Fairfax 2024

[nwoodman]

The sub positions are an interesting thought exercise.  My take is that it creates some clever optionality and a sign that Fairfax is not short on ideas.  It creates a reasonably clear pathway to decent returns if they are light on for ideas in the future or there is a significant changing of the guard.  I guess the other side of the argument is the tipping point of running a highly leveraged book.  

 

I will never become complacent about their debt levels but I do give them the benefit of the doubt in terms of how they manage the risk and wherever possible make it non-recourse and bump it into “equity”.

Edited August 26 by nwoodman

[UK]

3 hours ago, SafetyinNumbers said:

Because they can always sell a stake again if they need capital for any other opportunistic reason but perhaps more importantly a defensive reason.

 

2 hours ago, nwoodman said:

I will never become complacent about their debt levels but I do give them the benefit of the doubt in terms of how they manage the risk and wherever possible make it non-recourse and bump it into “equity”.

 

These are really good observations. Thanks!

[SafetyinNumbers]

2 hours ago, nwoodman said:

 

I will never become complacent about their debt levels but I do give them the benefit of the doubt in terms of how they manage the risk and wherever possible make it non-recourse and bump it into “equity”.

I think keeping the excess liquidity at the insurance subsidiaries makes a lot more sense then sending it up to the holdco for a variety of reasons but principally the debt levels are less concerning  while that is true.

[Xerxes]

Is there a tax advantage/implication between say Allied or Odessey using its own surplus to buy back the minorities vs. dividend to the mothership, and it writing a check for the minority ?

 

or is that not relevant because these are corporate tax

 

 

[dartmonkey]

On 8/22/2024 at 4:55 PM, Viking said:

If we continue to get a few large asset sales in the coming years (likely, given what we have seen the past 10 years) then I think 7% is a reasonable baseline estimate to use looking out the next 3 to 5 years. and yes, the results will be volatile from year to year.

 

Makes sense to me.

 

This return would be on investment assets that are currently at $66b, whereas equity is $23b, so results are levered about 3 times. So I think it is fair to say that Fairfax is currently on track to earn 21% on equity, at least in the next few years. Thoughts?

[SafetyinNumbers]

49 minutes ago, dartmonkey said:

 

Makes sense to me.

 

This return would be on investment assets that are currently at $66b, whereas equity is $23b, so results are levered about 3 times. So I think it is fair to say that Fairfax is currently on track to earn 21% on equity, at least in the next few years. Thoughts?

The way I like to think about it is that the odds of earning north of 15% for the next three years could be as high as 90%. Also, the odds of earning 20%+ are much higher than earning 12% or less.
 

That makes buying at 1.2x BV seem like an incredible bargain but I appreciate many on this board think it’s fairly valued currently.

[Hamburg Investor]

41 minutes ago, SafetyinNumbers said:

The way I like to think about it is that the odds of earning north of 15% for the next three years could be as high as 90%. Also, the odds of earning 20%+ are much higher than earning 12% or less.
 

That makes buying at 1.2x BV seem like an incredible bargain but I appreciate many on this board think it’s fairly valued currently.

 

I like the way you think. Mine is a bit similar:

The rule of 72 tells us, that at 15% ROE equity doubles in around 5 years, at 18% it doubles in 4 and at 24% it needs 3 years. Of course ROE can be less or more in the upcoming 3 years (and thereafter hard to say), but I wouldn't bet on less than 15% or more than 24% for the next 3 years. My best guess is around 20%. So that's around a double in 3 1/2 years, isn't it?

Than I try to find a comparison of FFH to the market. It doesn't make a lot of sense to me to compare the book value of the market (think: S&P500) against book of FFH, as most companies of the index are better understood with pe. So how to come up with a normalized pe for FFH? I just pick a normalized ROE of FFH (my best guess is 15+% over the long run, so I take 15%). If FFH earns 15% on book and I can buy it at less than 1.2 book, than that's a normalized pe ratio of 8, compared to nearly 30 for the S&P500. Wow, that's cheap and I am pretty sure the average S&P500 company won't make 15%, not even 12%. That's my definition of Quality at a cheap price and of GARP.

Thinking one step further: Assuming a double of FFHs equity in 3 1/2 years and the price stays where it is, than FFH would be valued below a pe ratio of 4 (!). I would love that, as the buybacks would bring returns even higher. Assuming 15% after the next 3 1/2 years, would bring pe ratio down to 2 after 8 1/2 years. 

