Fairfax 2024

[73 Reds]

14 minutes ago, TwoCitiesCapital said:

 

I still don't understand this argument. Sure it makes sense in theory - but then why was insurance so morose in the 2010s when interest rates were also at 0% for most of the decade? 

 

Why did the hard market were seeing now start post-covid when interest rates were rising to a highest level they've been since pre-GFC? 

 

Overall, the theory may be true - but it seems the lags in effects on profitability are so long as to be meaningless in forecasting anything in the next 1-3 years in terms of hardness/softness and earnings. 

 

 

My main concern isn't a mark to market loss on equities in a down market, but a liquidity drain from the TRS if Fairfax gets sold off in tandem. 

 

That didn't happen in 2022. It DID happen in 2020 and 2018 and 2007. 

 

Perhaps the leverage is worth the quarterly liquidity risk. But I'd feel more comfortable if Fairfax didn't own the TRS in a down market. 

 

 

For us novices when it comes to total return swaps, can someone explain the mechanics, i.e., how often payments are made, whether there are any added costs to Fairfax for maintaining the TRS and whether either party can exit some or all of the TRS at any time and if so at what cost?  Also is there an expiration or maturity date?

[Crip1]

1 hour ago, TwoCitiesCapital said:

 

I still don't understand this argument. Sure it makes sense in theory - but then why was insurance so morose in the 2010s when interest rates were also at 0% for most of the decade? 

 

Why did the hard market were seeing now start post-covid when interest rates were rising to a highest level they've been since pre-GFC? 

 

Overall, the theory may be true - but it seems the lags in effects on profitability are so long as to be meaningless in forecasting anything in the next 1-3 years in terms of hardness/softness and earnings. 

 

 

My main concern isn't a mark to market loss on equities in a down market, but a liquidity drain from the TRS if Fairfax gets sold off in tandem. 

 

That didn't happen in 2022. It DID happen in 2020 and 2018 and 2007. 

 

Perhaps the leverage is worth the quarterly liquidity risk. But I'd feel more comfortable if Fairfax didn't own the TRS in a down market. 

 

 

I would think that management does something akin to a Monte Carlo simulation on the TRS position on an ongoing basis to assess the risk potential and damage projections related to the TRS position, and possibly to create one or more “escape routes” should a more damaging scenario play out. I mean, one would think they do similar type analyses as part of the insurance business as a whole to avoid risk concentration. The fact that the TRS deal is leveraged so, even moreso than a large investment, suggests that if a confluence of negative factors do occur, the damage can be substantial.

 

-Crip

[Viking]

On 9/7/2024 at 11:40 AM, Viking said:

Fairfax Financial - 8 Lessons Learned Over the Past 4 Years

 

“There is nothing new in Wall Street. There can’t be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again.” Jesse Livermore Reminiscences of a Stock Operator

 

What it takes to be a successful investor has not changed very much over the years. That is because capitalism is a wonderful economic system - our standard of living continues to improve. And human nature has not changed - people will continue to act like they always have. Learning from the past is an important way for an investor to get an edge - it can give you a preview of what is likely to happen again in the future.

 

The Fairfax story

 

The last 4 years has been an amazing time to be invested in Fairfax. The company is executing one of the great comebacks in recent Canadian business history - both in terms of business and share price performance. It is both an interesting and instructive story.

 

As investors, what can we learn from Fairfax’s improbable transformation/performance over the past 4 years?

 

That is the question we will explore in this post.

 

But first let’s do a quick review of a very important performance measure.

 

—————

 

How has Fairfax’s stock performed?

 

Fairfax’s stock is up 297% over the past 4 years. That is a CAGR of 41.1%. $1,000 invested in Fairfax 4 years ago would be worth $3,968 today, an increase of $2,968. That is a crazy good.

 

How does Fairfax’s performance compare to the market averages?

• The S&P500 is up a total of 61% over the past 4 years.
• The S&P/TSX is up a total of 42% over the past 4 years.

Fairfax’s outperformance of the market averages in the US and Canada has been breathtaking.

 

 

 

How does Fairfax’s performance compare to P/C insurance peers?

 

P/C insurance companies, as a group, have significantly outperformed the broad market averages  over the past 4 years.

 

The big winner of the 6 companies compared below has been Fairfax - their performance has trounced P/C insurance peers over the past 4 years. Fairfax’s CAGR is about 2x that of peers. The big laggard (of the 6 companies compared below) has been Markel.

 

Fairfax’s performance over the past 4 years - in absolute and relative terms - has been epic.

 

 

 

—————-

 

"What we learn from history is that people don't learn from history." Warren Buffett

 

With that warning from Buffett, let’s get back to our original question. Let’s try and be inquisitive and open minded…

 

As investors, what can we learn from Fairfax’s improbable transformation/performance over the past 4 years?

 

Below are 10 lessons that come to mind for me.

 

What do other posters think? Am I way off base? I do like to stir the pot. Do you see anything missing? Please chime in.

 

—————

 

Lesson 1: Investors need to be rational at all times with their investments

 

Investing (buying stocks) is not like getting married. Or like joining a club/clique (sorry Tom Gaynor).

 

Ideally, we are able to buy stocks and hold them forever. But that is just not realistic for most stocks. And that is because shit happens. Facts change. Fundamentals / earnings change. Sometimes management teams lose their way. A great investment can become a terrible investment. But unlike marriage, exiting a broken stock is an easy thing for an investor to do.

 

When should an investor sell an investment?

 

According to Peter Lynch, a pretty smart guy, an investor should sell an investment when the story / fundamentals take a turn for the worse. Pretty simple.

 

The Fairfax ‘story’

 

Over its long history, a person usually invested in Fairfax because of their investing skills - not because of the quality of their P/C insurance business. (Yes, that has changed today.)

 

But something important happened at Fairfax from 2010 to 2020. Fairfax lost its way with its investing framework:

• The ‘equity hedge/short’ strategy was a disaster, costing the company an average of $494 million/year from 2010 to 2020. The issue with this ‘position’ was its size (massive) and duration (largely in place for 11 years).
• The equity purchases made from 2014 to 2017 were also largely a disaster.

This caused earnings at the company to stagnate. And the stock went sideways from 2010 to 2020. During this time, the S&P500 went up 200%. Measured in terms of opportunity cost, Fairfax investors ‘lost’ a significant amount of money from 2010 to 2020.

 

This, of course, violated Warren Buffett’s rule #1 (when investing) which is ‘don’t lose money.’

 

What was the learning - looking back, what should a rational investor have done?

 

By about 2012/2013 it was clear that  Fairfax had lost its way on the investing side of the business. As a result, the Fairfax ‘story’ had changed significantly - and for the worse.

 

The correct course of action for an investor back in 2012/2013 was to sell their Fairfax stock - and move on.

 

This course of action would have saved many investors years of anguish and massive underperformance.

 

This does not mean that an investor could never again invest in Fairfax. Like any other opportunity, what an investor did in the future would depend on their assessment of the opportunity (fundamentals, management, prospects, valuation etc). Again, an investor needs to be as rational as possible at all times.

 

Now i am looking at things from the perspective of a small investor. If i do a good job with my investments my family eats. If i do a shitty job my family doesn’t eat. As a result, i need to be very rational at all times with my investment decisions.

 

The silver lining

 

"The most important thing to do if you find yourself in a hole is to stop digging." Warren Buffett

 

Fairfax’s problems were self inflicted. Therefore, the ‘fix’ was also in their control. So the situation was not hopeless. It deserved to be monitored. If Fairfax was able to fix its investing framework then it might make sense for an investor to buy shares. Logic, not hope, should drive the investment decision.

 

But given the stocks exceptional run the past 4 years, doesn’t this mean buy and hold was - with hindsight - the correct course of action to have taken with Fairfax?

