Fairfax 2024

[Xerxes]

1 hour ago, TwoCitiesCapital said:

 

My hope would be similar to my hope for Exor and their Ferrari position. I don't necessarily want Exor to sell Ferrari when Ferrari's valuation is stupidly high. I want Exor to exert its majority control to compel Ferrari to issue shares/capital at those levels.

 

It's not as clean as a share sale and probably doesn't lock in as much of the upside, but it avoids taxes, maintains a control position (assuming you don't get diluted too much), and puts in a higher-floor for the Ferrari shares while giving them balance sheet flexibility. 

 

I would hope the same for Fairfax/Digit until the market is more mature. 

On EXOR and Ferrari, isn’t Ferrari issuing shares anti-thesis to the scarcity of their formidable brand and their commanding position. 

[TwoCitiesCapital]

21 minutes ago, Xerxes said:

On EXOR and Ferrari, isn’t Ferrari issuing shares anti-thesis to the scarcity of their formidable brand and their commanding position. 

 

The value is in the scarcity of their cars. 

 

If people bid up the shares, issue shares to meet the demand. Buy them back opportunistically. 

 

Is a better solution than selling the shares, paying taxes, and losing control of irreplaceable asset. 

Edited November 13 by TwoCitiesCapital

[Hoodlum]

It looks like Paul Rivett is getting involved with and insurance startup.

 

https://www.insurancebusinessmag.com/ca/news/mergers-acquisitions/western-investment-company-announces-strategic-shift-to-insurance-513872.aspx

 

Western has also forged a partnership with Paul Rivett, former president of Fairfax Financial, renowned for his expertise in value-based float management. Tannas believes Rivett’s experience will support the company’s aim to integrate insurance underwriting with conservative float management, which is anticipated to provide stable, compounded returns.

 

“Float management seems antithetical to most insurance companies,” Tannas noted. “Given their enormous success, it’s puzzling that only a handful of people see that these two separate activities – insurance underwriting and float management – belong in one business. While at Fairfax, Paul was at the center of this approach and their value investing philosophy. He has seen it, knows it, lived it, and succeeded at it.”

Edited November 14 by Hoodlum

[Viking]

Excess of FV over CV - Are you paying attention?

 

EPS, BVPS, ROE and Calculating Intrinsic Value

 

Successful investing is centred around properly calculating the intrinsic value of a company. This involves properly estimating the cash flows of the business - past, present and future. Do only accounting cash flows matter? With a little help from Warren Buffett, that is the question we will try and answer in this post.

 

For Fairfax, annual EPS and the change in BVPS provides an incomplete picture of the growth in intrinsic value that is happening at the company. We need to supplement these important performance measures with other sources. Fortunately, Fairfax helps investors do this with their communication and some of their additional disclosures.

 

Having an information advantage is a wonderful way to make money

 

One of the easiest way to outperform other investors is to have an information advantage over them. It is like taking candy from a baby.

 

But markets are efficient… right? Everything that is know about a company - at any point in time - is priced into its share price. Or at least that is how the story goes. Right?

 

Of course, that is complete garbage. Especially for under-followed, misunderstood and under appreciated companies. Like Fairfax.

 

The really interesting thing is Fairfax has been doing a very good job of trying to help investors understand the company. But despite Fairfax’s best efforts, many investors do not seem to be paying attention. As a result, many investors do not have an accurate grasp on the economic results that Fairfax has been delivering - they are underestimating Fairfax’s past performance (the cash flows it has delivered). And this is causing them to underestimate Fairfax’s future performance (and cash flows), leading them to undervalue the company.

 

What are we talking about?

 

Read on grasshopper…

 

How to value a P/C insurance company

 

Investors are taught that the correct way to value a P/C insurance company is to focus on two metrics:

 

1.) ROE - How much is the company earning?

• ROE = EPS / (average) BVPS

2.) P/BV - What does Mr. Market expect earnings to be in the future?

• P/BV = Stock price / BV

Because it feeds into both ROE and BVPS, annual EPS is the key input to both metrics. The one year change in EPS is generally what drives the one year change in book value. And the one year change in book value is used as a rough approximation for the change in intrinsic value. Easy peasy.

 

Annual EPS, which feeds ROE, is also a good measure of the performance of the management team.

 

This approach (centred on ROE and P/BV) works well for most P/C insurance companies. And that is because most P/C insurance companies hold mostly bonds in their investment portfolio. And bonds are very easy to value. Therefore, BVPS is a solid tool to use to calculate intrinsic value. And the annual change in BVPS is a good measure of how the management team is performing.

 

Over time, for most P/C insurance companies the annual change in accounting value tends to be highly correlated with the change in economic value.

 

This works for most P/C insurance companies. But not for some. Like Berkshire Hathaway. Markel. And increasingly, Fairfax.

 

What is so special about Berkshire Hathaway, Markel and Fairfax?

 

These three companies do not invest their investment portfolios primarily in bonds. They invest a significant amount of their investment portfolio in equities.

 

But we need to make a distinction here. Publicly traded stocks (that are market to market accounted) are not the issue. Yes, publicly traded stocks are volatile. But over time, Mr. Market tends to value publicly traded stocks properly. So for publicly traded mark to market stocks the change in value over time will get reflected in EPS and BVPS for companies like BRK, MKL and FFH.   

 

The issue lies with associate and consolidated equity holdings. Because of how accounting works, the economic/intrinsic value of these holdings can diverge greatly from their accounting value (the 'carry value' which is what is what is captured in book value). Over time the divergence can become very large.

 

The net result is annual EPS chronically understates the annual increase in economic/intrinsic value that is happening at the company. EPS feeds BVPS. Over time, BVPS diverges more and more from the economic/intrinsic value of the company. As a result, BVPS eventually becomes a poor tool to use to value a company.

 

And that is what happened at Berkshire Hathaway.

 

What was Warren Buffett’s solution?

 

In the 2018 annual report, Buffett banished book value from existence at Berkshire Hathaway.

 

It was a seismic event for Berkshire Hathaway shareholders. They had been trained for 53 years by Buffett to worship at the alter of book value. And in 2018… poof… it was gone.

 

Why would Buffett do this?

 

Because it was important. Really important.

 

Book value had ‘lost the relevance it once had’ as a tool for investors to use to value Berkshire Hathaway. Buffett did it to help investors.

 

Here is what Buffett had to say in Berkshire Hathaway’s 2018AR:

 

“Long-time readers of our annual reports will have spotted the different way in which I opened this letter. For nearly three decades, the initial paragraph featured the percentage change in Berkshire’s per-share book value. It’s now time to abandon that practice.

 

“The fact is that the annual change in Berkshire’s book value – which makes its farewell appearance on page 2 – is a metric that has lost the relevance it once had. Three circumstances have made that so.

• First, Berkshire has gradually morphed from a company whose assets are concentrated in marketable stocks into one whose major value resides in operating businesses. Charlie and I expect that reshaping to continue in an irregular manner.
• Second, while our equity holdings are valued at market prices, accounting rules require our collection of operating companies to be included in book value at an amount far below their current value, a mismark that has grown in recent years.
• Third, it is likely that – over time – Berkshire will be a significant repurchaser of its shares, transactions that will take place at prices above book value but below our estimate of intrinsic value. The math of such purchases is simple: Each transaction makes per-share intrinsic value go up, while per-share book value goes down. That combination causes the book-value scorecard to become increasingly out of touch with economic reality.”

What does this have to do with Fairfax?

 

What has Fairfax been doing over the past 5 years?

 

Fairfax has been rapidly growing out its collection of associate/consolidated equity holdings, with Sleep Country being the most recent example. Fairfax has more than $20 billion in equity investments and more than $10 billion are now associate/consolidated holdings.

 

Importantly, the economic value of these holdings is diverging from their accounting or ‘carrying value.’ This divergence has been increasing in size in recent years. This is creating an EPS and book value informational problem for Fairfax investors - increasingly, EPS and book value is not telling investors what they think it is.

 

Fairfax is trying to help investors

 

Unlike Berkshire Hathaway, Fairfax has not (yet) decided to throw out book value.

 

When Fairfax reports results each quarter they do report book value. But they also report another item: ‘excess (deficiency) of fair value over adjusted carrying value’ for their non-insurance associate and consolidated equity holdings.

 

In their quarterly/interim and annual reports Fairfax report these two items together in the ‘Book Value Per Basic Share’ section of the reports.

 

Why does Fairfax report the two items together?

 

This is also important.

 

Fairfax is trying to educate and inform investors - give them the information they need to properly value the company and to evaluate the management team.

