing.

HBO Documentary: Becoming Warren Buffett (30:30 minute mark)

• https://youtu.be/2Q5zhl4YVo8?si=A5RY0o3ivBfbPHYz

“I was genetically blessed with a certain wiring that is very useful in a highly developed market system that has lots of chips on the table where I happen to be good at that game

 

“Ted Williams wrote a book called the science hitting. In it he has a picture of himself at bat and the strike zone broken into 77 squares. He said if he waited for the pitch that was really in his sweet spot he would bat 400 and if he had to swing at something in the lower corner he would probably bat 235.

 

“In investing I’m in a no-called strike business, which is the best business you can be in. I can look at 1000 different companies and I don’t have to be right on every one of them or even 50 of them. So I can pick the ball i want to hit.

 

“The trick with investing is to sit there and watch pitch after pitch go by and wait for the one that is right in your sweet spot. If people are yelling ‘swing you bum!’ Just ignore them.

 

“There is a temptation for people to act far too frequently in stocks simply because they’re so liquid.

 

“Over the years you develop a lot of filters. I do know what is called my circle of competence. So i stay within that circle. I don’t worry about things that are outside of that circle. Defining what your game is… where you’re going to have an edge… is enormously important.”

 

—————

 

Margin of safety

 

“If you were to distil the secret of sound investment into three words we venture the motto, margin of safety.” Ben Graham The Intelligent Investor - Chapter 20

 

Margin of safety is one of the most important principles/concepts in investing. It is defined as the difference between a stock’s price and its intrinsic value.

 

Buying a stock with a large margin of safety does two things at the same time:

• Limits the downside risk.
• Provides a high return opportunity.

Circle of competence and margin of safety

 

Only invest in opportunities that:

• fall within your circle of competence.
• can be purchased at prices that provide a margin of safety

"If you understood a business perfectly — the future of a business — you would need very little in the way of a margin of safety," Warren Buffett - 1997 Berkshire Hathaway Annual Meeting

 

—————

 

Concentration

 

"Diversification may preserve wealth, but concentration builds wealth." Warren Buffett

 

“If you can identify six wonderful businesses, that is all the diversification you need. And you will make a lot of money. And I can guarantee that going into a seventh one instead of putting more money into your first one is gotta be a terrible mistake. Very few people have gotten rich on their seventh best idea. But a lot of people have gotten rich with their best idea. So I would say for anyone working with normal capital who really knows the businesses they have gone into, six is plenty…” Warren Buffett - Talk at Florida University 1998 (1:05:30 mark)

• https://youtu.be/2MHIcabnjrA (great 90 minute video)

A key part of Berkshire Hathaway’s long term success has been holding a concentrated portfolio of investments.

 

Circle of competence and concentration

 

Only investing in his ‘circle of competence’ gives Buffett conviction - and allows him to concentrate in his best ideas. This further improves Berkshire Hathaway’s long term returns.

 

—————

 

Circle of competence, margin of safety and concentration

 

Circle of competence, margin of safety and concentration are concepts that are inter-related and synergistic. Combined, they provide results that are far more powerful than those that could be achieved on their own. (1 + 1 + 1 = 5)

• Circle of competence  = good returns
• Circle of competence + margin of safety  = better returns
• Circle of competence + margin of safety + concentration in best ideas = best returns

Key take-away: of the three, circle of competence is perhaps the most important component. It is the lynchpin. It is what allows the other two components to work their magic.

 

—————

 

As he told us earlier, this has been the approach that Buffett has been using with great success to grow Berkshire Hathaway for decades. This also gives investors a blueprint to evaluate the capital allocation skills of management teams at other companies.

 

Let’s now apply what we have learned. Let’s look at the capital allocation decisions of Fairfax Financial. We are also going to explore something Charlie Munger called ‘cannibal investing.’ Part 2 should be out in the next couple of days.