[Haryana]

1 hour ago, Hamburg Investor said:

 

Thinking one step further: Assuming a double of FFHs equity in 3 1/2 years and the price stays where it is, than FFH would be valued below a pe ratio of 4 (!). I would love that, as the buybacks would bring returns even higher. Assuming 15% after the next 3 1/2 years, would bring pe ratio down to 2 after 8 1/2 years. 

 

What do you mean "the price stays where it is"?

Why would that be?

 

Did you mean P/B stays the same?

In that case, the price would also double along with doubling of of book/equity.

 

[dartmonkey]

 

22 minutes ago, Hamburg Investor said:

If FFH earns 15% on book and I can buy it at less than 1.2 book, than that's a normalized pe ratio of 8,

Just to show how this works, P/E=P/B*B/E = P/B÷E/B = 1.2÷15% = 8...

 

25 minutes ago, Hamburg Investor said:

Thinking one step further: Assuming a double of FFHs equity in 3 1/2 years and the price stays where it is, than FFH would be valued below a pe ratio of 4 (!). I would love that, as the buybacks would bring returns even higher. Assuming 15% after the next 3 1/2 years, would bring pe ratio down to 2 after 8 1/2 years. 

 

Realistically, if Fairfax continues to do well for 3 more years, the price is not going to be the same. But you got me wondering, what might a realistically repurchase scenario look like?

 

 

So I took current book of $23b, 22.48m shares outstanding at the end of Q2, share price of $1180, and $4b a year in earnings that management says we have visibility for for the next 3 years. Then I assume that half of those earnings ($2b/year) will be used for repurchases ($2b/year) and half will be retained (and invested). But since some of the earnings will be retained, book will increase over time, and there will be earnings on that extra book. So I assume that the current $23b in book will keep making $4b/year (a 17% ROE), but whatever is added to equity over the next 3 years will get a lower return (as interest rates fall, etc.), which I have very pessimistically put at 10%. 

 

Even with P/B staying at 1.15, that means share prices would almost double. Book would only go from $23b to $29.5b, but because of the 6.4m shares repurchased, book per share would almost double, as would the share price at a constant multiple of book. P/E would just come down a bit, from 7 to 6.

 

If the P/B multiple keeps rising, say to 1.3 in 3 years, there would be a little less repurchasing, but on the other hand, the share price would be a bit higher, just over a double. 

 

, 

 

[Munger_Disciple]

41 minutes ago, dartmonkey said:

 

Just to show how this works, P/E=P/B*B/E = P/B÷E/B = 1.2÷15% = 8...

 

 

Realistically, if Fairfax continues to do well for 3 more years, the price is not going to be the same. But you got me wondering, what might a realistically repurchase scenario look like?

 

 

So I took current book of $23b, 22.48m shares outstanding at the end of Q2, share price of $1180, and $4b a year in earnings that management says we have visibility for for the next 3 years. Then I assume that half of those earnings ($2b/year) will be used for repurchases ($2b/year) and half will be retained (and invested). But since some of the earnings will be retained, book will increase over time, and there will be earnings on that extra book. So I assume that the current $23b in book will keep making $4b/year (a 17% ROE), but whatever is added to equity over the next 3 years will get a lower return (as interest rates fall, etc.), which I have very pessimistically put at 10%. 

 

Even with P/B staying at 1.15, that means share prices would almost double. Book would only go from $23b to $29.5b, but because of the 6.4m shares repurchased, book per share would almost double, as would the share price at a constant multiple of book. P/E would just come down a bit, from 7 to 6.

 

If the P/B multiple keeps rising, say to 1.3 in 3 years, there would be a little less repurchasing, but on the other hand, the share price would be a bit higher, just over a double. 

 

, 

 

 

Doesn't one need to take into account the possibility of super CAT events and their effect on the "normalized ROE" and P/B?

Edited August 26 by Munger_Disciple

[dartmonkey]

5 minutes ago, Munger_Disciple said:

Doesn't one need to take into account the possibility of super CAT events and their effect on the "normalized ROE"?

Watsa's projected $4b in operating earnings in the next 3 years is based on:  "underwriting profit of $1.25 billion or more; interest and dividend income of at least $2.0 billion; and income from associates of $750 million, or about $125 per share after taxes, interest expense, corporate overhead and other costs."

 

Net premiums written in 2023 were $28.9b, so $1.25b is about a CR of 96. Last year the CR was 93%; in 2022 it was 96%; 2021 it was 88%. It is true that some day, there will be a super CAT that will knock a hole in one year's earnings, but perhaps a 96% average CR is realistic. In the catastrophic 2001, the total combined ratio was 121%, although only half of that was from megacats;  the CR would have been 110%, just from underreserving. What average CR do you think we should use?