 

They are telling investors loud and clear that if they want to properly evaluate management’s performance they need to consider two things each year:

1. The change in BVPS (adjusted for dividends paid).
2. The change in excess of FV over CV for non-insurance associate and consolidated equity holdings.

 

But don’t take my word for it. Here is what Fairfax had to say in their Q3, 2024 interim report.

 

“The table below presents the pre-tax excess (deficiency) of fair value over adjusted carrying value of investments in non-insurance associates and market traded consolidated non-insurance subsidiaries the company considers to be portfolio investments. Those amounts, while not included in the calculation of book value per basic share, are regularly reviewed by management as an indicator of investment performance.” Fairfax Q3 Interim Earnings Report

 

Fairfax is providing a roadmap for investors. Of course, investors need to actually use the roadmap for it to be of value.   

 

What do the numbers tell us?

 

At September 30, 2024, the excess of FV over CV was $1.9 billion or $87/share (pre-tax). Over the past 3.75 years, the excess of FV over CV has increased by an average of $689 million per year. This is a significant amount of value creation over 4 years that did not show up in EPS or book value. This means it also does not show up in ROE.

 

Is this important? I think it is. A lot. 
 

Let’s try and fold this in to EPS and ROE.

 

We can break the numbers down by year and apply a tax rate (we use 25%). This allows us to make an ‘adjusted’ estimate for EPS, BVPS and ROE that includes ‘excess of FV over CV’. Our goal is to use the information provided by Fairfax to:

1. Better understand the change in the intrinsic value of the company.
2. Better evaluate the performance of the management team.   

What do we learn?

 

As measured by ‘excess of FV over CV’, over the past 4 years, Fairfax has created additional value for shareholders of about $20/share per year (after -tax). This boosts ROE by about 2.5% per year. This is a meaningful increase.

 

Bottom line, the management team has been doing much better than the reported numbers suggest. (And the reported numbers already suggest that have been doing an exceptional job in recent years).

 

What will happen moving forward?

 

I am in process of updated my earnings estimates for Fairfax for 2024 and 2025 (so the numbers I use below might change a little).

 

For 2024, I adjusted ‘excess of FV to CV’ down from its current value of $1.9 billion to $1.6 billion to reflect the sale of Stelco. For 2025, I estimate ‘excess of FV over CV’ will increase about $300 million = $10/share.

 

If my estimates for 2024 and 2025 are accurate, for the 5-year period from 2021 to 2025, adjusted ROE at Fairfax will average about 19% per year. That is exceptional performance over a 5-year period. Fairfax’s stock continues to trade at a valuation multiple (you pick whatever one you want to use) that is well below that of peers. Does that make any sense?

 

Importantly, Fairfax’s management team is executing exceptionally well. And Fairfax’s prospects have rarely looked better.

  

 

An important source of future investment gains

 

‘Excess of FV over CV’ will be a source of significant investment gains for Fairfax in the future.

 

Fairfax has many ways of harvesting/monetizing the gains sitting in ‘Excess of FV over CV’.

 

Asset sales. Stelco is a timely example. The deal to sell Stelco to Clevelenad-Cliffs closed on November 1, 2024. At September 30, 2024, the excess of FV over CV for Fairfax’s position in Stelco was $366 million. When Fairfax reports Q4 results, they will book an investment gain of $366 million from the sale of Stelco.

 

Asset re-valuations. Sometimes Fairfax will change its ownership stake in an associate or consolidated holdings and this will usually trigger a revaluation of the carrying value of the asset (to the new value). This is what will likely happen with Peak Achievement when it closes in Q4 (Fairfax bought out its majority partner).

 

Importantly, in the coming years, the significant amount of value residing (hiding?) in ‘excess of FV over CV’ should supply a steady stream of investment gains for Fairfax. We can be pretty certain that sizeable gains are coming. We just don’t know the amount and the timing. When they do get recognized, like with Stelco in Q4, 2024, they will flow through the accounting statements and provide a nice bump to EPS, BVPS and ROE.

 

Importantly, the coming investment gains from ‘excess of FV over CV’ are not currently built into analyst estimates. Like Stelco, these gains will be ’surprise’ gains.

 

Per share

 

(Hat tip to @Hamburg Investor for pointing this out.)

 

Buffett teaches us that absolute numbers (earnings, book value, investment portfolio, float) are not what really matters. What really matters to shareholders is the growth in the per share numbers over time. 
 

Over the past 3.75 years, Fairfax has reduced effective shares outstanding from 26.2 million at Dec 31, 2020, to 22.0 million at Sept 30, 2024. This is a reduction of 4.2 million shares or 16%. 
 

So when it comes to ‘excess of FV over CV’, over the past 3.75 years, Fairfax shareholders have benefitted in two ways:

1. Via the $2.6 billion increase in the value of ‘excess of FV over CV’ 
2. Via the 16% reduction in effective shares outstanding - this boosts the per share benefit even more.

 

'One more thing'

‘Excess of FV over CV’ is just one example of how Fairfax is building value for shareholders with its equity holdings in a way that is not captured by EPS and book value. There are more examples. Like what? 

 

The fair value for some of Fairfax’s associate and consolidated equity holdings look like they are materially understated. The best example of this is Fairfax India with a FV of $856.8 million. The FV is calculated using the stock price of Fairfax India ($15.07) at September 30, 2024. If FV was instead calculated using the BVPS of Fairfax India ($21.67/share) it would be $1.25 billion. That is a $400 million gap. And for Fairfax India, intrinsic value is likely much higher than BVPS.

 

The bottom line is the quality of the equity portfolio at Fairfax (in terms of management and earnings power) has never been better. The equity portfolio is generating significant value for Fairfax and its shareholders. However, a significant amount of the value creation is not showing up in reported EPS and BV.
 

Learning the lesson of missing the big money with Berkshire Hathaway

 

I have followed Berkshire Hathaway for decades. I understood the amazing abilities of Warren Buffett. And i understood the value of the P/C insurance model (float and equities).

 

How much money did i make from my ‘knowledge’? 
 

Very little. Especially compared to what Berkshire Hathaway delivered to its shareholders. 
 

What was my big miss? 
 

I was focussed on accounting value. And i completely missed the economic value that was being generated each year, primarily by Berkshire Hathaway’s equity holdings. The economic value being created each year was much larger than the accounting value. And over the years this ‘excess value’ compounded.
 

I thought i understood Warren Buffett and Berkshire Hathaway. I did not. My ignorance cost me dearly - it caused me to missed out on making the big money. 
 

I am determined to not let this happen a second time - this time with Fairfax. 

 

Conclusion

 

For P/C insurance companies, reported EPS, BVPS and ROE are important metrics to use to calculate intrinsic value and to evaluate the performance of the management team. However, for a company like Fairfax, these measures are incomplete.

 

The standard tools need to be supplemented with an additional tools, one of which Fairfax provides for investors: the ‘excess of FV over CV’ for associate and consolidated holdings.

 

Fairfax is doing their best to help investors. They make it easy. But as the old saying goes… “You can lead a horse to water, but you can’t make it drink.”

 

So the next time you talk to someone about Fairfax ask them if they are incorporating ‘excess of FV over CV’ into their analysis of the company, especially their future EPS estimates. My guess is they won’t know what you are talking about. And that probably tells you something about how well they understand the company.

 

————

 

Excess of Fair Value over Carrying Value

 

Below are details of Fairfax’s associate and consolidated holdings. And the change in value over each of the past 4 years.

 

Key take aways:

• Over the past 3.75 years, the fair value has increased from $4.3 billion to $10.1 billion, or a total of 135%, which is a CAGR of 25.6%. That is significant growth.
• Excess of FV over CV has increased $2.6 billion, from a deficiency of $663 million at December 31, 2020, to an excess of $1.9 billion at Sept 30, 2024.
• Excess of FV over CV has increased by an average of $689 million per year over the past 3.75 years. This is an average of $27/share (pre tax).

 

 

Edited November 15 by Viking

[73 Reds]

11 minutes ago, Viking said:

Excess of FV over CV - Are you paying attention?

 

EPS, BVPS, ROE and Calculating Intrinsic Value

 

Successful investing is centred around properly calculating the intrinsic value of a company. This involves properly estimating the cash flows of the business - past, present and future. Do only accounting cash flows matter? With a little help from Warren Buffett, that is the question we will try and answer in this post.

 

For Fairfax, the annual change in EPS provides an incomplete picture of the growth in intrinsic value. We need to supplement EPS with other sources. Fortunately, Fairfax helps out investors with some of their additional disclosures.

 

Having an information advantage is a wonderful way to make money

 

One of the easiest way to outperform other investors is to have an information advantage over them. It is like taking candy from a baby.