 

Edited May 19 by Viking

[Viking]

How to be a good investor / capital allocator: Part 2

 

For Part 1 - scroll up to read the previous post

 

‘Look at the cannibals’

 

One of Charlie Munger’s investing strategies was to look for ‘financial cannibals.’ This referred to companies that were buying back a large amount of their own stock over long periods of time. Of course, the price paid for the stock was important. Buying back large amounts of stock at cheap prices creates extraordinary value for shareholders.

 

The math:

 

 

(Important: Net earnings attributable to non-controlling interests (minority shareholders) is not part of EPS calculation. We will come back to this later.)

 

Assuming net earnings stays the same, a lower share count will result in an increase in EPS. And if net earnings grows (numerator increases) at the same time the share count is reduced (denominator decreases) then EPS will increase even more. This becomes quite a powerful combination if it can be sustained over many years.

 

This strategy can work so well because it checks all three boxes of a successful capital allocator:

• circle of competence - the management team has a big edge here - it understands the company/business better than anyone else.
• margin of safety - the management team also has a a big edge here - it understands the intrinsic value of the company better than anyone else and how it compares to the market price.
• concentration - when shares get wicked cheap (intrinsic value is much greater than the market value) management can buy back shares in volume.

“…what those (prosperous) companies had in common was they bought huge amounts of their own stock and that contributed enormously to the ending record. Lou, Warren, and I would always think the average manager diversifying his company with surplus cash that’s been earned more than half the time they’ll screw it up. They’ll pay too high a price and so on. In many cases they’ll buy things where an idiot could see they would have been better to buy their own stock than buy this diversifying investment. And so somebody with that mind-set would be naturally drawn to what Jim Gibson used to call “financial cannibals,” people that were eating themselves.” Janet Lowe - Damn Right: Behind the Scenes with Berkshire Hathaway Billionaire Charlie Munger

 

Fairfax: Record earnings and capital allocation

 

Today Fairfax is generating a record amount of earnings. And given their sources (high quality), very high earnings are expected to continue for the next 3 or 4 years. This means Fairfax will be generating and allocating a record amount of capital over the next 4 years.

 

Like all companies, Fairfax has three basic options when it comes to capital allocation:

1. Re-invest in the business (organic growth or acquisitions)
2. Buy back stock
3. Pay a dividend

What exactly will Fairfax do?

 

Of course, this is the rub. The answer is we don’t know exactly what Fairfax will do. What Fairfax does will depend on a number of factors (internal and external). So when it comes to future capital allocation decisions, investors will need to trust the management team at Fairfax.

 

Should we trust the management team at Fairfax?

 

Will they be rational? Will they allocate capital in a way that it builds long term shareholder value?

 

To help answer these questions we need to look into the past.

 

But how far back do we need to go?

 

Given Fairfax’s colourful history, this is a really interesting question.

 

My view is investors should focus primarily on the past 5 years, with emphasis given to the past 3 years.   

 

Let’s start by looking at what Fairfax has been doing so far in 2024. And then let’s zoom out and look at what they have been doing over the past 4 years.

 

What has Fairfax been doing on the capital allocation front so far in 2024?

 

With three different activities, over the first 4.5 months of 2024, Fairfax has allocated $1.1 billion of capital. That is a significant number.

 

1.) Share buybacks = $613 million

 

To May 10, Fairfax has reduced effective shares outstanding by 561,102 or 2.44%. The total cost was $613 million or $1,092/share. Book value at March 30, 2024 was $940/share.

 

The shares were taken out at 1.15 x BV which is a very low valuation given the quality of Fairfax and its very strong earnings outlook over the next couple of years.

 

It should be noted that Fairfax’s book value does not capture the excess of fair value (FV) over carrying value (CV) for the associate equity holdings of $1.2 billion pre-tax (about $50/share).

 

“At March 31, 2024 the excess of fair value over carrying value of investments in non-insurance associates and consolidated non-insurance subsidiaries was $1,185.6 million.” Fairfax Q1 2024 Earnings Release

 

If we include the excess of FV over CV ($35 after-tax) and expected 2024 earnings (US$140/share - current estimate at Yahoo Finance), Fairfax is buying back its shares at less than 1 x estimated 2024YE BV. That is very cheap.

