Fairfax 2024

[roundball100]

39 minutes ago, Viking said:

Can someone educate me a little: Fairfax appears to be reducing its preferred share exposure and shifting it to debt (where the capital is held on the balance sheet is shifting). Other than saving a little (or a lot?) on the cost side (after tax), are there also strategic reasons/benefits to what they are doing?

 

Preferred shares are considered equity capital. Fairfax's financial position and earnings trajectory has never been better.

Does the shift from preferred shares to debt result in greater per-share income numbers?

[dartmonkey]

4 minutes ago, roundball100 said:

46 minutes ago, Viking said:

Other than saving a little (or a lot?) on the cost side (after tax), are there also strategic reasons/benefits to what they are doing?

 

Preferred shares are considered equity capital. Fairfax's financial position and earnings trajectory has never been better.

Does the shift from preferred shares to debt result in greater per-share income numbers?

To the latter question, clearly the answer should be yes, since EPS is net after tax income less preferred share dividends, divided by common shares. If you buy out the preferred shares by takiing on debt, the interest on the debt will reduce your pre-tax income by the same amount as you reduce your preferred dividends, but then you get the tax benefit of those interest payments, which you don't get with the preferred dividends paid.

 

In response to viking's question, I would think that this would reduce the equity capital of the company, like a buyback, but I look forward to the responses of people more familiar with insurance regulation.

[nwoodman]

The shift in funding is definitely a sign of strength and signals confidence in future cash flows.  Apart from the bottom line impacts,   strategically there might be some upside in terms of credit ratings.  Lower WACC, improved cashflow, EBITDA margins etc.  

 

All very positive

 

Edit: It would impact their capital adequacy ratios as Prefs are Tier 1 and Debt obviously doesn’t count.  So they must be seeing the change as neutral in terms of their capital adequacy threshold.  
 

I also wonder if it provides some clues in terms of their view on the pricing of debt in general and the direction of rates.

Edited November 20 by nwoodman

[value_hunter]

I have FFH.PR.C. The reset rate will be 5 year canada bond+3.15%. Roughly 6.25% now. Definitely take 5.23% debt is much cheaper. Good move.

[mananainvesting]

Should help improve ROE (lower equity base), and more to the bottom line as others have mentioned. Should help with valuations in the longer run too imo.  

[nwoodman]

MS out with their review of if the Insurance industry for Q3/24. Is the hard market over? Summary as follows:

 

PERSONAL LINES: YES - TRANSITIONING OUT

- Auto rate increases decelerating in Q4 2024 and into 2025
- Major carriers like Progressive & Allstate pivoting from rate-taking to growth
- Competition ramping up as companies target growth in rate-adequate states
- Margins expected to remain healthy but pricing power diminishing

 

COMMERCIAL LINES: NO - BUT SOFTENING
- Pricing showing "slight deceleration" in Q3 2024
- Still need rate in many areas due to social inflation pressures
- Admitted market seeing increased competition
- Business flowing to E&S market where pricing power remains stronger
- Companies focusing on reserving discipline over aggressive growth

 

REINSURANCE: MIXED
Positive Signs:
- Property cat rates expected to decline low-to-mid single digits in 2025
- Excess capital putting pressure on pricing
- Return of capacity to market

Still Firm:
- Terms & conditions holding strong
- Some potential for casualty reinsurance rate increases
- Catastrophe losses still manageable at current pricing levels

 

KEY TAKEAWAY:
The report suggests we're not seeing a dramatic market turn, but rather a gradual transition varying by segment:
- Personal Lines: Clearly transitioning out
- Commercial Lines: Still firm but moderating
- Reinsurance: Mixed with property softening while casualty remains firm

 

The market appears to be entering a more nuanced phase where underwriting discipline and efficient capital deployment will be more important than pure pricing power.

 

How will this affect Fairfax:

 

While Fairfax Financial isn't directly covered in this Morgan Stanley report, we can analyze the likely impacts based on Fairfax's business mix and the report's industry insights:

 

POTENTIAL POSITIVES:

1. Investment Income
- Higher rate environment helpful for Fairfax's large investment portfolio
- Report suggests variable investment returns could improve with:
  * Better capital markets activity
  * Improved private market valuations
  * Higher prepayment income

2. Commercial Lines Positioning
- Fairfax has significant commercial specialty presence through companies like Allied World, Odyssey Group
- While commercial pricing is decelerating, social inflation providing support for continued rate adequacy
- E&S market (where Fairfax has strong presence) likely to remain stronger than admitted market
- Focus on underwriting discipline aligns with Fairfax's historical approach

3. Global Diversification
- Like peer Chubb (mentioned in report), Fairfax's international diversification provides growth opportunities
- Report notes international business remains a strong growth area