 

But markets are efficient… right? Everything that is know about a company - at any point in time - is priced into its share price. Or at least that is how the story goes. Right?

 

Of course, that is complete garbage. Especially for under-followed, misunderstood and under appreciated companies. Like Fairfax.

 

The really interesting thing is Fairfax has been doing a very good job of trying to help investors understand the company. But despite Fairfax’s best efforts, many investors do not seem to be paying attention. As a result, many investors do not have an accurate grasp on the economic results that Fairfax has been delivering - they are underestimating Fairfax’s past performance (the cash flows it has delivered). And this is causing them to underestimate Fairfax’s future performance (and cash flows), leading them to undervalue the company.

 

What are we talking about?

 

Read on grasshopper…

 

How to value a P/C insurance company

 

Investors are taught that the correct way to value a P/C insurance company is to focus on two metrics:

 

1.) ROE - How much is the company earning?

• ROE = EPS / (average) BVPS

2.) P/BV - What does Mr. Market expect earnings to be in the future?

• P/BV = Stock price / BV

Because it feeds into both ROE and BVPS, annual EPS is the key input to both metrics. The one year change in EPS is generally what drives the one year change in book value. And the one year change in book value is used as a rough approximation for the change in intrinsic value. Easy peasy.

 

Annual EPS, which feeds ROE, is also a good measure of the performance of the management team.

 

This approach (centred on ROE and P/BV) works well for most P/C insurance companies. And that is because most P/C insurance companies hold mostly bonds in their investment portfolio. And bonds are very easy to value. Therefore, BVPS is a solid tool to use to calculate intrinsic value. And the annual change in BVPS is a good measure of how the management team is performing.

 

Over time, for most P/C insurance companies the annual change in accounting value tends to be highly correlated with the change in economic value.

 

This works for most P/C insurance companies. But not for some. Like Berkshire Hathaway. Markel. And increasingly, Fairfax.

 

Why is this?

 

These three companies do not invest their investment portfolios primarily in bonds. They invest a significant amount of their investment portfolio in equities.

 

But we need to make a distinction here. Publicly traded stocks (that are market to market accounted) are not the issue. Yes, publicly traded stocks are volatile. But over time, Mr. Market tends to value publicly traded stocks properly. So for publicly traded mark to market stocks the change in value over time will get reflected in EPS and BVPS for companies like BRK, MKL and FFH.   

 

The issue lies with associate and consolidated equity holdings. Because of how accounting works, the economic/intrinsic value of these holdings can diverge greatly from their carry value (which is what is captured in book value). Over time the divergence can become very large.

 

The net result is annual EPS chronically understates the annual increase in economic/intrinsic value that is happening at the company. EPS feeds BVPS. Over time, BVPS diverges more and more from the economic/intrinsic value of the company. As a result, BVPS eventually becomes a poor tool to use to value a company.

 

And that is what happened at Berkshire Hathaway.

 

What was Warren Buffett’s solution?

 

In the 2018 annual report, Buffett banished book value from existence at Berkshire Hathaway.

 

It was a seismic event for Berkshire Hathaway shareholders. They had been trained for 53 years by Buffett to worship at the alter of book value. And in 2018… poof… it was gone.

 

What would Buffett do this?

 

Because it was important. Really important.

 

Book value had ‘lost the relevance it once had’ for investors to use to value Berkshire Hathaway. Buffett did it to help investors.

 

Here is what Buffett had to say in Berkshire Hathaway’s 2018AR:

 

“Long-time readers of our annual reports will have spotted the different way in which I opened this letter. For nearly three decades, the initial paragraph featured the percentage change in Berkshire’s per-share book value. It’s now time to abandon that practice.

 

“The fact is that the annual change in Berkshire’s book value – which makes its farewell appearance on page 2 – is a metric that has lost the relevance it once had. Three circumstances have made that so.

• First, Berkshire has gradually morphed from a company whose assets are concentrated in marketable stocks into one whose major value resides in operating businesses. Charlie and I expect that reshaping to continue in an irregular manner.
• Second, while our equity holdings are valued at market prices, accounting rules require our collection of operating companies to be included in book value at an amount far below their current value, a mismark that has grown in recent years.
• Third, it is likely that – over time – Berkshire will be a significant repurchaser of its shares, transactions that will take place at prices above book value but below our estimate of intrinsic value. The math of such purchases is simple: Each transaction makes per-share intrinsic value go up, while per-share book value goes down. That combination causes the book-value scorecard to become increasingly out of touch with economic reality.”

What does this have to do with Fairfax?

 

What has Fairfax been doing over the past 5 years?

 

Fairfax has been rapidly growing out its collection of associate/consolidated equity holdings, with Sleep Country being the most recent example. Fairfax has more than $20 billion in equity investments and more than $10 billion are now associate/consolidated holdings.

 

Importantly, the economic value of these holdings is diverging from their account or ‘carrying value.’ This divergence has been increasing in size in recent years. This is creating a book value informational problem for Fairfax investors - increasingly, book value is not telling investors what they think it is.

 

Fairfax is trying to help investors

 

Unlike Berkshire Hathaway, Fairfax has not (yet) decided to throw out book value.

 

When Fairfax reports results each quarter they do report book value. But they also report another item: ‘excess (deficiency) of fair value over adjusted carrying value’ for their non-insurance associate and consolidated equity holdings.

 

In their quarterly/interim and annual reports they report these two items together in the ‘Book Value Per Basic Share’ section of the reports.

 

Why does Fairfax report the two items together?

 

This is important.

 

Fairfax is trying to educate and inform investors - give them the information they need to properly value the company and evaluate the management team.

 

They are telling investors loud and clear that if they want to properly evaluate management’s performance they need to consider two things each year:

1.) The change in BVPS (adjusted for dividends paid).

2.) The change in excess of FV over CV for non-insurance associate and consolidated equity holdings.

 

But don’t take my word for it. Here is what Fairfax has to say.

 

“The table below presents the pre-tax excess (deficiency) of fair value over adjusted carrying value of investments in non-insurance associates and market traded consolidated non-insurance subsidiaries the company considers to be portfolio investments. Those amounts, while not included in the calculation of book value per basic share, are regularly reviewed by management as an indicator of investment performance.” Fairfax Q3 Interim Earnings Report

 

Fairfax is providing a roadmap for investors. Of course, investors need to actually use the roadmap for it to be of value.   

 

 

What do the numbers tell us?

 

At September 30, 2024, the excess of FV over CV was $1.9 billion or $87/share (pre-tax). This is value that has been created but has not yet been captured in EPS or BVPS. This means it also does not show up in ROE.

 

We can break the numbers down by year and apply a tax rate (we use 25%). This allows us to make an ‘adjusted’ estimate for EPS, BVPS and ROE that includes ‘excess of FV over CV’. Our goal is to use the information provided by Fairfax to:

1. Better understand the change in the intrinsic value of the company.
2. Better evaluate the performance of the management team.   

What do we learn?

 

As measured by ‘excess of FV over CV’, over the past 4 years, Fairfax has created additional value for shareholders of about $20/share per year (after -tax). This boosts ROE by about 2.5% per year. This is a meaningful increase.

 

Bottom line, the management team has been doing much better than the reported numbers suggest. (And the reported numbers already suggest that have been doing an exceptional job in recent years).

 

What will happen moving forward?

 

I am in process of updated my earnings estimates for Fairfax for 2024 and 2025 (so the numbers I use below might change a little).

 

For 2024, I adjusted ‘excess of FV to CV’ down from its current value of $1.9 billion to $1.6 billion to reflect the sale of Stelco. For 2025, I estimate ‘excess of FV over CV’ will increase about $300 million = $10/share.

 

If my estimates for 2024 and 2025 are accurate, for the 5-year period from 2021 to 2025, adjusted ROE at Fairfax will average about 19% per year. That is exceptional. Fairfax’s stock continues to trade at a valuation multiple (you pick whatever one you want to use) that is well below that of peers. Does that make any sense?

 

Importantly, Fairfax’s management team is executing exceptionally well. And Fairfax’s prospects have rarely looked better.

  

 

An important source of future investment gains

 

Excess of FV over CV will be a source of significant investment gains for Fairfax in the future.

 

Fairfax has many ways of harvesting/monetizing the gains sitting in ‘excess of FV over CV’.

 

Asset sales. Stelco is a timely example. The deal to sell Stelco to Clevelenad-Cliffs closed on November 1, 2024. At September 30, 2024, the excess of FV over CV for Fairfax’s position in Stelco was $366 million. When Fairfax reports Q4 results, they will book an investment gain of $366 million from the sale of Stelco.