 

Lowering the share count boosts earnings per share. Share buybacks, when done at attractive prices, is a very shareholder friendly action.

 

2.) Take out minority interest in insurance companies = $127 million

 

In April of 2024, Fairfax increased its stake in Gulf Insurance Group (GIG) from 90% to 97.1%

 

“Subsequent to March 31, 2024, the company completed a mandatory tender offer for the non-controlling interests in Gulf Insurance and increased its equity interest from 90.0% to 97.1% for cash consideration of $126.7.” Fairfax Q1 2024 Interim Report

 

Taking out minority partners means ‘net earnings attributable to non-controlling interests’ (minority shareholders) decreases. And ‘Net earnings attributable to shareholders’ increases.

 

Taking out a minority partner means Fairfax shareholders are now entitled to receive a larger share of the future earnings at GIG. Like a share buyback, this activity also boosts earnings per share.

 

3.) Dividend = $363 million

 

On January 3, 2024, Fairfax increased the dividend from $10 to $15/share, an increase of 50%. At the time Fairfax shares were US$914. The $15 dividend provided a yield to shareholders of 1.6%.

 

“Given Fairfax’s substantial growth since it inaugurated a US$10 per share annual dividend 14 years ago, and given Fairfax’s current position of foreseeing strong earnings for the next few years based on insurance company underwriting income, locked-in interest and dividend income and income from associates, we felt it was appropriate to raise our annual dividend this year to US$15 per share, and we believe that this should be a sustainable level,” said Prem Watsa, Chairman and Chief Executive Officer of Fairfax.” Fairfax New Release January 3, 2024

 

Dividend payments provide an income stream for investors that can be reinvested to compound returns over time. Paying a consistent and growing dividend is seen as a sign of financial strength for a company.

 

It is important to note that Fairfax is has been making many more capital allocation decisions than just the three highlighted above. Importantly, they continue to grow their P/C insurance operations in the current hard market. And they continue to actively manage their large fixed income and equity investment portfolio.

 

Summary

 

With these three activities highlighted above Fairfax allocated $1.1 billion of capital in the first 4.5 months of 2024.

 

Investors want to see Fairfax grow earnings per share over time. Share buybacks reduce the denominator. Buying out minority shareholders increases the numerator. One of these activities would have been good. Both of these happening at the same time is even better - resulting in even larger EPS growth.

 

And paying a dividend allows an investor, should they choose, to buy more shares - and increase their ownership share in the company even more.

 

All three of these activities are very shareholder friendly - each delivers a solid return for shareholders. Importantly, they are also very low risk. Fairfax is also exercising good ‘plate  discipline’ - with these capital allocation decisions they are swinging at pitches that are in their sweet spot.

 

Each of these are what I would call ‘solid single’ types of investments. They move the runners around the bases. And of course, that is how you win the game.

 

Importantly, the management team at Fairfax is acting rationally and building long term shareholder value with these decisions. This bodes well for the future.

 

 

What if we look at each of these decisions - but over a slightly longer time horizon?

 

When we look out a couple of years we see ‘cannibal investing’ at its best.

 

Stock buybacks

 

Over the past 6.4 years, Fairfax has spent $2.9 billion and reduced effective shares outstanding by 19.1%. That is a massive reduction in the share count.

 

The average cost was $549/share. Book value at Dec 31, 2024 was $940/share. Intrinsic value is likely north of 1.4 x BV = $1,300.

 

Bottom line, shares were repurchased at a price that was well below intrinsic value.

 

For fun, let’s add in the total return swap position - giving Fairfax exposure to 1.96 million Fairfax shares at an average cost of $373/share.

 

Over the past 6.4 years, Fairfax repurchased/got exposure to 26.2% of shares outstanding at an average cost of $501/share. These purchases have been very  accretive for long term shareholders. This is a great example of superior capital allocation.

 

These string of transactions will likely go down as one of Fairfax’s greatest investment decisions (to aggressively take out/get exposure to shares).