 

POTENTIAL CHALLENGES:

1. Pricing Pressure
- General softening in property catastrophe reinsurance (important for Odyssey Group)
- Increased competition in commercial lines
- Personal lines transitioning to growth focus over rate increases

2. Investment Risks 
- Report notes continued challenges in real estate investments within alternatives portfolios
- Fairfax has significant real estate exposure through various investments

3. Reserving Focus
- Report highlights industry-wide concern about commercial casualty reserves
- Increased attention to social inflation impact on long-tail business

 

KEY TAKEAWAYS:
Fairfax appears relatively well-positioned given:
1. Strong specialty/E&S presence where pricing remains more stable
2. Global diversification providing growth options
3. Investment portfolio benefiting from higher rates
4. Historical focus on underwriting discipline becoming more important as market softens

 

INSURANCE_20241121_0502.pdf

[Viking]

48 minutes ago, nwoodman said:

MS out with their review of if the Insurance industry for Q3/24. Is the hard market over? Summary as follows:

 

PERSONAL LINES: YES - TRANSITIONING OUT

- Auto rate increases decelerating in Q4 2024 and into 2025
- Major carriers like Progressive & Allstate pivoting from rate-taking to growth
- Competition ramping up as companies target growth in rate-adequate states
- Margins expected to remain healthy but pricing power diminishing

 

COMMERCIAL LINES: NO - BUT SOFTENING
- Pricing showing "slight deceleration" in Q3 2024
- Still need rate in many areas due to social inflation pressures
- Admitted market seeing increased competition
- Business flowing to E&S market where pricing power remains stronger
- Companies focusing on reserving discipline over aggressive growth

 

REINSURANCE: MIXED
Positive Signs:
- Property cat rates expected to decline low-to-mid single digits in 2025
- Excess capital putting pressure on pricing
- Return of capacity to market

Still Firm:
- Terms & conditions holding strong
- Some potential for casualty reinsurance rate increases
- Catastrophe losses still manageable at current pricing levels

 

KEY TAKEAWAY:
The report suggests we're not seeing a dramatic market turn, but rather a gradual transition varying by segment:
- Personal Lines: Clearly transitioning out
- Commercial Lines: Still firm but moderating
- Reinsurance: Mixed with property softening while casualty remains firm

 

The market appears to be entering a more nuanced phase where underwriting discipline and efficient capital deployment will be more important than pure pricing power.

 

How will this affect Fairfax:

 

While Fairfax Financial isn't directly covered in this Morgan Stanley report, we can analyze the likely impacts based on Fairfax's business mix and the report's industry insights:

 

POTENTIAL POSITIVES:

1. Investment Income
- Higher rate environment helpful for Fairfax's large investment portfolio
- Report suggests variable investment returns could improve with:
  * Better capital markets activity
  * Improved private market valuations
  * Higher prepayment income

2. Commercial Lines Positioning
- Fairfax has significant commercial specialty presence through companies like Allied World, Odyssey Group
- While commercial pricing is decelerating, social inflation providing support for continued rate adequacy
- E&S market (where Fairfax has strong presence) likely to remain stronger than admitted market
- Focus on underwriting discipline aligns with Fairfax's historical approach

3. Global Diversification
- Like peer Chubb (mentioned in report), Fairfax's international diversification provides growth opportunities
- Report notes international business remains a strong growth area

 

POTENTIAL CHALLENGES:

1. Pricing Pressure
- General softening in property catastrophe reinsurance (important for Odyssey Group)
- Increased competition in commercial lines
- Personal lines transitioning to growth focus over rate increases

2. Investment Risks 
- Report notes continued challenges in real estate investments within alternatives portfolios
- Fairfax has significant real estate exposure through various investments

3. Reserving Focus
- Report highlights industry-wide concern about commercial casualty reserves
- Increased attention to social inflation impact on long-tail business

 

KEY TAKEAWAYS:
Fairfax appears relatively well-positioned given:
1. Strong specialty/E&S presence where pricing remains more stable
2. Global diversification providing growth options
3. Investment portfolio benefiting from higher rates
4. Historical focus on underwriting discipline becoming more important as market softens

 

INSURANCE_20241121_0502.pdf 9.71 MB · 2 downloads

@nwoodman, great summary. Thanks for sharing. Bottom line, quality insurance companies should continue to do well in 2025. Except most don’t view Fairfax’s insurance business as high quality. And that is what creates the opportunity. 

[nwoodman]

16 minutes ago, Viking said:

@nwoodman, great summary. Thanks for sharing. Bottom line, quality insurance companies should continue to do well in 2025. Except most don’t view Fairfax’s insurance business as high quality. And that is what creates the opportunity. 