 

Asset re-valuations. Sometimes Fairfax will change its ownership stake in an associate or consolidated holdings and this will usually trigger a revaluation of the carrying value of the asset (to the new value). This is what will likely happen with Peak Achievement when it closes in Q4 (Fairfax bought out its majority partner).

 

Importantly, in the coming years, the significant amount of value residing (hiding?) in ‘excess of FV over CV’ should supply a steady stream of investment gains for Fairfax. We can be pretty certain that sizeable gains are coming. We just don’t know the amount and the timing. When they do get recognized, like with Stelco in Q4, 2024, they will flow through the accounting statements and provide a nice bump to EPS, BVPS and ROE.

 

Importantly, the coming investment gains from ‘excess of FV over CV’ are not currently built into analyst estimates. Like Stelco, these gains will be ’surprise’ gains.

 

One more wrinkle

 

The fair value for some of Fairfax’s associate and consolidated equity holdings look like they are materially understated. The best example of this is Fairfax India with a FV of $856.8 million. The FV is calculated using the stock price of Fairfax India ($15.07) at September 30, 2024. If it used the BVPS of Fairfax India it would be $1.25 billion ($21.67). That is a $400 million gap. And for Fairfax India, intrinsic value is much higher than BVPS.

 

The bottom line, this is just another example of how significant value is hiding - unrecognized in the financial statements - in Fairfax’s collection of associate and consolidated equity holdings.

 

Conclusion

 

For P/C insurance companies, EPS, BVPS and ROE are important metrics to use to calculate intrinsic value and to evaluate the performance of the management team. However, for a company like Fairfax, these measures are incomplete.

 

The standard tools need to be supplemented with an additional tool, which Fairfax provides for investors: the ‘excess of FV over CV’ for associate and consolidated holdings.

 

Fairfax is doing their best to help investors. They make it easy. But as the old saying goes… “You can lead a horse to water, but you can’t make it drink.”

 

So the next time you talk to someone about Fairfax ask them if they are incorporating ‘excess of FV over CV’ into their analysis of the company. My guess is they won’t know what you are talking about. And that probably tells you something about how well they understand the company.

 

————

 

Excess of Fair Value over Carrying Value

 

Below are details of Fairfax’s associate and consolidated holdings. And the change in value over each of the past 4 years.

 

Key take aways:

• Over the past 3.75 years, the fair value has increased from $4.3 billion to $10.1 billion, or a total of 135%, which is a CAGR of 25.6%. That is significant growth.
• Excess of FV over CV has increased $2.6 billion, from a deficiency of $663 million to a excess of $1.9 billion at Sept 30, 2024.
• Excess of FV over CV has increased by an average of $689 million per year over the past 3.75 years. This is an average of $27/share (pre tax).

 

Thanks for the nice explanation, Viking.  Perhaps someone will convince Warren or future management to do the same for BRK.

[Viking]

1 hour ago, 73 Reds said:

Thanks for the nice explanation, Viking.  Perhaps someone will convince Warren or future management to do the same for BRK.

@73 Reds , as i do my deep dives on Fairfax it is helping me get to the core of value creation. With a large equity portfolio there are so many ways value is created - but much of it is not captured in real time by the accounting models (EPS and BVPS). This was likely the biggest reason why i missed out on the big gains in BRK 20 years ago - I did not understand all the value that was building (and compounding) in the equity holdings that was not showing up in the reported results. 
 

One of the things i like about Fairfax is they do have a habit of surfacing this value. This makes it easier for investors to understand what is going on under the hood. 
 

Having said all that, there is still a lot that we don’t understand:

- Depsite its big run the past 4 years, Eurobank still looks very undervalued. 

- What is Poseidon worth today? My guess is it is worth much more than its reported CV. 
- What is BIAL worth today?
- How is Grivalia Hospitality doing? It is an asset play, not an earnings play. And property prices in Greece have spiked higher for years.

- What is AGT Food Ingredients worth?
- I could go on. 

Fairfax also has a large amount (well over $1.5 billion) invested with private equity shops like BDT, Shaw Kwei, JAB Holdings etc. They are reported as mark to market but they really are not. My guess is there is a significant amount of value residing on the balance sheets of those companies that is waiting to be harvested in the coming years.
 

Bottom line, BVPS at Fairfax is likely much more understated than investors realize. The other way to think about that is reported earnings for Fairfax over the past 4 years has been materially understating the value that is being created by the company. This will become apparent in the coming years as these hidden gains get harvested. Lots of investors will say … ‘Who could have possibly known?’

 

Patience really is probably the most important trait to have to be a successful investor… (Unfortunately that is not my strength. @dealraker is my role model in this regard). 

Edited November 14 by Viking

[dealraker]

19 minutes ago, Viking said:

@73 Reds , as i do my deep dives on Fairfax it is helping me get to the core of value creation. With a large equity portfolio there are so many ways value is created - but much of it is not captured in real time by the accounting models (EPS and BVPS). This was likely the biggest reason why i missed out on the big gains in BRK 20 years ago - I did not understand all the value that was building (and compounding) in the equity holdings that was not showing up in the reported results. 
 

One of the things i like about Fairfax is they do have a habit of surfacing this value. This makes it easier for investors to understand what is going on under the hood. 
 

Having said all that, there is still a lot that we don’t understand:

- Depsite its big run the past 4 years, Eurobank still looks very undervalued. 

- What is Poseidon worth today? My guess is it is worth much more than its reported CV. 
- What is BIAL worth today?
- How is Grivalia Hospitality doing? It is an asset play, not an earnings play. And property prices in Greece have spiked higher for years.

- What is AGT Food Ingredients worth?
- I could go on. 

Fairfax also has a large amount (well over $1.5 billion) invested with private equity shops like BDT, Shaw Kwei, JAB Holdings etc. They are reported as mark to market but they really are not. My guess is there is a significant amount of value residing on the balance sheets of those companies that is waiting to be harvested in the coming years.
 

Bottom line, BVPS at Fairfax is likely much more understated than investors realize. The other way to think about that is reported earnings for Fairfax over the past 4 years has been materially understating the value that is being created by the company. This will become apparent in the coming years as these hidden gains get harvested. Lots of investors will say … ‘Who could have possibly known?’

 

Patience really is probably the most important trait to have to be a successful investor… (Unfortunately that is not my strength. @dealraker is my role model in this regard). 

Viking I've been part of a few different forums and groups over the decades in my journey of being interested in and owning things like - and maybe expecially Fairfax given it has now (price wise) roared back to life.  The nice thing about your leadership of this thread is that it isn't like "oh...this is my idea and never before did anyone ever..." and so forth.  You did lots of work and you just put it out while stating your case.  For a long time I was a loner-owner, nowhere could I find others to share discussion about Fairfax.  

 

It is hard to relay without seemingly projecting some arrogance as to how much I have enjoyed the experience of long term investing - again in things outliers like Fairfax that most typical investment types would never feel good sticking with or making the gap to grasp how it works. 

 

I'm a tad different than you as how I go about the insurance business.  I basically choose managements that I think are the Labron James' of the business, better and more able to keep outperforming, and I roll right on through the bad periods.  Interestingly, and I know you are fully aware, a few of Berkshire's insurance areas are having a tough go of it, Geico being left miles behind Progressive...

 

So the story of Fairfax is one where I felt it inevitable of the comeback.  As usual, as a long term owner, I'm quite happy with Fairfax's valuation whether high or low as to our intrinsic model.  There's always choices that can be made based on the price-to-value.  I don't expect full or over-valuation to come often, and if it does it will be very brief.

 

Have a good day.   

[roundball100]

1 hour ago, dealraker said:

... I basically choose managements that I think are the Labron James' of the business, better and more able to keep outperforming ...

LeBron just recorded another triple-double, his third straight, becoming the oldest player (he's now 39) to record three straight triple doubles.  Keeps setting more records as he gets older --- which is what Viking has been telling us about Fairfax for quite some time now.

[dealraker]

40 minutes ago, roundball100 said:

LeBron just recorded another triple-double, his third straight, becoming the oldest player (he's now 39) to record three straight triple doubles.  Keeps setting more records as he gets older --- which is what Viking has been telling us about Fairfax for quite some time now.

Yea roundball I just heard that a few 38 year old NBA players had scored 30 just one time while LJ is already over 30 times headed to 100.  LOL.

[Hamburg Investor]

4 hours ago, Viking said:

Excess of FV over CV - Are you paying attention?

 

EPS, BVPS, ROE and Calculating Intrinsic Value

 

Successful investing is centred around properly calculating the intrinsic value of a company. This involves properly estimating the cash flows of the business - past, present and future. Do only accounting cash flows matter? With a little help from Warren Buffett, that is the question we will try and answer in this post.