 

No. Selling back in 2012/2013 was still the correct course of action. And that is because back then Fairfax had lost its way with its investing framework.

 

And back in 2012/2013 (and over the next couple of years that followed) it was clear that Fairfax did not yet recognize that they even had a problem.

 

Fairfax did not start righting their investing framework until late 2016 when they finally exited the equity hedges. By 2018 they were making much better decisions with new equity purchases. The final ‘fix’ was made at the end of 2020, when they exited the last of their short positions. It still took another couple of years for Fairfax to clean up the many problem children that were still residing in their equity portfolio. As a result, it was only around 2021 that investors started to trust that Fairfax had indeed righted the ship and fixed their investing framework. That was a full 7 years after it was pretty clear that Fairfax had a problem.

 

And back in 2012/2013 it was not a given that Fairfax would actually fix anything. This could have easily gone the other way - with their investments, Fairfax could have continued to go down their old disastrous path.

 

Long term shareholders have been very lucky with how their investment in Fairfax has played out over the past 4 years - not smart. Yes, Fairfax was able to execute a successful turnaround. But that is not what usually happens.

 

There is also an important lesson here for Fairfax

 

Fairfax wants to attract long term shareholders - that was pretty apparent during the Q&A sessions at the AGM this year. If this is the case, then Fairfax needs to hold up its end of the bargain - they need to run the business in a way that attracts/aligns with long term shareholders. When it comes to the type of shareholder base they have, companies generally get what they deserve.

 

—————

 

Lesson 2: Financial markets sometimes get it completely wrong - for years

 

"The most important quality for an investor is temperament, not intellect. You need a temperament that neither derives great pleasure from being with the crowd or against the crowd." Warren Buffett

 

Pretty much everyone got Fairfax wrong 4 years ago.

 

Who got Fairfax the most wrong? The haters. Their hate stopped them from being rational. It stopped them from looking at the company objectively. As a result, they likely did not invest in Fairfax at all. So they missed out on one of the great investments of the past 4 years.

 

The haters are a pretty quiet bunch these days. But they were out in full force in 2020.

 

But even many of those who were positive on Fairfax 4 years ago were also very wrong. They grossly underestimated the opportunity. As a result they likely did not size their position properly. And many likely sold their position much too soon.

 

Who got Fairfax the most right 4 years ago? Some lucky guy named Prem Watsa who invested $150 million in Fairfax at US$308/share in June of 2020 at pretty much the bottom. If only he had not kept his investment (and his rationale) secret… we all could have learned and benefitted from what he knew!

 

Of course, Prem did tell investors what he was doing and why. Prem nailed it. And we all completely ignored him. (I guess this also explains why he is a billionaire and we are not!)

 

From Fairfax’s press release on June 15, 2020:

 

Mr. Watsa commented as follows in connection with this purchase: “At our AGM and on our first quarter earnings release call, I said that our shares are ‘ridiculously cheap’. That statement reflected my recognition that in the 35 years since Fairfax began, I have never seen Fairfax shares sell at a bigger discount to their intrinsic value than they have recently. I have now backed up my strong words by purchasing close to US$150 million of Fairfax shares in the market over the last few days, as I believe that this will be an excellent long term investment.”

 

—————

 

Be careful who you listen to

 

Who and what you let into your brain is super important. It is crazy how easily an investor can get messed up by their ‘information’ sources. Bad analysis and faulty logic can pollute rational thought / actions - once it gets into your head/thought process it can be very difficult to remove.

 

Ignore the haters

 

As we learned in lesson #1, successful investing is centred on being rational. Haters don’t care about fundamentals/earnings, management, prospects or valuation. Haters are blinded by the facts, especially at inflection points. The problem is the haters usually say things with a lot of conviction - and the old (wrong) narrative makes so much sense. This makes their views sound very persuasive at the time.

 

Back in 2020, the haters were out in full force. What were they saying? ‘Prem is an idiot.’ Or something similar. Their ‘analysis’ was exclusively rear-view mirror in nature. The positive changes happening at the company didn’t matter. The improving fundamentals / earnings didn’t matter.

 

This leads into our next lesson.

 

—————

 

3.) The Corner of Berkshire & Fairfax is an amazing resource for investors.

 

"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

 

Having the opportunity to hang out with, learn from and debate with many other successful investors from all walks of life and all over the world is amazing. Being able to do so for 20 years is priceless.

 

The Corner of Berkshire and Fairfax (CofBF) has been sprinkling pixie dust on its members for more than 20 years. Thank you Sanjeev for running this wonderful investment forum.

 

And when it comes to Fairfax, there is no better resource for investors out there. The analysis provided by board members over the years (20 and counting) has been simply outstanding. And for the past 4 years, members of CofBF have had a front row seat to Fairfax’s amazing turnaround.

 

Out of favour = under-followed

 

The fact that sentiment in Fairfax got so bad back in 2020 was actually a big help in this regard.

 

Pretty much no one was following the company back then. At the same time, the old narrative surrounding the company was completely wrong. That is a wonderful set up for an independently thinking, open-minded investor.

 

When it came to Fairfax as investment, this gave CofBF board members a massive information advantage over the entire investment community. This advantage has persisted for years.

 

But seeing an opportunity is not enough.

 

—————

 

4.) Knowledge without action often results in the biggest mistakes for investors.

 

“The most extreme mistakes in Berkshire's history have been mistakes of omission. We saw it, but didn't act on it. They're huge mistakes — we've lost billions. And we keep doing it. We're getting better at it. We never get over it.” There are two types of mistakes: 1) doing nothing; what Warren calls “sucking my thumb” and 2) buying with an eyedropper things we should be buying a lot of.” Charlie Munger

 

To make money an investor can’t just read/study and sit in cash. At some point in time they have to act on what they have learned and buy something. And they need to size their position properly (more on this later in the post).

 

Sanjeev (and others) were pounding the table very loudly on Fairfax during the entire summer of 2020. At the time, they provided lots of great analysis in support of their views. The opportunity in Fairfax was gift wrapped for the members of the Corner of Berkshire and Fairfax.

 

For a trip down memory lane, below are links to a couple of threads from 2020 with Sanjeev (and a few others) pointing out how cheap Fairfax had gotten - with pushback from lots of others. In the second link, Sanjeev suggests Fairfax could return 300% over a 5-7 year time frame. It got there in 4 years.

• https://thecobf.com/forum/topic/18079-remember-this-quote/#comment-411701
• https://thecobf.com/forum/topic/17401-fairfax-2020/page/12/#comment-401311

What is interesting is how fast the general stock market bounced back in 2020 - by August the S&P500 took out its pre-Covid high (reached in February) and was back at all-time highs.

 

In February of 2020, Fairfax was trading at $475/share. From March 17 to November 13, 2020, Fairfax traded below $320/share. Investors had about 8 months to do their research, get comfortable with the story and still buy Fairfax at a historically cheap valuation.

 

Fairfax did not take out its pre-Covid (February) high until December of 2021. It stayed cheap for years.

 

But how many board members actually invested in Fairfax in 2020? Or 2021? Or 2022? Or 2023?

 

Not acting on what you know - Buffett calls that ‘thumb sucking.’ My guess is when it comes to Fairfax, there has been a lot of thumb sucking going on the past 4 years.

 

What about me? What was I doing?

 

All through the summer I was listening to Sanjeev and others on the board - I just wasn’t doing anything about it (that ‘thumb sucking’ thing). That changed in late October 2020, when I re-established a position in the stock.  I got very lucky with my timing. Not surprisingly, that is also when my posting on Fairfax started to increase.

• https://thecobf.com/forum/topic/17401-fairfax-2020/page/26/#comment-422165

—————-

 

To be continued: The final 4 lessons will come in my next long-form post which should be completed in the next week. 