 

 

Buying out minority partners

 

Insurance Holdings

 

Over the past 3.4 years, Fairfax has spent $1.9 billion to take out its partners and increase its ownership stake in its existing P/C insurance businesses.

 

There were two big moves:

1.) In 2022, significantly increasing its ownership in Allied World from 70.9% to 83.4%.

2.) In 2023/24, obtaining a control position and increasing its ownership in Gulf Insurance Group from 43.4% to 97.1%. This move solidifies Fairfax’s position in the rapidly growing Middle East North Africa (MENA) region.

 

These are quality P/C insurance companies. These decisions are very low risk and deliver a solid return to shareholders.

 

Taking out minority partners is a solid way for Fairfax to grow ‘net earnings attributable to Fairfax shareholders.’

 

Price paid matters: I think the take-out price that Fairfax will eventually pay is largely set when the initial deal is struck with the minority partners in the insurance businesses. This provides Fairfax with some degree of certainty - and it provides the minority partners with an acceptable return over the life of the transaction. Do I have this generally right? I would appreciate hearing what others think on this topic.

 

 

Non-insurance Consolidated Equities

 

Over the past 3.4 years, Fairfax has spent $700 million to increase the size of its collection of consolidated equity holdings. This is slowly growing another income stream for Fairfax - one that is unrelated to its insurance business. This makes Fairfax a stronger, more financially resilient company.

 

It will be interesting to see if Fairfax continues to grow this bucket of holdings in the future.

 

 

Dividends

 

Over the past 4 years, Fairfax has paid a total of $1.13 billion in dividends on its common shares.

 

 

Summary

• Buying back shares on the cheap: over the past 6.4 years, Fairfax has spent $2.9 billion and reduced effective share outstanding by 19.1%.
• Buying out partners in its consolidated insurance and non-insurance holdings: over the past 3.4 years, Fairfax has spent $2.5 billion taking out minority partners in its insurance and non-insurance businesses.

When it comes to capital allocation, for years now Fairfax has been a ‘financial cannibal.’ The kind that Charlie Munger would have really liked.

• Over the past 4 years, Fairfax has also paid out $1.1 billion in dividends.

These are funds investors can reinvest to compound returns even more over time.

 

But the Fairfax story gets better. Thats not all Fairfax has been doing with capital allocation over the past 4 years. Its has also been:

• Aggressively organically growing its P/C insurance business - taking full advantage of the hard market that started in late 2019.
• Selling assets at premium valuations - pet insurance, Resolute Forest Products, Ambridge Parners - for +$2 billion.
• Fixed income team navigated greatest bond bull / bear market in history. Protected balance sheet. Now earning record interest income.
• Dramatically improved the overall quality of their equity portfolio. Exited many poor investments. Merged others with stronger companies. New investments have been performing well. Some legacy investments have turned around. Group has never been better positioned.

As a result of all of Fairfax’s capital allocation decisions, earnings at Fairfax have spiked higher. At the same time, the share count has come down meaningfully. Earnings per share have increased dramatically.

 

What have we learned about the management team at Fairfax?

1. The management team at Fairfax has been acting very rationally with their decisions - over many years.
2. They have been swinging at pitches that are in their sweet spot - that are in their circle of competence.
3. They have been scaling/concentrating their best opportunities appropriately.
4. Their decisions have been building an enormous amount of shareholder value.

When it comes to capital allocation, Fairfax’s track record in recent years has been outstanding. The team at Hamlin Watsa has been hitting the ball like Ted Williams. Not only have they been hitting for a very high average, but many of their decisions have been the financial equivalent of a home run. This is very encouraging for Fairfax shareholders.

 

Guess what Fairfax is going to do in the future?

 

Fairfax continues to have many good options in front of them:

1. Buy back Fairfax stock - it still very cheap
2. Buy out minority partners in its insurance operations (Eurolife, Brit, Allied World, Odyssey) - the table is set.

 

Of course, Fairfax will also continue to do all the other regular things:

• Organically grow its P/C insurance business.
• Actively manage its fixed income and equity investment portfolio.
• Pay a modest dividend.