 

For Fairfax, the annual change in EPS provides an incomplete picture of the growth in intrinsic value. We need to supplement EPS with other sources. Fortunately, Fairfax helps out investors with some of their additional disclosures.

 

Having an information advantage is a wonderful way to make money

 

One of the easiest way to outperform other investors is to have an information advantage over them. It is like taking candy from a baby.

 

But markets are efficient… right? Everything that is know about a company - at any point in time - is priced into its share price. Or at least that is how the story goes. Right?

 

Of course, that is complete garbage. Especially for under-followed, misunderstood and under appreciated companies. Like Fairfax.

 

The really interesting thing is Fairfax has been doing a very good job of trying to help investors understand the company. But despite Fairfax’s best efforts, many investors do not seem to be paying attention. As a result, many investors do not have an accurate grasp on the economic results that Fairfax has been delivering - they are underestimating Fairfax’s past performance (the cash flows it has delivered). And this is causing them to underestimate Fairfax’s future performance (and cash flows), leading them to undervalue the company.

 

What are we talking about?

 

Read on grasshopper…

 

How to value a P/C insurance company

 

Investors are taught that the correct way to value a P/C insurance company is to focus on two metrics:

 

1.) ROE - How much is the company earning?

• ROE = EPS / (average) BVPS

2.) P/BV - What does Mr. Market expect earnings to be in the future?

• P/BV = Stock price / BV

Because it feeds into both ROE and BVPS, annual EPS is the key input to both metrics. The one year change in EPS is generally what drives the one year change in book value. And the one year change in book value is used as a rough approximation for the change in intrinsic value. Easy peasy.

 

Annual EPS, which feeds ROE, is also a good measure of the performance of the management team.

 

This approach (centred on ROE and P/BV) works well for most P/C insurance companies. And that is because most P/C insurance companies hold mostly bonds in their investment portfolio. And bonds are very easy to value. Therefore, BVPS is a solid tool to use to calculate intrinsic value. And the annual change in BVPS is a good measure of how the management team is performing.

 

Over time, for most P/C insurance companies the annual change in accounting value tends to be highly correlated with the change in economic value.

 

This works for most P/C insurance companies. But not for some. Like Berkshire Hathaway. Markel. And increasingly, Fairfax.

 

What is so special about Berkshire Hathaway, Markel and Fairfax?

 

These three companies do not invest their investment portfolios primarily in bonds. They invest a significant amount of their investment portfolio in equities.

 

But we need to make a distinction here. Publicly traded stocks (that are market to market accounted) are not the issue. Yes, publicly traded stocks are volatile. But over time, Mr. Market tends to value publicly traded stocks properly. So for publicly traded mark to market stocks the change in value over time will get reflected in EPS and BVPS for companies like BRK, MKL and FFH.   

 

The issue lies with associate and consolidated equity holdings. Because of how accounting works, the economic/intrinsic value of these holdings can diverge greatly from their accounting value (the 'carry value' which is what is what is captured in book value). Over time the divergence can become very large.

 

The net result is annual EPS chronically understates the annual increase in economic/intrinsic value that is happening at the company. EPS feeds BVPS. Over time, BVPS diverges more and more from the economic/intrinsic value of the company. As a result, BVPS eventually becomes a poor tool to use to value a company.

 

And that is what happened at Berkshire Hathaway.

 

What was Warren Buffett’s solution?

 

In the 2018 annual report, Buffett banished book value from existence at Berkshire Hathaway.

 

It was a seismic event for Berkshire Hathaway shareholders. They had been trained for 53 years by Buffett to worship at the alter of book value. And in 2018… poof… it was gone.

 

Why would Buffett do this?

 

Because it was important. Really important.

 

Book value had ‘lost the relevance it once had’ as a tool for investors to use to value Berkshire Hathaway. Buffett did it to help investors.

 

Here is what Buffett had to say in Berkshire Hathaway’s 2018AR:

 

“Long-time readers of our annual reports will have spotted the different way in which I opened this letter. For nearly three decades, the initial paragraph featured the percentage change in Berkshire’s per-share book value. It’s now time to abandon that practice.

 

“The fact is that the annual change in Berkshire’s book value – which makes its farewell appearance on page 2 – is a metric that has lost the relevance it once had. Three circumstances have made that so.

• First, Berkshire has gradually morphed from a company whose assets are concentrated in marketable stocks into one whose major value resides in operating businesses. Charlie and I expect that reshaping to continue in an irregular manner.
• Second, while our equity holdings are valued at market prices, accounting rules require our collection of operating companies to be included in book value at an amount far below their current value, a mismark that has grown in recent years.
• Third, it is likely that – over time – Berkshire will be a significant repurchaser of its shares, transactions that will take place at prices above book value but below our estimate of intrinsic value. The math of such purchases is simple: Each transaction makes per-share intrinsic value go up, while per-share book value goes down. That combination causes the book-value scorecard to become increasingly out of touch with economic reality.”

What does this have to do with Fairfax?

 

What has Fairfax been doing over the past 5 years?

 

Fairfax has been rapidly growing out its collection of associate/consolidated equity holdings, with Sleep Country being the most recent example. Fairfax has more than $20 billion in equity investments and more than $10 billion are now associate/consolidated holdings.

 

Importantly, the economic value of these holdings is diverging from their accounting or ‘carrying value.’ This divergence has been increasing in size in recent years. This is creating a book value informational problem for Fairfax investors - increasingly, book value is not telling investors what they think it is.

 

Fairfax is trying to help investors

 

Unlike Berkshire Hathaway, Fairfax has not (yet) decided to throw out book value.

 

When Fairfax reports results each quarter they do report book value. But they also report another item: ‘excess (deficiency) of fair value over adjusted carrying value’ for their non-insurance associate and consolidated equity holdings.

 

In their quarterly/interim and annual reports they report these two items together in the ‘Book Value Per Basic Share’ section of the reports.

 

Why does Fairfax report the two items together?

 

This is also important.

 

Fairfax is trying to educate and inform investors - give them the information they need to properly value the company and evaluate the management team.

 

They are telling investors loud and clear that if they want to properly evaluate management’s performance they need to consider two things each year:

1.) The change in BVPS (adjusted for dividends paid).

2.) The change in excess of FV over CV for non-insurance associate and consolidated equity holdings.

 

But don’t take my word for it. Here is what Fairfax has to say.

 

“The table below presents the pre-tax excess (deficiency) of fair value over adjusted carrying value of investments in non-insurance associates and market traded consolidated non-insurance subsidiaries the company considers to be portfolio investments. Those amounts, while not included in the calculation of book value per basic share, are regularly reviewed by management as an indicator of investment performance.” Fairfax Q3 Interim Earnings Report

 

Fairfax is providing a roadmap for investors. Of course, investors need to actually use the roadmap for it to be of value.   

 

What do the numbers tell us?

 

At September 30, 2024, the excess of FV over CV was $1.9 billion or $87/share (pre-tax). Over the past 3.75 years, the excess of FV over CV has increased by an average of $689 million per year. 
 

This is value that has been created but has not yet been captured in EPS or BVPS. This means it also does not show up in ROE.

 

We can break the numbers down by year and apply a tax rate (we use 25%). This allows us to make an ‘adjusted’ estimate for EPS, BVPS and ROE that includes ‘excess of FV over CV’. Our goal is to use the information provided by Fairfax to:

 

1. Better understand the change in the intrinsic value of the company.
2. Better evaluate the performance of the management team.   

What do we learn?

 

As measured by ‘excess of FV over CV’, over the past 4 years, Fairfax has created additional value for shareholders of about $20/share per year (after -tax). This boosts ROE by about 2.5% per year. This is a meaningful increase.

 

Bottom line, the management team has been doing much better than the reported numbers suggest. (And the reported numbers already suggest that have been doing an exceptional job in recent years).

 

What will happen moving forward?

 

I am in process of updated my earnings estimates for Fairfax for 2024 and 2025 (so the numbers I use below might change a little).

 

For 2024, I adjusted ‘excess of FV to CV’ down from its current value of $1.9 billion to $1.6 billion to reflect the sale of Stelco. For 2025, I estimate ‘excess of FV over CV’ will increase about $300 million = $10/share.

 

If my estimates for 2024 and 2025 are accurate, for the 5-year period from 2021 to 2025, adjusted ROE at Fairfax will average about 19% per year. That is exceptional. Fairfax’s stock continues to trade at a valuation multiple (you pick whatever one you want to use) that is well below that of peers. Does that make any sense?

 

Importantly, Fairfax’s management team is executing exceptionally well. And Fairfax’s prospects have rarely looked better.

  

 

An important source of future investment gains

 

Excess of FV over CV will be a source of significant investment gains for Fairfax in the future.