 

On Saturday I posted Part 1 (lessons 1 to 4). It is linked above for those who have not read it. Here is the conclusion, Part 2 (lessons 5 to 8). 

 

Fairfax Financial - 8 Lessons Learned Over the Past 4 Years

 

Lesson 5.) Value investing works - really well.

 

"The three most important words in investing are margin of safety.” Warren Buffett

 

What is margin of safety?

 

Buy something for less than it is worth.

 

This investment framework works so well for 2 simple reasons:

1. If you are right, you can make a lot of money.
2. If you are wrong, your downside is protected.

And the bigger the discount (margin of safety) the better.

 

“It is extraordinary to me that the idea of buying dollar bills for 40 cents takes immediately with people or doesn't take at all.” Warren Buffett

 

What is a good way to value an insurance company?

 

By using book value.

 

What was Fairfax’s price/book value multiple in 2020?

 

At the end of 2019, Fairfax traded at a P/BV = 1x. At the time, Fairfax was out of favour as an investment - and this was reflected in its very low P/BV multiple.

 

After Covid hit, Fairfax sold off aggressively. From March to December of 2020 it traded at a P/BV multiple of about 0.7x and there were times when it traded below 0.6x.

 

That was a historically low valuation for Fairfax.

 

 

What was a rational investor to do?

 

Buy the stock, of course.

 

Fairfax was a textbook value investment in 2020.

 

Buying Fairfax was a pretty easy decision. The difficult decision in 2020 was position size - how much should an investor buy?

 

—————

 

Lesson 6.) Sizing a position is critically important to long term investment performance

 

“Sizing is 70% to 80% of the equation. Part of the equation is seeing the investment, part of the investment is seeing myself in a good trading rhythm. It’s not whether you’re right or wrong, it’s how much you make when you’re right and how much you lose when you’re wrong,” Stan Druckenmiller

• https://moneyweek.com/investments/investment-strategy/605020/stan-druckenmiller-position-size-really-matters

In 2022, Warren Buffett said that 12 investment decisions - one about every 5 years - is what has delivered much of Berkshire Hathaway’s outperformance over the years.

 

“In 58 years of Berkshire management, most of my capital-allocation decisions have been no better than so-so... Our satisfactory results have been the product of about a dozen truly good decisions – that would be about one every five years.” Warren Buffett - Berkshire Hathaway 2022AR

 

Truly great investment opportunities come along very infrequently - Buffett found about two each decade. And he is really good at this game. Guess how many an average investor are going to find?

 

These are investments that:

• you understand better than almost everyone else.
• are trading at a very cheap valuation.

When you find one of these you need to take full advantage - and get the position size right. Getting this right is what allows an investor to outperform the market averages over time.

 

Concentrating a position does a couple of important things for an investor:

• It focusses the mind (that ‘skin in the game’ thing).
• It results in a higher purchase threshold (reserved for best ideas).

Of course this strategy only works if you are right.

 

Concentration is a great example of how the theory part of investing is incredibly simple. And the practice/execution part is incredibly difficult.

 

Is concentration not a risky think to do?

 

I like Buffett’s definition of risk:

 

“Risk comes from not knowing what you are doing.” Warren Buffett

 

Fairfax

 

For much of 2020, Fairfax was trading at a historically low valuation of 0.7 x BV (even going as low as 0.6 x BV). This means the stock was trading at the largest ‘margin of safety’ in the company’s history.

 

Later in 2020, Fairfax’s investments had stabilized (cyclical stocks rebounded) and its insurance business was growing nicely (hard market).

 

Yes, this was a great time to buy the stock. But more importantly, it was the perfect time to back up the truck and build out a concentrated position.

 

With Fairfax, investors got one of those ‘punch card’ moments that Buffett has often talked about in the past.

 

—————-

 

Back in 2020, Sanjeev’s was saying much of the same thing. Below is one of his posts from May 14, 2020:

 

“What I can provide you is perspective, my rational assumptions and how I came to my conclusions.  Yes, I've seen this rodeo before...including with Fairfax.  Amazing what 22 years of investing teaches you, especially over this last generation where we've incredibly seen compressed cycles of 50% drops in the market 3 times...1999/2000, 2008/2009 and 2020/2021. 

 

“You generally get one of those cycles every other generation...we've seen three in one generation.  Is that due to the internet?  Computer trading?  ETF's?  Massive amounts of competition by hedge funds, private equity, pensions, etc?  Recklessness in financial instruments, by the Fed, IMF?  Distortions in monetary policy?  Maybe a combination of all them!

 

“All I know is that I've been given 3 massive swings at the bat in one generation...300% gains over several years.  This is probably the last one before I retire, and I'm going big!  I expect the stuff I'm buying today to be up 300% or better from my current cost over the next 5-7 years.”

• https://thecobf.com/forum/topic/17401-fairfax-2020/page/12/#comment-401311

—————-

 

Lesson 7.) Following the fundamentals  - this is what should have kept an investor in Fairfax

 

“You’re not buying a stock, you’re buying part ownership in a business. You will do well if the business does well. And if you didn't pay a totally silly price.” Warren Buffett

 

“What possible assurance do you have that (a stock you own) will go up in price? And if you are buying, how much should you pay? What you’re asking here is what makes a company valuable, and why it will be more valuable tomorrow than it is today. There are many theories, but to me, it always comes down to earnings and assets. Especially earnings.” Peter Lynch - One Up On Wall Street

 

OK. So you discovered a great investment. You bought it. And then you sized it properly - made it a significant position.

 

What do you do next?

 

You own a piece of a business. So the next thing you do is you closely monitor how the business is performing:

• Financials/earnings
• Management
• Insurance industry
• Financial markets
• Prospects

You monitor the fundamentals of the business. Are they improving? Staying the same? Or deteriorating?

 

—————

 

"If past history was all that is needed to play the game of money, the richest people would be librarians." Warren Buffett

 

Monitoring the fundamentals is even more important for a turnaround play. And that is what kind of investment Fairfax was back in 2020.

 

What happened with Fairfax?

 

In 2021, the fundamentals of the company got better. Much better.

 

Why?

 

Three things were happening at the same time:

1. Driven by the hard market, the insurance business was growing rapidly.
2. Cyclical stocks (Fairfax has lots in their portfolio) spiked higher.
3. The management team began executing exceptionally well in terms of capital allocation.

Headwinds had flipped to tailwinds. Also, by 2021, Fairfax had fixed its investing framework. The turnaround was turning around - and quickly.

 

The fundamentals of the business continued to improve in 2022. And again in 2023. A decade long headwind  - low interest rates - turned into a tailwind when interest rates spiked. By the end of 2023, the turnaround was complete. Truth be told, it was probably complete the end of 2022.

 

What happened to earnings?

 

Earnings spiked higher. Importantly, the increase in earnings was being driven by spiking operating income. Operating income at Fairfax averaged $1.1 billion/year ($45/share) from 2016 to 2021. In 2023 it was $4.4 billion ($193/share). Per share, operating income increased by 329%. That is a simply amazing increase over a 3 year period.

 

 

What about the stock price?

 

The stock price spiked higher.

 

What about the valuation of the stock?

 

This is where the story gets even more interesting - and a little nuts.

 

Mr Market was focussed on Fairfax’s stock price. Those who followed the company closely were focussed on fundamentals/earnings.

 

Fairfax’s stock went up lots. But so did Fairfax’s fundamentals. As a result, the valuation gap wasn’t shrinking by all that much. As a result, the stock continued to be undervalued.

 

Following the fundamentals closely is what likely stopped many investors in Fairfax from selling their shares after a quick gain. This gets to our next lesson.

 

————-

 

Lesson 8.) Patience is how you make the big money.