[Munger_Disciple]

19 minutes ago, dartmonkey said:

Watsa's projected $4b in operating earnings in the next 3 years is based on:  "underwriting profit of $1.25 billion or more; interest and dividend income of at least $2.0 billion; and income from associates of $750 million, or about $125 per share after taxes, interest expense, corporate overhead and other costs."

 

Net premiums written in 2023 were $28.9b, so $1.25b is about a CR of 96. Last year the CR was 93%; in 2022 it was 96%; 2021 it was 88%. It is true that some day, there will be a super CAT that will knock a hole in one year's earnings, but perhaps a 96% average CR is realistic. In the catastrophic 2001, the total combined ratio was 121%, although only half of that was from megacats;  the CR would have been 110%, just from underreserving. What average CR do you think we should use?

 

Buffett said in 2017 that the probability of a $400B (USD) industry loss event in any given year (in his estimate) is 2%. Adjusting for inflation and increase in the cost of construction, that would be a $600B event today. I assume that that events that have lower loss may occur at greater probability than 2%. 

At Berkshire, they underwrite for a long term CR of 100% including CAT and super CAT years. I have no idea what CR is achievable for Fairfax over the next 3 years (which depends on whether there is a CAT/super CAT event in the next three years or not and its magnitude) but I would think that a 10-15 year average CR of 100 taking into account a couple of really bad CAT years is prudent. 

Edited August 26 by Munger_Disciple

[SafetyinNumbers]

2 hours ago, Munger_Disciple said:

 

Buffett said in 2017 that the probability of a $400B (USD) industry loss event in any given year (in his estimate) is 2%. Adjusting for inflation and increase in the cost of construction, that would be a $600B event today. I assume that that events that have lower loss may occur at greater probability than 2%. 

At Berkshire, they underwrite for a long term CR of 100% including CAT and super CAT years. I have no idea what CR is achievable for Fairfax over the next 3 years (which depends on whether there is a CAT/super CAT event in the next three years or not and its magnitude) but I would think that a 10-15 year average CR of 100 taking into account a couple of really bad CAT years is prudent. 

If we had to place odds (and in a way we are) what probability should we assign to a 93, 95, 100 or 105CR for the next 15 years. The fairest way is to probably measure in aggregate over a 15 year period and not an average because if there is a SuperCat in that time frame, there will probably a big increase in premiums for the years that follow.

Edited August 26 by SafetyinNumbers

[Munger_Disciple]

4 minutes ago, SafetyinNumbers said:

The fairest way is to probably measure in aggregate over a 15 year period and not an average because if there is a SuperCat in that time frame, there will probably a big increase in premiums for the years that follow.

 

Yeah aggregation makes sense. Most important is the ability of Fairfax to survive a super CAT event like a $600B loss event, which allows them to prosper in the hard market to follow the event.

Let us say in the worst case, Fairfax suffers 1.25% of 600B = 7.5B loss event pre-tax. They can survive that reasonably well but it would wipe out a couple of years worth of earnings.  

Edited August 26 by Munger_Disciple

[SafetyinNumbers]

11 minutes ago, Munger_Disciple said:

 

Yeah aggregation makes sense. Most important is the ability of Fairfax to survive a super CAT event like a $600B loss event, which allows them to prosper in the hard market to follow the event.

Let us say in the worst case, Fairfax suffers 1.25% of 600B = 7.5B loss event pre-tax. They can survive that reasonably well but it would wipe out a couple of years worth of earnings.  

How many years would it take to recover those earnings do you think? 

[Munger_Disciple]

23 minutes ago, SafetyinNumbers said:

How many years would it take to recover those earnings do you think? 

 

 I already provided an estimate in the earlier post based on the next three years earning visibility but after that I don't know. 

[Viking]

49 minutes ago, Munger_Disciple said:

 

Yeah aggregation makes sense. Most important is the ability of Fairfax to survive a super CAT event like a $600B loss event, which allows them to prosper in the hard market to follow the event.

Let us say in the worst case, Fairfax suffers 1.25% of 600B = 7.5B loss event pre-tax. They can survive that reasonably well but it would wipe out a couple of years worth of earnings.  

 

@Munger_Disciple , the challenge I have with 'tail risks' like the one scenario you mention above is I have no idea how to model them into my valuation for the company. What you are discussing is not specific to Fairfax - it is a risk to the entire P/C re/insurance industry. TODAY, NO P/C INSURANCE STOCKS HAVE YOUR SCENARIO FACTORED INTO THEIR STOCK PRICE. 