 

Fairfax has many ways of harvesting/monetizing the gains sitting in ‘excess of FV over CV’.

 

Asset sales. Stelco is a timely example. The deal to sell Stelco to Clevelenad-Cliffs closed on November 1, 2024. At September 30, 2024, the excess of FV over CV for Fairfax’s position in Stelco was $366 million. When Fairfax reports Q4 results, they will book an investment gain of $366 million from the sale of Stelco.

 

Asset re-valuations. Sometimes Fairfax will change its ownership stake in an associate or consolidated holdings and this will usually trigger a revaluation of the carrying value of the asset (to the new value). This is what will likely happen with Peak Achievement when it closes in Q4 (Fairfax bought out its majority partner).

 

Importantly, in the coming years, the significant amount of value residing (hiding?) in ‘excess of FV over CV’ should supply a steady stream of investment gains for Fairfax. We can be pretty certain that sizeable gains are coming. We just don’t know the amount and the timing. When they do get recognized, like with Stelco in Q4, 2024, they will flow through the accounting statements and provide a nice bump to EPS, BVPS and ROE.

 

Importantly, the coming investment gains from ‘excess of FV over CV’ are not currently built into analyst estimates. Like Stelco, these gains will be ’surprise’ gains.

 

One more wrinkle

 

The fair value for some of Fairfax’s associate and consolidated equity holdings look like they are materially understated. The best example of this is Fairfax India with a FV of $856.8 million. The FV is calculated using the stock price of Fairfax India ($15.07) at September 30, 2024. If it used the BVPS of Fairfax India it would be $1.25 billion ($21.67). That is a $400 million gap. And for Fairfax India, intrinsic value is much higher than BVPS.

 

The bottom line, this is just another example of how significant value is hiding - unrecognized in the financial statements - in Fairfax’s collection of associate and consolidated equity holdings.

 

Conclusion

 

For P/C insurance companies, EPS, BVPS and ROE are important metrics to use to calculate intrinsic value and to evaluate the performance of the management team. However, for a company like Fairfax, these measures are incomplete.

 

The standard tools need to be supplemented with an additional tool, which Fairfax provides for investors: the ‘excess of FV over CV’ for associate and consolidated holdings.

 

Fairfax is doing their best to help investors. They make it easy. But as the old saying goes… “You can lead a horse to water, but you can’t make it drink.”

 

So the next time you talk to someone about Fairfax ask them if they are incorporating ‘excess of FV over CV’ into their analysis of the company, especially their future EPS estimates. My guess is they won’t know what you are talking about. And that probably tells you something about how well they understand the company.

 

————

 

Excess of Fair Value over Carrying Value

 

Below are details of Fairfax’s associate and consolidated holdings. And the change in value over each of the past 4 years.

 

Key take aways:

• Over the past 3.75 years, the fair value has increased from $4.3 billion to $10.1 billion, or a total of 135%, which is a CAGR of 25.6%. That is significant growth.
• Excess of FV over CV has increased $2.6 billion, from a deficiency of $663 million at December 31, 2020, to an excess of $1.9 billion at Sept 30, 2024.
• Excess of FV over CV has increased by an average of $689 million per year over the past 3.75 years. This is an average of $27/share (pre tax).

 

 

 

Thank you, @Viking, that way of thinking is so good and important!

 

I have one further question, and hopefully you might bring light into the dark: Doesn‘t even this adjusted ROE understate the value creation of Fairfax on a per share basis? Why? Buybacks. There‘s clearly more value creation, when a lot of shares are bought back (way) below intrinsic value. But I don‘t know how to calculate that, not even roughly. There are so many moving parts and variables - price of the shares, when bought, roe of the company in the specific year and in the future, (I’ll bet there’s even a price move, if a lot of shares are bought back over long timeframes, which affects the TRS, but let’s leave that away). Do you have any idea, roughly, or am I totally wrong with that thinking?

 

[[email protected]]

9 hours ago, Hoodlum said:

It looks like Paul Rivett is getting involved with and insurance startup.

 

https://www.insurancebusinessmag.com/ca/news/mergers-acquisitions/western-investment-company-announces-strategic-shift-to-insurance-513872.aspx

 

Western has also forged a partnership with Paul Rivett, former president of Fairfax Financial, renowned for his expertise in value-based float management. Tannas believes Rivett’s experience will support the company’s aim to integrate insurance underwriting with conservative float management, which is anticipated to provide stable, compounded returns.

 

“Float management seems antithetical to most insurance companies,” Tannas noted. “Given their enormous success, it’s puzzling that only a handful of people see that these two separate activities – insurance underwriting and float management – belong in one business. While at Fairfax, Paul was at the center of this approach and their value investing philosophy. He has seen it, knows it, lived it, and succeeded at it.”

This one really interests me. I've been watching it for the past 6 months ish ( I think thats when the first announcement was? ) They did a big warrant offering though that Americans couldn't participate in sadly. 

[nwoodman]

2 hours ago, [email protected] said:

This one really interests me. I've been watching it for the past 6 months ish ( I think thats when the first announcement was? ) They did a big warrant offering though that Americans couldn't participate in sadly. 

Deserves its own thread!  It’s triggering my PTSD

Edited November 15 by nwoodman

[Viking]

34 minutes ago, Hamburg Investor said:

Thank you, @Viking, that way of thinking is so good and important!

 

I have one further question, and hopefully you might bring light into the dark: Doesn‘t even this adjusted ROE understate the value creation of Fairfax on a per share basis? Why? Buybacks. There‘s clearly more value creation, when a lot of shares are bought back (way) below intrinsic value. But I don‘t know how to calculate that, not even roughly. There are so many moving parts and variables - price of the shares, when bought, roe of the company in the specific year and in the future, (I’ll bet there’s even a price move, if a lot of shares are bought back over long timeframes, which affects the TRS, but let’s leave that away). Do you have any idea, roughly, or am I totally wrong with that thinking?

@Hamburg Investor, as per usual, your instincts are spot on. Buffett teaches us that absolute numbers (earnings, book value, investment portfolio, float) are not what really matters. It is the growth in the per share numbers over time that really matters. 
 

Over the past 3.75 years, Fairfax has reduced effective shares outstanding from 26.2 million at Dec 31, 2020 to 22.0 million at Sept 30, 2024. This is a reduction of 4.2 million or 16%. 
 

So when it comes to ‘excess of FV over CV’, over the past 3.75 years, Fairfax shareholders have benefitted in two ways:

1.) via the $2.6 billion increase in the value of ‘excess of FV over CV’ 

2.) via the 16% reduction in effective shares outstanding - this boosts the per share benefit even more. 
 

Fairfax is pulling so many good moves… they really have been putting on a clinic over the past 6 years on how to do unconstrained capital allocation - how to fully exploit the P/C insurance model to build shareholder value. 

[Parsad]

3 hours ago, roundball100 said:

LeBron just recorded another triple-double, his third straight, becoming the oldest player (he's now 39) to record three straight triple doubles.  Keeps setting more records as he gets older --- which is what Viking has been telling us about Fairfax for quite some time now.

 

Quite a night last night in the NBA...LeBron with his triple double, Wembayana hit 50 points as the 4th youngest ever to do so, and Giannis hit 59 points!  All three won their games on top of that.  Cheers!

[Parsad]

1 hour ago, [email protected] said:

This one really interests me. I've been watching it for the past 6 months ish ( I think thats when the first announcement was? ) They did a big warrant offering though that Americans couldn't participate in sadly. 

 

I've been watching it as well.  I didn't bring it up, because I wanted to get some shares at cheap prices here and there.  

 

I know there has been criticism of Paul on here, but his tenure at Fairfax was quite a long period and he's one of the hardest working men I've ever met.

 

With a good investment team and the power of float, it's definitely worth watching!  I guess now that the cat is out of the bag, I'll start a thread in the Investment Ideas section.

 

Cheers!  

[Hamburg Investor]

On 11/14/2024 at 7:07 PM, Viking said:

If my estimates for 2024 and 2025 are accurate, for the 5-year period from 2021 to 2025, adjusted ROE at Fairfax will average about 19% per year. That is exceptional performance over a 5-year period. Fairfax’s stock continues to trade at a valuation multiple (you pick whatever one you want to use) that is well below that of peers. Does that make any sense?

@Viking Thank you for your answer, which I really appreciate, but I think I haven't made my question clear:

1.There's a roe on the surface, let's call that "face roe". But - as you pointed out and I totally agree - that's understated.