 

“And right here let me say one thing: After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight! It is no trick at all to be right on the market. You always find lots of early bulls in bull markets and early bears in bear markets. I've known many men who were right at exactly the right time, and began buying or selling stocks when prices were at the very level which should show the greatest profit. And their experience invariably matched mine - that is, they made no real money out of it. Men who can both be right and sit tight are uncommon. I found it one of the hardest things to learn. But it is only after a stock operator has firmly grasped this that he can make big money...” Reminiscences of a Stock Operator

 

“Be patient. The stocks that have been most rewarding to me have made their greatest gains in the third or fourth year I owned them. A few took ten years.” Peter Lynch

 

“Selling your winners and holding your losers is like cutting the flowers and watering the weeds.” Peter Lynch

 

How many investors sold their Fairfax shares for a quick small gain in 2021. Or 2022. Or 2023? Or 2024? Most of the investors that sold Fairfax over the past three years have likely missed out on making the big money.

 

What is the hardest thing in investing?

 

Holding winners might be the hardest thing for an investor to do. Holding big winners… well, that is almost impossible.

 

So guess what?

 

Most investors have few if any big winners. As a result they usually underperform the market averages.

 

Why is this?

 

Monitor (following the fundamentals) and patience (hold your winners) are often contradictions. Because monitor often results in action. Your brain just can’t help itself - it’s busy computing and… well, it’s decided you need to do something… anything! It needs you to act on what it think it knows.

 

And then your gut gets involved - it doesn’t want to be ignored or left out. So it starts telling you do something as well (sometimes it is screaming).

 

As a result, winning positions usually get sold way too early. The reasons always make sense at the time.

 

Do nothing? Ignore what both your brain and gut are telling you? Now that is hard. Pretty much impossible for most investors.

 

This process gets even harder for big positions - because you monitor your big positions even more closely (so your brain and your gut have even more to say).

 

Selling a big winner way too early can be disastrous to an investors long term results. Because they come along so infrequently.

 

So what is an investor to do?

 

Be as rational as possible. And here we are, back at the start of our story (see ‘Lesson 1: Investors need to be rational at all times with their investments')

 

Where does Fairfax go from here?

 

Fairfax has already been a 3 bagger for many members of Corner of Berkshire and Fairfax.

 

Are we done? I don’t think so.

 

Fairfax continues to trade at a valuation (P/BV) that is well below that of its P/C insurance peers. We also know Fairfax’s book value is understated (one reason is the excess of FV over CV) - so this makes it even cheaper. Earnings are strong (near record highs). When it comes to capital allocation, the management team at Fairfax has been best in class over the past 5 years. Bottom line, stock still looks cheap and its prospects look solid.

 

But don’t take my word for it. It looks like Fairfax has repurchased and retired another 61,000 of their shares in August. They are on pace to reduce effective shares outstanding by more than 1 million in 2024. Fairfax are value investors - they only buy back shares if they think they are trading at a discount to their intrinsic value.

Edited September 10 by Viking

[Viking]

3 hours ago, TwoCitiesCapital said:

 

I still don't understand this argument. Sure it makes sense in theory - but then why was insurance so morose in the 2010s when interest rates were also at 0% for most of the decade? 

 

Why did the hard market were seeing now start post-covid when interest rates were rising to a highest level they've been since pre-GFC? 

 

Overall, the theory may be true - but it seems the lags in effects on profitability are so long as to be meaningless in forecasting anything in the next 1-3 years in terms of hardness/softness and earnings. 

 

 

My main concern isn't a mark to market loss on equities in a down market, but a liquidity drain from the TRS if Fairfax gets sold off in tandem. 

 

That didn't happen in 2022. It DID happen in 2020 and 2018 and 2007. 

 

Perhaps the leverage is worth the quarterly liquidity risk. But I'd feel more comfortable if Fairfax didn't own the TRS in a down market. 

@TwoCitiesCapital , at the end of the day, over time ROE for P/C insurance companies is driven by two things:

- underwriting profit

- total return on investments

 

All publicly traded P/C insurance companies need to deliver an acceptable ROE over time. Or the CEO / senior team gets fired. 
 

Most publicly traded P/C insurance companies invest primarily in bonds. If bond yields are low then underwriting profit needs to do more of the heavy lifting - drive a larger share of earnings.

 

This is over time. Lots can happen in a given year - or over a couple of years.
 

In terms of trying to explain what happened in the past - the short answer is its complicated. There are lots of other factors also involved like reserve levels, region, line. Some are company specific like reserve levels (and reserve releases). 
 

So we will see what happens moving forward.

 

Bottom line, my guess is much lower bond yields will simply put more importance on earning an underwriting profit. My point is more that this is a dynamic process. A negative in one area often shows up as a positive in another important area. And vice versa. How it plays out is impossible to know. So the key is to not get too pessimistic or too optimistic - and to closely monitor the situation.
 

Most importantly, decisions should be based as much as possible on facts and not fears. 

Edited September 10 by Viking

[Viking]

Here are some comments on the FFH total return swaps.

 

1.) Fairfax holds them as an investment - at least that is what they have said in the past. 
 

If they still own them, that suggests they still like the risk / reward trade off. And it is probably heavily skewed in a favourable way. Given the risks, why hold them otherwise?

 

For those who think Fairfax should sell… can you also indicate what you think fair value is for Fairfax’s stock? 
 

When i was at Fairfax’s AGM this year my question for other attendees was “What is a reasonable P/BV for Fairfax?” Consensus was Fairfax should trade at a minimum P/BV of 1.5x.
 

Book value of Fairfax today is $980/share. Q3 earnings should come in around $40 (with the Stelco gain) which means ‘real time’ BV at Sept 30 = $1,020. 

• 1.5x BV = $1,530. Stock closed today at $1,211, which is significantly below $1,530.

We also know book value is understated. Excess of FV over CV is large. Other assets like BIAL are also likely significantly undervalued in reported BV. 
 

As a result, US$1,600 or even $1,700/share might represent a reasonable fair value for Fairfax today. 

 

2.) Fairfax is aggressively buying back stock. They have been doing this for the past 7 years. But the pace of buybacks has picked up in 2024. This is likely because the hard market is slowing. What will the insurance subs do with the excess capital? Send it to Fairfax who will buy back stock.

 

3.) Fairfax has very robust cash flow. Fairfax is also earning about $2.5 billion in interest income. A $2 billion number is largely locked in for the next couple of years. This is just one income stream. There are many more income streams. Fairfax also could sell assets. Even if adversity hits, Fairfax should have pretty robust cash flow. 

 

4.) Fairfax appears to be the marginal buyer of its stock this year. what determines the value of Fairfax’s stock? 
 

By buying back stock Fairfax is driving value in two ways:

- buying stock at prices well below intrinsic value.

- significantly increasing earnings via gains from the TRS. 
 

The value creation from this one-two punch over the past 4 years has been significant. My guess is there is more to come - and perhaps much more. 
 

Again, it all comes down to what you think Fairfax’s stock is worth. 
 

When Fairfax made the TRS investment at the end of 2020/beginning of 2021, Prem said he felt it would become one of Fairfax’s best-ever investments. And it has - in 3.5 short years. 
 

Remember - how do you make the big money? Patience.

Edited September 10 by Viking

[73 Reds]

19 minutes ago, Viking said:

Here are some comments on the FFH total return swaps.

 

1.) Fairfax holds them as an investment - at least that is what they have said in the past. 
 

If they still own them, that suggests they still like the risk / reward trade off. And it is probably heavily skewed in a favourable way. Given the risks, why hold them otherwise?

 

For those who think Fairfax should sell… can you also indicate what you think fair value is for Fairfax’s stock? 
 

When i was at Fairfax’s AGM this year my question for other attendees was “What is a reasonable P/BV for Fairfax?” Consensus was Fairfax should trade at a minimum P/BV of 1.5x.
 