 

One of the biggest reasons I like Fairfax so much today is relative valuation - it trades at a much cheaper valuation than all peers. Despite having:

1.) the best 5 year track record (growth in BVPS) 

2.) the best management team (in terms of capital allocation)

3.) the best near-term earnings outlook

 

Given the exceptional near-term outlook for the company I am willing to overlook the risk of $600B loss event. It really is an interesting thought exercise - not specific to Fairfax, but all P/C insurance stocks.

 

Does it really mean they are all uninvestable for a rational investor? If so, why is Buffett loading up on Chubb? They would get killed if we had a $600B loss event. Is Buffett not thinking clearly?

Edited August 26 by Viking

[Munger_Disciple]

41 minutes ago, Viking said:

 

@Munger_Disciple , the challenge I have with 'tail risks' like the one scenario you mention above is I have no idea how to model them into my valuation for the company. What you are discussing is not specific to Fairfax - it is a risk to the entire P/C re/insurance industry. TODAY, NO P/C INSURANCE STOCKS HAVE YOUR SCENARIO FACTORED INTO THEIR STOCK PRICE. 

 

One of the biggest reasons I like Fairfax so much today is relative valuation - it trades at a much cheaper valuation than all peers. Despite having:

1.) the best 5 year track record (growth in BVPS) 

2.) the best management team (in terms of capital allocation)

3.) the best near-term earnings outlook

 

Given the exceptional near-term outlook for the company I am willing to overlook the risk of $600B loss event. It really is an interesting thought exercise - not specific to Fairfax, but all P/C insurance stocks.

 

Does it really mean they are all uninvestable for a rational investor? If so, why is Buffett loading up on Chubb? They would get killed if we had a $600B loss event. Is Buffett not thinking clearly?

 

I don't disagree that Fairfax is cheap, especially relative to others (ignoring for a moment tail risks). However I am a long term investor and I think about tail risks when I invest. I own only Berkshire & Fairfax and no other insurers (so can't comment on those). I am very confident Berkshire can very easily handle a $600B industry event. In fact Berkshire will report net profit in a year such an event happens. I think Fairfax will survive but take a hit to earnings (for two years I think at current run rate), so I am ok with it. Most other P/C insurers will go bankrupt in such a scenario. 

Edited August 26 by Munger_Disciple

[Viking]

1 hour ago, Munger_Disciple said:

 

Yeah aggregation makes sense. Most important is the ability of Fairfax to survive a super CAT event like a $600B loss event, which allows them to prosper in the hard market to follow the event.

Let us say in the worst case, Fairfax suffers 1.25% of 600B = 7.5B loss event pre-tax. They can survive that reasonably well but it would wipe out a couple of years worth of earnings.  

 

@Munger_Disciple , here is another way to look at tail risk... I live in Vancouver. There is a very good chance that we will get hit with an earthquake at some point in the future - we just don't know when and how big. So knowing this, is it rational for a person to live in Vancouver?  

 

Perhaps a better example is hurricane risk in Florida - or in many parts of the US. Lots of really bad hurricanes are coming in the next 50 years. we just don't know exactly where they are going to hit and when. Is the rational solution to move to a different part of the US? 

 

Again, the problem I have is I just don't know how to create something actionable from what I think I 'know.'  

 

If there is a 1% or even a 2% risk (timing of which is unknown), does that mean the investment should be avoided? Perhaps the answer is that ultimately there are no risk free investments (including Berkshire Hathaway). And perhaps this opens up the element of luck and its influence on investment returns. This is a really interesting topic.

Edited August 26 by Viking

[Munger_Disciple]

17 minutes ago, Viking said:

Again, the problem I have is I just don't know how to create something actionable from what I think I 'know.'  

 

If there is a 1% or even a 2% risk (timing of which is unknown), does that mean the investment should be avoided? Perhaps the answer is that ultimately there are no risk free investments (including Berkshire Hathaway). And perhaps this opens up the element of luck and its influence on investment returns. This is a really interesting topic.

 

 

First of all, the risk is 2% that the big one can happen in any single year, and it is obviously much higher when you expand your investment horizon. If you have a really long horizon, the probability of getting hit with at least one big one is close to 100%. So you can't just ignore it. 

It doesn't necessarily make Fairfax un-investable but it does affect my position sizing. 

 

Randomness (or luck as you say) is inherent in any probabilistic game including investing especially in the short run. In the long run, the stock performance should converge to the business performance. 