2. So you come up with an adjusted ROE on the basis of FV. That's 19%. 
3. Okay, nice. now we have it. As Munger said many times (from memory) "If you have a business with a roe of 20% and you hold it over decades, your return will be roughly 20% - regardless, if you over- or underpay! In other words, if we have the adjusted roe, we know how the intrinsic value grows over time. Perfect, no more questions! But... No... wait?! We forgot the buybacks! Even over 2 decades there's clearly a big difference, between two businesses, where:
BUSINESS A never bought back any stock nor sold out any dividends etc. and
BUSINESS B, which bought back 99.9% of all stocks outstanding (okay... that never happens, I know ... but I want to illustrate my point... so let's just say for a moment 999 of 1.000 stocks have been bought back).

So here you have it, that's my question: How can we take your "adjusted ROE" one step further to get to a number that shows the "growth of intrinsic value per share" (let's call that "givps"). It clearly must be above 19% - but where exactly? My thinking begins with something like: If in a given year we have 19% roe and 5% of stocks are bought back in that year I just divide 19% through 0.95 and get 20%. So the buyback activity would translate a roe 19% into a "givps" of 20% in that specific year. And if you buy back 5% of stocks in the next year and you have a roe of 19% again - is "givps" then 20% or 21% in the second year?  I tend to the latter, as now I'd have to divide 19% through 0.9025. But is it just as simple? I don't think so, as e.g. buybacks above book value disturb the "e" in ROE. But how do we adjust the "e"quity back? And the growth in intrinsic value can't be agnostic to the price being paid for the stocks in the process of buybacks, but my simple formula ignores the price. And then we all know, that buybacks at a price below intrinsic value create new value, while above they destroy it ... Maybe it's just not possible to take that step from roe to "givps", not even roughly?! And maybe my idea is just wrong and I am just having knots in the head and I write nonsense here?

[nwoodman]

@Hamburg Investor interesting topic and one that I have pondered for Berkshire as well as Fairfax. Obviously value is created when purchases are below IV, but see if the thinking below links ROE to GIVPS.  Quasi maths (motherhood statements) to one side the value that has been created through the TRS/Buyback program has been phenomenal.  A Charlie Munger “lollapalooza” springs to mind.

 

Formula for Growth in Intrinsic Value Per Share (GIVPS):

 

GIVPS Growth = ROE + BY × (IV / P)

 

Definitions:

 

1. ROE (Return on Equity):

• Definition: The annual return generated on shareholders’ equity.

• Importance: Reflects the organic growth rate of equity if all earnings are retained.

2. BY (Buyback Yield):

• Definition: The rate of shares repurchased relative to the company’s market cap.

• Formula: BY = Buyback Rate / Price Paid per Share (P)

• Importance: Indicates how much of the company’s equity is retired annually via buybacks, directly influencing GIVPS.

 

3. IV (Intrinsic Value per Share):

• Definition: The estimated true economic value of a single share.

• Importance: Determines whether buybacks create or destroy value, as buybacks below IV are accretive while those above are dilutive.

 

4. P (Price Paid per Share):

• Definition: The market price at which shares are repurchased.

• Importance: If P < IV, buybacks amplify intrinsic value growth; if P > IV, they dilute it.

 

5. Adjustment Factor:

• Formula: (IV / P)

• Definition: Adjusts the impact of buybacks based on the relationship between intrinsic value and price paid.

• Importance: Ensures buybacks’ effect on intrinsic value per share is correctly accounted for.

 

Why These Components Matter:

 

• ROE represents operational performance and sets the baseline for equity growth.

• Buyback Yield measures the effect of share reduction on GIVPS.

• The relationship between IV and P determines whether buybacks are accretive or dilutive.

GIVPS Growth = ROE + Buyback Yield × (Intrinsic Value / Price Paid)

Edited November 16 by nwoodman

[mananainvesting]

Prem on Investing in India. 

 

https://www.cnbctv18.com/business/companies/prem-watsa-on-fairfax-financials-7-billion-dollar-investment-in-india-india-canada-relations-19510220.htm

[Viking]

Fairfax Earnings Estimate Update for 2024 & 2025

 

Below is my two-year earnings estimate for Fairfax. This forecast includes learnings from Fairfax’s earnings releases and ‘new news’ from the past couple of months (since the last update). 

 

Summary

 

My current estimate is Fairfax will earn about $160/share in 2024 and about $166/share in 2025. I think both of these estimates have been constructed using mildly conservative assumptions. 

 

To the right of the table below is the annual change in ‘excess of fair value over carrying value’ for Fairfax’s associate and consolidated equity holdings. This is value that is being created each year in Fairfax’s equity holdings that is not reported in EPS, BVPS or ROE. Bottom line, Fairfax’s economic performance in recent years has been stronger than that captured by its accounting results.

 

 

Will retained earnings be re-invested in a way that builds value for shareholders?

 

Perhaps the hardest piece to forecast with Fairfax today is what they will be doing with the substantial amount of earnings that they are currently generating (about $4 billion per year). And the impact the re-investment of current earnings will have on future earnings. Both the size - how much. And the speed - how fast. 

 

When it comes to re-investing earnings, Fairfax has a lot of very good options:

• Grow insurance - Continuation of the hard market? Bolt-on acquisitions?
  • Buy out minority partners in insurance?
• Buy equities or fixed income securities?
• Buy back a meaningful amount of Fairfax stock? 

Looking at the last 5 years, the management team at Fairfax has done an outstanding job with capital allocation. My guess is they will continue to make good decisions (on balance) and this will benefit shareholders in the coming years – likely providing a tailwind to my forecasts for 2025 and beyond.

 

What are the key assumptions built into the forecast?

 

To estimate future EPS, BVPS and ROE for Fairfax, an investor needs to estimate three things:

1. Combined ratio – How good is Fairfax at underwriting?
2. Return on the total investment portfolio = return on fixed income + return on equities
3. Capital allocation – How good is management? 

 

Note, when calculating investment returns for equities, I am including the change each year for ‘excess of FV over CV’ for associate and consolidated holdings. As stated earlier, this is value that is being created and it needs to be incorporated into models that estimate future returns.

 

When it comes to capital allocation, the management team at Fairfax has been best in class among P/C insurance peers over the past 5 years. This is borne out in the change in BVPS over time – over the past 5 years, Fairfax has significantly outperformed peers like CB, WRB, MKL, TRV, IFC.TO and BRK. 

 

Interest rates: I am assuming interest rates remain roughly at current levels (at November 16, 2024). Of course, this will likely not be the case. Given the duration of the fixed income portfolio (about 3.5 years) is now closer to the duration of the insurance liabilities (a little under 4 years?), changes in interest rates will likely roughly balance out (in ‘net gains/losses on investments’ and ‘effects of discounting and risk adjustment- IFRS 17’). Bottom line, changes in interest rates should result in much less volatility in Fairfax’s reported results moving forward. Mr. Market should like that.

 

Below is a 6-year snapshot of earnings for Fairfax. It communicates in a concise manner the dramatic transformation that has happened at the company, beginning around 2021. There has been a spike in operating income per share – from an average of $39/share from 2016-2020, to $192/share in 2023. This much higher amount now looks like the new baseline for the company. For 2024, my estimate has operating income increasing to $212/share, which is a 444% increase from the average from 2016-2020. ‘Normalized earnings’ at Fairfax have moved to a much higher level – and, importantly, this higher level looks durable/sustainable.

 

 

What are current analyst’s earnings estimates for Fairfax?

 

Using Yahoo Finance as a guide, analysts estimate that Fairfax will earn (November 11, 2024):

• US$139/share (C$194) in 2024
• US$148/share (C$206) in 2025 

From what I can see, most analysts are assigning little benefit to the reinvestment of Fairfax’s significant earnings and the company’s proven capital allocation skills. My guess is most analysts will include these benefits into their earnings estimates only after Fairfax has announced something. As a result, analyst estimates will likely be too low. And that is what we have seen over the past 3 years. 

 

Here are the most important assumptions that went into each line item in our forecast:

 

1.) Underwriting profit: Estimate = $1.48 billion in 2024.

• Net premiums written growth of 11% in 2024 and 4% in 2025. This is being driven by:
  • For 2024, continuation of the hard market, which we estimate will add $800 million of NPW. The Gulf Insurance Group (GIG) acquisition, which will add $1.7 billion of NPW.
  • For 2025, continuation of the hard market. Growth at Odyssey and Brit could also pick up (management mentioned this on the Q3 earnings call).
• Combined ratio (CR) of 94% in 2024 and 94.5% in 2025.Catastrophe losses: 2024 will be a more normal year (higher than 2023).
  • Fairfax continues to modestly shrink their total catastrophe exposure.
  • Reserve releases: continuation of the positive trend observed in 2023 and YTD 2024.

2.) Interest and dividend income: Estimate = $2.4 billion in 2024.