Book value of Fairfax today is $980/share. Q3 earnings should come in around $40 (with the Stelco gain) which means ‘real time’ BV at Sept 30 = $1,020. 

• 1.5x BV = $1,530. Stock closed today at $1,211, which is significantly below $1,530.

We also know book value is understated. Excess of FV over CV is large. Other assets like BIAL are also likely significantly undervalued in reported BV. 
 

As a result, US$1,600 or even $1,700/share might represent a reasonable fair value for Fairfax today. 

 

2.) Fairfax is aggressively buying back stock. They have been doing this for the past 7 years. But the pace of buybacks has picked up in 2024. This is likely because the hard market is slowing. What will the insurance subs do with the excess capital? Send it to Fairfax who will buy back stock.

 

3.) Fairfax has very robust cash flow. Fairfax is also earning about $2.5 billion in interest income. A $2 billion number is largely locked in for the next couple of years. This is just one income stream. There are many more income streams. Fairfax also could sell assets. Even if adversity hits, Fairfax should have pretty robust cash flow. 

 

4.) Fairfax appears to be the marginal buyer of its stock this year. what determines the value of Fairfax’s stock? 
 

By buying back stock Fairfax is driving value in two ways:

- buying stock at prices well below intrinsic value.

- significantly increasing earnings via gains from the TRS. 
 

The value creation from this one-two punch over the past 4 years has been significant. My guess is there is more to come - and perhaps much more. 
 

Again, it all comes down to what you think Fairfax’s stock is worth. 
 

When Fairfax made the TRS investment at the end of 2020/beginning of 2021, Prem said he felt it would become one of Fairfax’s best-ever investments. And it has - in 3.5 short years. 
 

Remember - how do you make the big money? Patience.

The irony is, the more stock Fairfax repurchases at ever-higher prices, the more the TRS grows in value.  I'm not entirely comfortable with that relationship.  Also there is at least one counterparty - do we know who is on the other side of this bet and what control, if any they may have?  Given that the TRS is now one of Fairfax's largest equity positions, the details are worth knowing.  I'd imagine there is a written contract somewhere but is it available to shareholders?

[TwoCitiesCapital]

5 hours ago, 73 Reds said:

For us novices when it comes to total return swaps, can someone explain the mechanics, i.e., how often payments are made, whether there are any added costs to Fairfax for maintaining the TRS and whether either party can exit some or all of the TRS at any time and if so at what cost?  Also is there an expiration or maturity date?

 

Fairfax is receiving the return on a number of shares, as if it owned them, in exchange for a financing rate (LIBOR or whatever iteration it exists today plus a spread). 

 

Typically, the return and financing costs are better and paid either monthly or quarterly. 

 

In cases where the return on Fairfax shares exceeds the financing cost, Fairfax receives cash. 

 

In cases where the return on Fairfax shares is less than the financibg costs, Fairfax pays cash. 

[73 Reds]

3 minutes ago, TwoCitiesCapital said:

 

Fairfax is receiving the return on a number of shares, as if it owned them, in exchange for a financing rate (LIBOR or whatever iteration it exists today plus a spread). 

 

Typically, the return and financing costs are better and paid either monthly or quarterly. 

 

In cases where the return on Fairfax shares exceeds the financing cost, Fairfax receives cash. 

 

In cases where the return on Fairfax shares is less than the financibg costs, Fairfax pays cash. 

Thanks @TwoCitiesCapital.  Can Fairfax terminate this transaction at any time?  Otherwise, how long does it last?  I would think that if the company anticipates an operational rough patch of any duration it might want to terminate the TRS in advance.

Edited September 10 by 73 Reds
spelling

[TwoCitiesCapital]

36 minutes ago, 73 Reds said:

Thanks @TwoCitiesCapital.  Can Fairfax terminate this transaction at any time?  Otherwise, how long does it last?  I would think that if the company anticipates an operational rough patch of any duration it might want to terminate the TRS in advance.

 

Hard to say for more bespoke contracts like this. 

 

But my experience with them is there is typically a stated maturity/reset date where the notional value and financing rates can be adjusted for an extension or terminated. 

 

It's not uncommon for these to be monthly or quarterly intervals, so I'd expect Fairfax to be able to exit with some flexibility if they want to. 

[SafetyinNumbers]

There is a lot of concern about the volatility of the earnings but even if the stock plunged back to (real time) BV, that’s only a ~$400m or ~$16/sh hit to earnings and it’s temporary. The potential loss also doesn’t seem big enough to cause any stress to the balance sheet. I know investors have a preference for smoothed earnings but FFH will always be lumpy. It also might make a bad quarter worse one of these days but right now when they are growing BV 3-5% a quarter at ~1x fwd BV it just doesn’t seem that risky. If it was just another investment, most investors wouldn’t think twice and it’s small enough they still shouldn’t. 

[Haryana]

On 9/7/2024 at 12:40 PM, Viking said:

...

Fairfax’s stock is up 297% over the past 4 years. That is a CAGR of 41.1%. $1,000 invested in Fairfax 4 years ago would be worth $3,968 today, an increase of $2,968. That is a crazy good.

...

First of all, many thanks for your postings.

You appreciate dialogue and things pointed out, therefore, I dare present the following.

 

Your numbers above seem to be without dividend. I think dividends should be reinvested for CAGR calculation.

With dividends, the stock would be up ~330%with a CAGR of ~44% over that 4 year period.

That is more than a quadruple. A $1000 would be $4290.

 

[Viking]

57 minutes ago, Haryana said:

First of all, many thanks for your postings.

You appreciate dialogue and things pointed out, therefore, I dare present the following.

 

Your numbers above seem to be without dividend. I think dividends should be reinvested for CAGR calculation.

With dividends, the stock would be up ~330%with a CAGR of ~44% over that 4 year period.

That is more than a quadruple. A $1000 would be $4290.

 

@Haryana that is a good catch. When i write my posts sometimes i get lazy with my metrics. So sometimes i default to what is easy to find. I typically just use Yahoo Finance or company reports for my data. I wonder if i should subscribe to a paid service so it would be easier to pull more inclusive data points. 
 

Do others on the board subscribe to any paid services for data collection / graphs etc? Do board members have any recommendations?

 

[UK]

9 hours ago, Viking said:

And then your gut gets involved - it doesn’t want to be ignored or left out. So it starts telling you do something as well (sometimes it is screaming).

 

As a result, winning positions usually get sold way too early. The reasons always make sense at the time.

 

Do nothing? Ignore what both your brain and gut are telling you? Now that is hard. Pretty much impossible for most investors.

 

This process gets even harder for big positions - because you monitor your big positions even more closely (so your brain and your gut have even more to say).

 

I am glad I can report that my gut is very comfortable with FFH since I made it into a big position in second half of 2022 and sometimes it is almost ahead of itself (I added to FFH during MW attack without even finishing reading all the report:)). But I still feel and think there has to be a limit somewhere and today I see it at ~40 percent (was above this in the early Summer, currently a tad below). What would be your ideas about this?

 

Edited September 11 by UK

[Viking]

1 hour ago, UK said:

 

I am glad I can report that my gut is very comfortable with FFH since I made it into a big position in 2022 and sometimes it is almost ahead of itself (I added to FFH during MW attack without even finishing reading all the report). But I still feel and think there has to be a limit somewhere and today see it at ~40 percent (was above this in the early Summer, currently somewhat below). What would be your ideas about this?

@UK good for you. Well done. 

Concentration is a hugely important topic. And definitely not one size fits all - probably because so many things go into the calculation. Everyone really needs to figure this out for themself.
 

When i was younger, i would sometimes go 100% with one stock (only for a short period of time). But only if it was something I understood exceptionally well. That just kept going down - so over time my position size would get quite large (as i would keep adding). The last time i did this with a stock was with Apple in 2013.
 