And Fairfax will be opportunistic and take advantage of volatility in financial markets.

 

As a result, we should see earnings continue to grow. And share count continue to shrink. And, like the past 4 years, this should result in much higher earnings per share.

 

As we said earlier, we don’t know exactly what Fairfax will do in the future. It will depend on a number of factors (internal and external). But with their actions over the past 4 years they certainly have earned our trust.

 

With record earnings coming over the next 4 years, Fairfax is in a great position - the set-up for Fairfax shareholders has never looked better.

 

In 2024, Fairfax has entered a new phase in its evolution as a company - the 'wonderful business' phase. And as Buffett teaches us: “Time is the friend of the wonderful business...”

Edited May 20 by Viking

[adventurer]

Hello,

 

is anyone here concerned about the fact that in the annual letter to Fairfax shareholders the CEO keeps talking about EBITDA? EBITDA does not seem to give an accurate update on the earnings as opposed to EBIT to my mind. Was there a discussion about that somewhere?

[StubbleJumper]

30 minutes ago, adventurer said:

Hello,

 

is anyone here concerned about the fact that in the annual letter to Fairfax shareholders the CEO keeps talking about EBITDA? EBITDA does not seem to give an accurate update on the earnings as opposed to EBIT to my mind. Was there a discussion about that somewhere?

 

 

How much does depreciation and amortization amount to for a holding company that is primarily an insurance outfit?  Without looking at the numbers, I would have assumed that EBIT and EBITDA would be pretty much the same thing.

 

 

SJ

[gfp]

I think they are just referring to the use of EBITDA in providing color on some of the unconsolidated marks on the balance sheet - private stuff, investments in associates, equity method stuff.

 

Prem isn't using EBITDA to discuss insurance company results as far as I am aware.

[adventurer]

1 hour ago, StubbleJumper said:

 

 

How much does depreciation and amortization amount to for a holding company that is primarily an insurance outfit?  Without looking at the numbers, I would have assumed that EBIT and EBITDA would be pretty much the same thing.

 

 

SJ

 

If depreciation and amortization do not apply for results of insurance operations (which I do not yet know as a newbie), yes. But considering all the non-insurance operation Fairfax is involved in it may be more useful to dispense with EBITDA. Out of transparency at least it seems to me.

[Xerxes]

28 minutes ago, adventurer said:

 

If depreciation and amortization do not apply for results of insurance operations (which I do not yet know as a newbie), yes. But considering all the non-insurance operation Fairfax is involved in it may be more useful to dispense with EBITDA. Out of transparency at least it seems to me.

it is exactly as GFP said. 
 

At company level, they talk book value and EPS. Never EBITDA. 
 

EPS goes hand in hand with BV. 

 

That said for private holding they quote EBITDA now and then. 

[MMM20]

Hot take: EBITDA is a completely valid metric to use for some businesses

 

*ducks*

[Parsad]

48 minutes ago, MMM20 said:

Hot take: EBITDA is a completely valid metric to use for some businesses

 

*ducks*

 

Yes, that is true.  Any statistic or accounting number should not be looked upon in a vacuum.  But each can provide some insight into the company's true nature and financial position.  P/E by itself offers nothing...same with EPS or P/BV...EBITDA is no different.  Cheers!

[gfp]

Someone asked Tom Gayner about why MKL references EBITDA occasionally in their reports, especially as it relates to the MKL Ventures type stuff. 

 

Start at 1:32:40 timestamp or thereabouts on this video for the question.  He eventually gets to why they still use it sometimes.  It is part of the language of private businesses, private business brokers, etc.  Make your own adjustments but cash flow available to pay debt and ownership has its uses -

 

[Haryana]

Look at the repeated follies of Artificial Intelligence -

https://www.theglobeandmail.com/investing/markets/stocks/FFH-T/pressreleases/26299224/26299224/

 

The same company (FFH) is twice in the table and with different valuation numbers without specifying in what currency.