• The size of the fixed income portfolio is estimated to increase as follows:
  • 2023 = $45 billion
  • 2024E = $50 billion (GIG + reinvestment + growth)
  • 2025E = $54 billion (reinvestment + growth)
• The average yield of the fixed income portfolio at September 30, 2024 was 4.7% and the average duration was 3.5 years. For 2025 we estimate the average yield will be 4.4%

3.) Share of profit of associates: Estimate = $855 million in 2024 and $900 million in 2025.

• Earnings at Eurobank and Poseidon/Atlas should continue to chug along.
• In 2024, GIG (shifted to a consolidated holding) was a small headwind.
• In 2025, Stelco (sold) and Peak (shifted to a consolidated holding) will be small headwinds.

4.) Effects of discounting and risk adjustment (IFRS 17):

• The two key drivers for this bucket are the trend in net written premiums of the insurance business and changes in interest rates.
• Net written premiums growth of 11% in 2024 should be a tailwind. 
• Now that the average duration of the fixed income portfolio (3.5 years) is about the same as the average duration of the insurance liabilities (a little under 4 years?), changes in interest rates should roughly balance out.

This bucket is difficult to model – therefore, my confidence level in my estimates is low. 

 

5.) Life insurance and runoff: Estimate = a loss of $325 million in 2024 and 2025.

• This combination of businesses lost an estimated $348 million in 2023 (not including the returns on its investment portfolio). 

6.) Other (revenue-expenses) - non-insurance subsidiaries: 

• Includes: Recipe, Dexterra, AGT, Grivalia Hospitality, Boat Rocker etc.
• This combination of businesses earned $46 million in 2023.
• 2024E = $170 million
  • Sleep Country was added in Q4, 2024
• 2025E = $300 million
  • Peak Achievement will be added when the sale closes (likely later in Q4, 2024)

This bucket is poised to grow nicely in the coming years. Yes, the results will be lumpy.

 

7.) Interest expense: Estimate = $640 million in 2024 and $660 million in 2025.

• An increase from 2023, which was $510 million.

8.) Corporate overhead and other: Estimate = $490 million in 2024 and $500 million in 2025.

• An increase from 2023, which was $430 million.

9.) Net gains on investments:

• 2024E = $770 billion
  • Big driver: FFH-TRS position
• 2025E = $1 billion
  • FFH-TRS = $400 million = $200 x 1.96 million shares
  • Remaining mark to market holdings = $600 million = $8 billion x 7.5%

10.) Gain on sale/deconsol of insurance sub: This is where I put the large asset sales/revaluations. These items are very lumpy and therefore difficult to forecast precisely for any one year. However, the gains are easier to forecast looking out over a longer time frame. 

• 2023 = $550 million (Sale of Ambridge and the revaluation of GIG).
• 2024E = $500 million (Sale of Stelco and the revaluation of Peak Achievement).
• 2025E = $500 million. Over the last 5 years, the average gain has been $530 million per year. 

Bottom line, this bucket is a wild card. But Fairfax has a long history of surfacing the significant value that is residing/hidden on its balance sheet. When they do, we see significant realized gains (from both insurance and non-insurance holdings).

 

11.) Income taxes: The historical average was around 20%. It has increased in 2024 due to changes in the Caribbean and India. On the Q3, 2024 earnings call, Fairfax upped guidance to 22% to 25%.

• 2024E = 24.5%
• 2025E = 24%

12.) Non-controlling interests: I expected Fairfax to take out one of its P/C insurance minority partners in 2024. Other than increasing its position in GIG from 90 to 97%, this did not happen. My guess is we will see something happen in 2025. Perhaps at Brit. Or Allied World.

• 2023 = 14.0% (amount of net earnings that was allocated to non-controlling interests)
• 2024E = 8.5% (this is the run-rate Sept YTD, 2024)
• 2025E = 8.5%

As minority P/C insurance partners are taken out, the result is a greater share of total earnings at Fairfax will accrue to shareholders. This is a solid use of free cash flow to grow EPS. 

 

13.) Effective Shares Outstanding (year-end): We focus on effective shares outstanding as this is what Fairfax highlights in its reporting.

• 2023 = 23.0 million
• 2024E = 21.9 million
  • Fairfax is on pace to buy back 4.8% in 2024. That is a significant amount. This has been Fairfax’s largest capital allocation decision / investment in 2024.
• 2025E = 21.5 million
  • We estimate Fairfax will continue to buy back shares in 2025, although at a slower pace compared to 2024.

Additional notes:

• ‘Underwriting profit’: Includes insurance and reinsurance; does not include runoff or Eurolife life insurance.
• ‘Interest and dividends’ and ‘share of profit of associates’: Includes insurance, reinsurance and runoff.

—————

 

Return on Equity Calculation

 

Return on equity (ROE) is calculated using ‘average equity’ which is:

• (PY ending BV/share + CY ending BV/share) / 2

I think most of the industry (other P/C insurance companies, analysts) calculates ROE using an average number for equity. This should make my ROE estimates comparable with industry numbers.

 

 

Edited November 17 by Viking

[sholland]

Just to add some color, this is what Peter Clarke had to say about Viking’s assumption #2 during the 3Q24 CC:

 

[Hoodlum]

1 hour ago, sholland said:

Just to add some color, this is what Peter Clarke had to say about Viking’s assumption #2 during the 3Q24 CC:

 

With the recent increase in long Treasuries, we may not see the average yield drop much during 2025 with Fairfax being able to continue extending the duration.
 

Fairfax could get another opportunity to extend duration again in the coming months and lock in at favourable rates. 

Edited November 17 by Hoodlum

[Viking]

4 hours ago, sholland said:

Just to add some color, this is what Peter Clarke had to say about Viking’s assumption #2 during the 3Q24 CC:

 

@sholland, a year ago i think lots of investors (and board members) felt $2 billion per year in interest and dividend income was unsustainably high. It was such a large number compared to what Fairfax had ever earned before… it just HAD to come down. 
 

What actually happened over the past year? Interest and dividend income went up and by a lot (especiallyon a per share basis, which is what really matters).
 

What were the mistakes made?

 

I can come up with a couple:

1.) Using Fairfax’s historical total interest and dividend numbers was wrong headed - they do not determine future interest and dividend income.
 

What does? Two things: The size of the fixed income portfolio. And the average yield. Looking into the future.
 

2.) The absolute size of the fixed income portfolio increased about 10%. And Fairfax has bought back close to 5% of shares outstanding. As a result, fixed income investments per share has increased about 15% in 2024. 15% growth was completely unexpected.
3.) At the same time, interest rates have remained higher than expected. And now Fairfax has extended the average duration to 3.5 years. And bond yields (other than less than one year) have popped higher once again. 
 

What about 2025? Given what we know today, Fairfax’s generic guide of $2 billion is likely much too low.
 

Fixed income investments per share will continue to grow nicely - something in the low double digit range seems reasonable. Yes, the average yield will comedown a little (more in Canada and Europe). Bottom line, total interest and dividend income per share should hold up pretty well in 2025.

 

Looking at interest and dividends is instructive. It provides a good example of how many investors continue to underestimate Fairfax and its EPS trajectory moving forward. They are underestimating the impact of $4 billion in earnings and the impact of Fairfax’s capital allocation decisions on EPS. 
 

Not knowing exactly what Fairfax is going to do (when it comes to $4 billion in earnings and capital allocation) doesn’t mean an assumption of them doing nothing is reasonable or appropriate. IMHO, that is not being conservative. That is simply going to lead people to undervalue the company.

 

So part of the valuation process boils down to: ‘do you trust management?’ Do you think they are any good at capital allocation? If so, how good? 

Edited November 18 by Viking

[petec]

17 hours ago, Viking said:

When it comes to re-investing earnings, Fairfax has a lot of very good options:

• Grow insurance - Continuation of the hard market? Bolt-on acquisitions?
  • Buy out minority partners in insurance?
• Buy equities or fixed income securities?
• Buy back a meaningful amount of Fairfax stock? 

 

Important to note that the first two of these are not mutually exclusive. If they retain earnings to grow insurance, they can ALSO invest those retained earnings in stocks and bonds. What they can't do is buy back shares and still retain the capital to grow insurance.

[SafetyinNumbers]

1 hour ago, petec said:

 

Important to note that the first two of these are not mutually exclusive. If they retain earnings to grow insurance, they can ALSO invest those retained earnings in stocks and bonds. What they can't do is buy back shares and still retain the capital to grow insurance.

My understanding is they can maintain premium growth of 5% and return 75% of FCF back to shareholders via the dividend and buybacks.

[jfan]

@SafetyinNumbers Great podcast! Thank you!