I also have core positions that i will flex up and down depending on what Mr. Market does. So this makes it difficult to give definitive numbers on position sizes (targets or actuals). That is what i was doing with Apple - but the story kept getting better and the stock kept getting cheaper - so i kept adding. Probably a really stupid thing to do.
 

The flexing is temporary and allows me to take advantage of short term volatility in my very best ideas while i am waiting for the longer term thesis to play out.
 

Fairfax is my biggest position today (it has been for the past 4 years) and i have flexed it up and back down twice this year (on both sell offs). 
 

My goal is to have no one position at more than about 33% of my total portfolio. Fairfax is over that today (I don’t want to give an exact number because it changes). 
 

After Fairfax, my biggest holdings are 3 index funds - VOO, VO and XIC). My goal is to build these up to about 40% of my total portfolio (roughly equal weights).
 

I also like cash - i am ok going up to 20%. I love the optionality of cash. I went 100% cash in Feb 2020 when Covid was bearing down - i didn’t like the risk/reward and all my investments at the time were in tax free accounts (so there were no tax issues).
 

The rest of my portfolio is a bunch of misc stuff that i will flex up and down depending on a bunch of different factors.

 

Not sure if that answers your question. It probably raises more questions than it answers. And be warned - i might change my mind tomorrow (to anything written above). I mean this seriously. Mr Market can do some really crazy things. And i will remain open minded and be opportunistic.

 

I also think i have been very lucky over the years, especially over the past 20 years… none of my concentrated positions have blown up on me. This could have easily happened (for any number of reasons). Now i don’t get highly concentrated that often. When i do, it is only with stuff i think i understand very well. And i generally don’t keep positions extremely concentrated for long. So i think it is probably time to tweak this part of my investment process/framework. 
 

Morgan Housel has written about how most investors are not able to evolve as they age from ‘grow capital’ to ‘preserve capital.’ That is what i am trying to use ETF/index funds for in my portfolio - the set and forget / preserve capital part. The rest is my ‘grow capital’ part.

Edited September 11 by Viking

[Haryana]

1 hour ago, Viking said:

@Haryana that is a good catch. When i write my posts sometimes i get lazy with my metrics. So sometimes i default to what is easy to find. I typically just use Yahoo Finance or company reports for my data. I wonder if i should subscribe to a paid service so it would be easier to pull more inclusive data points. 
 

Do others on the board subscribe to any paid services for data collection / graphs etc? Do board members have any recommendations?

 

 

One thing I like about Morningstar is their charts for Growth that include dividends for free, easy comparison. 

[Haryana]

11 hours ago, Viking said:

 

On Saturday I posted Part 1 (lessons 1 to 4). It is linked above for those who have not read it. Here is the conclusion, Part 2 (lessons 5 to 8). 

 

Fairfax Financial - 8 Lessons Learned Over the Past 4 Years

 

Lesson 5.) Value investing works - really well.

 

"The three most important words in investing are margin of safety.” Warren Buffett

 

What is margin of safety?

 

Buy something for less than it is worth.

 

This investment framework works so well for 2 simple reasons:

1. If you are right, you can make a lot of money.
2. If you are wrong, your downside is protected.

And the bigger the discount (margin of safety) the better.

 

“It is extraordinary to me that the idea of buying dollar bills for 40 cents takes immediately with people or doesn't take at all.” Warren Buffett

 

What is a good way to value an insurance company?

 

By using book value.

 

What was Fairfax’s price/book value multiple in 2020?

 

At the end of 2019, Fairfax traded at a P/BV = 1x. At the time, Fairfax was out of favour as an investment - and this was reflected in its very low P/BV multiple.

 

After Covid hit, Fairfax sold off aggressively. From March to December of 2020 it traded at a P/BV multiple of about 0.7x and there were times when it traded below 0.6x.

 

That was a historically low valuation for Fairfax.

 

 

What was a rational investor to do?

 

Buy the stock, of course.

 

Fairfax was a textbook value investment in 2020.

 

Buying Fairfax was a pretty easy decision. The difficult decision in 2020 was position size - how much should an investor buy?

 

—————

 

Lesson 6.) Sizing a position is critically important to long term investment performance

 

“Sizing is 70% to 80% of the equation. Part of the equation is seeing the investment, part of the investment is seeing myself in a good trading rhythm. It’s not whether you’re right or wrong, it’s how much you make when you’re right and how much you lose when you’re wrong,” Stan Druckenmiller

• https://moneyweek.com/investments/investment-strategy/605020/stan-druckenmiller-position-size-really-matters

In 2022, Warren Buffett said that 12 investment decisions - one about every 5 years - is what has delivered much of Berkshire Hathaway’s outperformance over the years.

 

“In 58 years of Berkshire management, most of my capital-allocation decisions have been no better than so-so... Our satisfactory results have been the product of about a dozen truly good decisions – that would be about one every five years.” Warren Buffett - Berkshire Hathaway 2022AR

 

Truly great investment opportunities come along very infrequently - Buffett found about two each decade. And he is really good at this game. Guess how many an average investor are going to find?

 

These are investments that:

• you understand better than almost everyone else.
• are trading at a very cheap valuation.

When you find one of these you need to take full advantage - and get the position size right. Getting this right is what allows an investor to outperform the market averages over time.

 

Concentrating a position does a couple of important things for an investor:

• It focusses the mind (that ‘skin in the game’ thing).
• It results in a higher purchase threshold (reserved for best ideas).

Of course this strategy only works if you are right.

 

Concentration is a great example of how the theory part of investing is incredibly simple. And the practice/execution part is incredibly difficult.

 

Is concentration not a risky think to do?

 

I like Buffett’s definition of risk:

 

“Risk comes from not knowing what you are doing.” Warren Buffett

 

Fairfax

 

For much of 2020, Fairfax was trading at a historically low valuation of 0.7 x BV (even going as low as 0.6 x BV). This means the stock was trading at the largest ‘margin of safety’ in the company’s history.

 

Later in 2020, Fairfax’s investments had stabilized (cyclical stocks rebounded) and its insurance business was growing nicely (hard market).

 

Yes, this was a great time to buy the stock. But more importantly, it was the perfect time to back up the truck and build out a concentrated position.

 

With Fairfax, investors got one of those ‘punch card’ moments that Buffett has often talked about in the past.

 

—————-

 

Back in 2020, Sanjeev’s was saying much of the same thing. Below is one of his posts from May 14, 2020:

 

“What I can provide you is perspective, my rational assumptions and how I came to my conclusions.  Yes, I've seen this rodeo before...including with Fairfax.  Amazing what 22 years of investing teaches you, especially over this last generation where we've incredibly seen compressed cycles of 50% drops in the market 3 times...1999/2000, 2008/2009 and 2020/2021. 

 

“You generally get one of those cycles every other generation...we've seen three in one generation.  Is that due to the internet?  Computer trading?  ETF's?  Massive amounts of competition by hedge funds, private equity, pensions, etc?  Recklessness in financial instruments, by the Fed, IMF?  Distortions in monetary policy?  Maybe a combination of all them!

 

“All I know is that I've been given 3 massive swings at the bat in one generation...300% gains over several years.  This is probably the last one before I retire, and I'm going big!  I expect the stuff I'm buying today to be up 300% or better from my current cost over the next 5-7 years.”

• https://thecobf.com/forum/topic/17401-fairfax-2020/page/12/#comment-401311

—————-

 

Lesson 7.) Following the fundamentals  - this is what should have kept an investor in Fairfax

 

“You’re not buying a stock, you’re buying part ownership in a business. You will do well if the business does well. And if you didn't pay a totally silly price.” Warren Buffett

 

“What possible assurance do you have that (a stock you own) will go up in price? And if you are buying, how much should you pay? What you’re asking here is what makes a company valuable, and why it will be more valuable tomorrow than it is today. There are many theories, but to me, it always comes down to earnings and assets. Especially earnings.” Peter Lynch - One Up On Wall Street

 

OK. So you discovered a great investment. You bought it. And then you sized it properly - made it a significant position.