Edited August 26 by Munger_Disciple

[Viking]

4 minutes ago, Munger_Disciple said:

 

 

First of all, the risk is 2% that the big one can happen in any single year, and it is obviously much higher when you expand your investment horizon. If you have a really long horizon, the probability of getting hit with at least one big one is close to 100%. So you can't just ignore it. 

It doesn't necessarily make Fairfax un-investable but it does affect my position sizing. 

 

 

@Munger_Disciple The key to your analysis are three numbers:

1.) $600 billion loss event

2.) 2% chance of happening

3.) $ impact on any single insurance company

 

As I said earlier, I have no idea how accurate each of these numbers are for a company like Fairfax. It would simply be a wild guess. 

 

Buffett may say he thinks there is a 2% chance of a $600B loss event... Lots of what Buffett says is marketing - so I am not sure I would take even what he says on this topic for gospel. 

 

Anyways, it is a really interesting topic. But I will sign off for now  

[Hamburg Investor]

5 hours ago, Haryana said:

What do you mean "the price stays where it is"?

Why would that be?

That‘s just a theoretical scenario. I like to think about the downside. Most, if not all, of us are implicit thinking the stock price of FFH should go up in the next years. I wouldn‘t bet against that. Still from time to time things happen and the world changes within a moment. Think Covid, think FFH trading at 0.4 book value. 
 

So by this scenario I try to get a rough idea about „What if I am wrong and Mr. Market is go crazy within the next years? After all you‘ll NEVER know, where rhe stock price goes to in the short term (and 3 1/2 years to me is shortterm). 
 

So why not think about that „bad“ scenario? Would it be as bad as I think? Often things turn out to be way better even (or: especially!) in a bad case scenario than one thinks in the beginning.

 

E. g. in the other thread about the question if FFH would reach 2.000 dollar until 2027 I just bet „yes“. But I don‘t hope for that outcome. For every longterm holder (net seller or holder) of FFH it would be even better, if the share price would be way below 2.000 dollar. As shares can be bought back way cheaper.
 

So in a nutshell: No, I don‘t think, that the share price will stay where it is. But if anything, than I would hope for such an unlikely scenario, as my share of FFHs earnings would only go up. And I like to lean to the downside. Having shares of a business with a pe ratio of 8 today, and having zero return over 8 1/2 years and than owning a business with a normalized pe ratio of 2 and a normalized roe of 15%- if that‘s the bad case scenario, than that’s a scenario I buy. (Again: ignoring buybacks, which would make the scenario even better).

 

 

4 hours ago, dartmonkey said:

Even with P/B staying at 1.15, that means share prices would almost double. Book would only go from $23b to $29.5b, but because of the 6.4m shares repurchased, book per share would almost double, as would the share price at a constant multiple of book. P/E would just come down a bit, from 7 to 6.

 

Thank you for the work, which I really appreciate! Gives a lot of colour. 

[Munger_Disciple]

3 minutes ago, Viking said:

Anyways, it is a really interesting topic. But I will sign off for now  

 

Agree  that it's an interesting topic . 

Edited August 26 by Munger_Disciple

[Hamburg Investor]

31 minutes ago, Munger_Disciple said:

I think Fairfax will survive but take a hit to earnings (for two years I think at current run rate), so I am ok with it. Most other P/C insurers will go bankrupt in such a scenario. 

To me, that‘s the key point. Buffett said something like - from memory - crisis is good for a good business, as the crisis wipes out the competitors. A good business WINS through crisis, as it wins market share. Not only, but especially in those times. Gayner wrote about that topic some years ago in his annual report too, saying something like, that it‘s an advantage for its subsidiaries, that Markel will always be there to e. g. buy a new machine, if it gets broke at one of it’s subsidiaries. So management is able to always think for the (very) longterm.

 

So how will the world look like some years after a 600 bn dollar event? BRKs and FFHs market share should have grown AND the premiums within the sector as a whole should have grown too (as prices within the insurance sector would have grown). So both BRK and FFH would get a bigger piece of a growing cake, some years after such a scenario and I wouldn‘t be surprised, if CR would go down a lot. 
 

So, yes, there are tail risks, that will ultimately hit BRK and FFH; but in the long run those risks are in fact not risks but chances.  

[SafetyinNumbers]

Definity and Intact preannouced big CAT losses for Q3. Fairfax will get hit hard in Northbridge but Canada is ~10% of premiums so it shouldn’t be as bad.

 

While IFC has hardly moved on the announcement, I find it hard to believe FFH wouldn’t be down big if they pre-announced a $68 hit to pretax earnings for Q3 on CAT losses.

 

Thoughts?