 

What do you do next?

 

You own a piece of a business. So the next thing you do is you closely monitor how the business is performing:

• Financials/earnings
• Management
• Insurance industry
• Financial markets
• Prospects

You monitor the fundamentals of the business. Are they improving? Staying the same? Or deteriorating?

 

—————

 

"If past history was all that is needed to play the game of money, the richest people would be librarians." Warren Buffett

 

Monitoring the fundamentals is even more important for a turnaround play. And that is what kind of investment Fairfax was back in 2020.

 

What happened with Fairfax?

 

In 2021, the fundamentals of the company got better. Much better.

 

Why?

 

Three things were happening at the same time:

1. Driven by the hard market, the insurance business was growing rapidly.
2. Cyclical stocks (Fairfax has lots in their portfolio) spiked higher.
3. The management team began executing exceptionally well in terms of capital allocation.

Headwinds had flipped to tailwinds. Also, by 2021, Fairfax had fixed its investing framework. The turnaround was turning around - and quickly.

 

The fundamentals of the business continued to improve in 2022. And again in 2023. A decade long headwind  - low interest rates - turned into a tailwind when interest rates spiked. By the end of 2023, the turnaround was complete. Truth be told, it was probably complete the end of 2022.

 

What happened to earnings?

 

Earnings spiked higher. Importantly, the increase in earnings was being driven by spiking operating income. Operating income at Fairfax averaged $1.1 billion/year ($45/share) from 2016 to 2021. In 2023 it was $4.4 billion ($193/share). Per share, operating income increased by 329%. That is a simply amazing increase over a 3 year period.

 

 

What about the stock price?

 

The stock price spiked higher.

 

What about the valuation of the stock?

 

This is where the story gets even more interesting - and a little nuts.

 

Mr Market was focussed on Fairfax’s stock price. Those who followed the company closely were focussed on fundamentals/earnings.

 

Fairfax’s stock went up lots. But so did Fairfax’s fundamentals. As a result, the valuation gap wasn’t shrinking by all that much. As a result, the stock continued to be undervalued.

 

Following the fundamentals closely is what likely stopped many investors in Fairfax from selling their shares after a quick gain. This gets to our next lesson.

 

————-

 

Lesson 8.) Patience is how you make the big money.

 

“And right here let me say one thing: After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It always was my sitting. Got that? My sitting tight! It is no trick at all to be right on the market. You always find lots of early bulls in bull markets and early bears in bear markets. I've known many men who were right at exactly the right time, and began buying or selling stocks when prices were at the very level which should show the greatest profit. And their experience invariably matched mine - that is, they made no real money out of it. Men who can both be right and sit tight are uncommon. I found it one of the hardest things to learn. But it is only after a stock operator has firmly grasped this that he can make big money...” Reminiscences of a Stock Operator

 

“Be patient. The stocks that have been most rewarding to me have made their greatest gains in the third or fourth year I owned them. A few took ten years.” Peter Lynch

 

“Selling your winners and holding your losers is like cutting the flowers and watering the weeds.” Peter Lynch

 

How many investors sold their Fairfax shares for a quick small gain in 2021. Or 2022. Or 2023? Or 2024? Most of the investors that sold Fairfax over the past three years have likely missed out on making the big money.

 

What is the hardest thing in investing?

 

Holding winners might be the hardest thing for an investor to do. Holding big winners… well, that is almost impossible.

 

So guess what?

 

Most investors have few if any big winners. As a result they usually underperform the market averages.

 

Why is this?

 

Monitor (following the fundamentals) and patience (hold your winners) are often contradictions. Because monitor often results in action. Your brain just can’t help itself - it’s busy computing and… well, it’s decided you need to do something… anything! It needs you to act on what it think it knows.

 

And then your gut gets involved - it doesn’t want to be ignored or left out. So it starts telling you do something as well (sometimes it is screaming).

 

As a result, winning positions usually get sold way too early. The reasons always make sense at the time.

 

Do nothing? Ignore what both your brain and gut are telling you? Now that is hard. Pretty much impossible for most investors.

 

This process gets even harder for big positions - because you monitor your big positions even more closely (so your brain and your gut have even more to say).

 

Selling a big winner way too early can be disastrous to an investors long term results. Because they come along so infrequently.

 

So what is an investor to do?

 

Be as rational as possible. And here we are, back at the start of our story (see ‘Lesson 1: Investors need to be rational at all times with their investments')

 

Where does Fairfax go from here?

 

Fairfax has already been a 3 bagger for many members of Corner of Berkshire and Fairfax.

 

Are we done? I don’t think so.

 

Fairfax continues to trade at a valuation (P/BV) that is well below that of its P/C insurance peers. We also know Fairfax’s book value is understated (one reason is the excess of FV over CV) - so this makes it even cheaper. Earnings are strong (near record highs). When it comes to capital allocation, the management team at Fairfax has been best in class over the past 5 years. Bottom line, stock still looks cheap and its prospects look solid.

 

But don’t take my word for it. It looks like Fairfax has repurchased and retired another 61,000 of their shares in August. They are on pace to reduce effective shares outstanding by more than 1 million in 2024. Fairfax are value investors - they only buy back shares if they think they are trading at a discount to their intrinsic value.

 

This was an amazing two part post. 

 

A live case study including nuggets. 

 

Better than reading two good books. 

 

[UK]

2 hours ago, Viking said:

@UK good for you. Well done. 

Concentration is a hugely important topic. And definitely not one size fits all - probably because so many things go into the calculation. Everyone really needs to figure this out for themself.
 

When i was younger, i would sometimes go 100% with one stock (only for a short period of time). But only if it was something I understood exceptionally well. That just kept going down - so over time my position size would get quite large (as i would keep adding). The last time i did this with a stock was with Apple in 2013.
 

I also have core positions that i will flex up and down depending on what Mr. Market does. So this makes it difficult to give definitive numbers on position sizes (targets or actuals). That is what i was doing with Apple - but the story kept getting better and the stock kept getting cheaper - so i kept adding. Probably a really stupid thing to do.
 

The flexing is temporary and allows me to take advantage of short term volatility in my very best ideas while i am waiting for the longer term thesis to play out.
 

Fairfax is my biggest position today (it has been for the past 4 years) and i have flexed it up and back down twice this year (on both sell offs). 
 

My goal is to have no one position at more than about 33% of my total portfolio. Fairfax is over that today (I don’t want to give an exact number because it changes). 
 

After Fairfax, my biggest holdings are 3 index funds - VOO, VO and XIC). My goal is to build these up to about 40% of my total portfolio (roughly equal weights).
 

I also like cash - i am ok going up to 20%. I love the optionality of cash. I went 100% cash in Feb 2020 when Covid was bearing down - i didn’t like the risk/reward and all my investments at the time were in tax free accounts (so there were no tax issues).
 

The rest of my portfolio is a bunch of misc stuff that i will flex up and down depending on a bunch of different factors.

 

Not sure if that answers your question. It probably raises more questions than it answers. And be warned - i might change my mind tomorrow (to anything written above). I mean this seriously. Mr Market can do some really crazy things. And i will remain open minded and be opportunistic.

 

I also think i have been very lucky over the years, especially over the past 20 years… none of my concentrated positions have blown up on me. This could have easily happened (for any number of reasons). Now i don’t get highly concentrated that often. When i do, it is only with stuff i think i understand very well. And i generally don’t keep positions extremely concentrated for long. So i think it is probably time to tweak this part of my investment process/framework. 
 

Morgan Housel has written about how most investors are not able to evolve as they age from ‘grow capital’ to ‘preserve capital.’ That is what i am trying to use ETF/index funds for in my portfolio - the set and forget / preserve capital part. The rest is my ‘grow capital’ part.

 

Viking, thank you very much for your elaborate response. It answers my question more than enough and it also resonates with me personally very well, perhaps maybe except for the part of being 100 percent in cash or one position, but also never say never:)

 

And btw, despite me being a very stubborn and slow learner, it was mostly yours (and also Parsad's and other members) material and posts, that finally had awakened me to the FFH opportunity in 2022 in the first place! And I has followed and owned FFH on/off (but never as very large position) since 2012, the year I had also joined this board:)

 

I usually cape my largest positions at 20-25 percent and I usually own 4-6, so that was also a start with FFH initially in 2022, but later, mostly after selling some of the M7 positions in 2023, I kept adding to FFH right until this MW situation and basically made this into 2x limit position in 2023. I also want to disclaim, that this might change tomorrow etc, but as I see situation today, I think for me this will oscillate between 30 and 40 percent for a while. I think I will cape my largest positions somewhere in the 20-30 range in the future more strictly though, or depending on the circumstances (e.g. perhaps I would like to be able to have total attention for my portfolio, if being concentrated more than this, while this could change in the future).  

 

Thanks again and looking forward for your future input on FFH appreciatively!

 

Edited September 11 by UK

[MMM20]

8 hours ago, Viking said:

Do others on the board subscribe to any paid services for data collection / graphs etc? Do board members have any recommendations?

 

I pay ~$300/year for Koyfin and get more value out of it than my old ~$20k/year (?) Bloomberg terminal.

[dartmonkey]

15 hours ago, Viking said:

1.) Fairfax holds them as an investment - at least that is what they have said in the past. 
 

If they still own them, that suggests they still like the risk / reward trade off. And it is probably heavily skewed in a favourable way. Given the risks, why hold them otherwise?

 

For those who think Fairfax should sell… can you also indicate what you think fair value is for Fairfax’s stock? 
 

 

I think owning these swaps is pretty much the economic equivalent of just buying back shares, so I would be interested to hear what management thinks about selling the TRSs and using the cash to buy back shares - would it give a roughly equivalent outcome? Are there advantages (I presume there must be) to holding the TRSs indefinitely, rather than buying back the equivalent number of shares with the proceeds of the TRSs? Do the TRSs better satisfy capital requirements for insurance companies, for instance? And one additional quesiton that occurs to me, given the fact that there is now a 2% tax on buybacks, is this avoided (or postponed) by holding the swaps instead of actually doing the buybacks?

 

Since management is unlikely to spell this out for us, I would be curious to hear thoughts from members of this board about this comparison!

[gfp]

8 minutes ago, dartmonkey said:

 

I think owning these swaps is pretty much the economic equivalent of just buying back shares, so I would be interested to hear what management thinks about selling the TRSs and using the cash to buy back shares - would it give a roughly equivalent outcome? Are there advantages (I presume there must be) to holding the TRSs indefinitely, rather than buying back the equivalent number of shares with the proceeds of the TRSs? Do the TRSs better satisfy capital requirements for insurance companies, for instance? And one additional quesiton that occurs to me, given the fact that there is now a 2% tax on buybacks, is this avoided (or postponed) by holding the swaps instead of actually doing the buybacks?

 

Since management is unlikely to spell this out for us, I would be curious to hear thoughts from members of this board about this comparison!

 

Just keep in mind that this isn't an instrument where you sell it and get the money to do something with.  The cash flows have been flowing back and forth the entire time, settled up regularly.

[73 Reds]

37 minutes ago, dartmonkey said:

 

I think owning these swaps is pretty much the economic equivalent of just buying back shares, so I would be interested to hear what management thinks about selling the TRSs and using the cash to buy back shares - would it give a roughly equivalent outcome? Are there advantages (I presume there must be) to holding the TRSs indefinitely, rather than buying back the equivalent number of shares with the proceeds of the TRSs? Do the TRSs better satisfy capital requirements for insurance companies, for instance? And one additional quesiton that occurs to me, given the fact that there is now a 2% tax on buybacks, is this avoided (or postponed) by holding the swaps instead of actually doing the buybacks?

 

Since management is unlikely to spell this out for us, I would be curious to hear thoughts from members of this board about this comparison!

The most compelling feature seems to be that Fairfax can put a floor on the price of the stock as long as the price remains cheap and the company has enough cash to continue repurchasing shares.   The biggest concern (to me at least) is that Fairfax has the power to terminate the TRS if and when desired for little or no added cost.   Also, the identity of the counterparty(ies) would be good to know; unless the TRS is hedged, this has not been a good bet for any such counterparties.

[nwoodman]

37 minutes ago, dartmonkey said:

 

I think owning these swaps is pretty much the economic equivalent of just buying back shares, so I would be interested to hear what management thinks about selling the TRSs and using the cash to buy back shares - would it give a roughly equivalent outcome? Are there advantages (I presume there must be) to holding the TRSs indefinitely, rather than buying back the equivalent number of shares with the proceeds of the TRSs? Do the TRSs better satisfy capital requirements for insurance companies, for instance? And one additional quesiton that occurs to me, given the fact that there is now a 2% tax on buybacks, is this avoided (or postponed) by holding the swaps instead of actually doing the buybacks?

 

Since management is unlikely to spell this out for us, I would be curious to hear thoughts from members of this board about this comparison!

I see it as a directional bet on something they know.  It’s not accretive to EPS as the shares outstanding isn’t reduced, but has provided cash for them to repurchase actual shares along the way.   It’s a bit of a unique situation so not 100% sure of the RBC/MCT implication, though I feel it is favourable which is what made the position appealing and allowed them to write like crazy into a hard market.  I doubt the 2% buyback tax influences their thinking too much.

 

Looking forward to seeing how they close it out, my guess it may hinge on index inclusion for both share demand and valuation.  As has been discussed at length, it has proved very clever, first company I have heard of, let alone owned, that has done it with their own shares.  

[gfp]

15 minutes ago, 73 Reds said:

The most compelling feature seems to be that Fairfax can put a floor on the price of the stock as long as the price remains cheap and the company has enough cash to continue repurchasing shares.   The biggest concern (to me at least) is that Fairfax has the power to terminate the TRS if and when desired for little or no added cost.   Also, the identity of the counterparty(ies) would be good to know; unless the TRS is hedged, this has not been a good bet for any such counterparties.

 

The counterparties are the major Canadian banks.  They are hedged.  It is a routine transaction for them, not some big losing directional bet.

[73 Reds]

2 minutes ago, gfp said:

 

The counterparties are the major Canadian banks.  They are hedged.  It is a routine transaction for them, not some big losing directional bet.

If hedged, one might anticipate a rather dramatic drop in the price of the stock when the TRS is terminated.  

 

BTW, you are in New Orleans, right?  Stay safe.

[gfp]

3 minutes ago, 73 Reds said:

If hedged, one might anticipate a rather dramatic drop in the price of the stock when the TRS is terminated.  

 

BTW, you are in New Orleans, right?  Stay safe.

 

If Fairfax exits a bit early and doesn't hold out for a high valuation, there is always the possibility they are an interested buyer for the "hedge blocks" for lack of a better term.  They bought Prem's block - another case where "Fairfax" was both interested in buying and selling at a certain price - so it isn't too far fetched.  If they wait for over-valuation to exit, which I doubt, they may not be a buyer of the hedge shares.

 

Yes, I am in New Orleans proper, inland and east of the track.  Plenty of rain today.  The hurricane doesn't look too bad, we should be fine.  Just waiting around to leave town until after the storm so we can check the properties.