True, the fact that E&S is sounding stable was music to my ears though

 

"Given the challenges around receiving enough rate to cover losses in the admitted markets, a lot of focus is now on Specialty/E&S market opportunities."

 

"As increasingly unpredictable weather-related CATs, and social inflation risks force commercial carriers to tighten up underwriting guidelines in the admitted markets, we expect continued strong submissions & pricing growth in the E&S market for 4Q24 and 2025, as insurers have more flexibility around setting E&S pricing and terms & conditions."

 

It’s probably been done to death, but damn Allied World was a master stroke.

 

KEY THEMES FOR 2025:
1. More competitive environment overall
2. Technical underwriting becoming more important
3. E&S market remaining relatively strong
4. Social inflation as ongoing challenge
5. Reserve adequacy growing in importance
6. Investment income potentially improving
7. Growth opportunities varying significantly by segment

Edited November 22 by nwoodman

[Viking]

14 minutes ago, nwoodman said:

True, the fact that E&S is sounding stable was music to my ears though

 

"Given the challenges around receiving enough rate to cover losses in the admitted markets, a lot of focus is now on Specialty/E&S market opportunities."

 

"As increasingly unpredictable weather-related CATs, and social inflation risks force commercial carriers to tighten up underwriting guidelines in the admitted markets, we expect continued strong submissions & pricing growth in the E&S market for 4Q24 and 2025, as insurers have more flexibility around setting E&S pricing and terms & conditions."

 

It’s probably been done to death, but damn Allied World was a master stroke.

The fact that Markel had the opportunity to take out Allied World but passed was likely an inflection point for both companies. Wonderful for Fairfax. Big mistake for Markel. Why Markel passed (or why Allied World said no thanks) would likely make a very interesting story.  
 

I thought it would be interesting to calculate about how much Allied is delivering to Fairfax today…(in terms of underwriting and the return of from its investment portfolio) it has been Fairfax’s top performing insurance business for two years running. Its performance has been top tier - simply amazing.

 

I remember the cat losses the year they bought Allied - Fairfax was very unlucky with the timing of the purchase. But Allied certainly has delivered the last couple of years. I had a chance to talk to the guy running Allied at Fairfax’s 2023 AGM (the dog and pony show before the AGM) - he was a class act. 

Edited November 22 by Viking

[Hoodlum]

The offering has been completed. 
 

https://www.fairfax.ca/press-releases/fairfax-completes-c700000000-senior-notes-offering-11-22-2024/

[Hamburg Investor]

On 11/16/2024 at 2:41 AM, nwoodman said:

@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)

Thank you! That makes sense to me. That seems perfectly reasonable and understandable to me, logical. 
 

Just one comment:

I have always found Munger and Buffett to be very forceful in their assertion that buybacks above intrinsic value are ‘capital-destroying’. But is that really the case? Isn't that oversimplifying? 
 

One example: Now let's imagine a company with a sustainable ROE of 40%. Munger would say, ‘No matter at what price you get in here, over a very long time horizon you will get roughly the ROE (assuming everything is reinvested in the company).’ 

And now let's assume that management buys significantly above intrinsic value, so that the repurchased shares ‘only’ yield 35% (instead of 40% as ROE is 40%) in the long run. I find Munger's judgement that (all) share buybacks above intrinsic value are always ‘capital-destroying’ somehow questionable. By the way, it can't be both ways: Either you get a return over the long term roughly in line with the ROE, regardless of the purchase price for the shares (in other words, regardless of whether you bought above or below intrinsic value), or purchases above intrinsic value are always ‘capital-destroying’. Or would anyone disagree that an average return of 35% per year for most of us doesn't exactly fit the definition of ‘value destruction’? To stay with the image: management would reinvest the surplus with a return of 35%; you have to achieve that yourself first (many of us would also have to pay tax on the dividends first; so we would have to achieve above 35% just to match the management).

But that's how I read your formula, @nwoodman: Share buybacks above intrinsic value do not destroy capital; they only lead to lower returns than the company's ROE. In other words, companies with very high ROEs can buy back a large amount of shares above intrinsic value, and yet these are still sensible buybacks (unless you have better reinvestment opportunities). 

You can also turn it around: If a company with a ROE of 10% buys back shares below intrinsic value, the share buybacks will hardly achieve such a high return for the investor, as in the first example. But how can that be, if Munger is right. For the investor holding both stocks (50/50), it would be better to have the company with a 40% ROE buying back shares (slightly) above intrinsic value than to have the other company with a 10% ROE buying back shares below intrinsic value. In the best case (assuming these are the only two stocks available), the 10% ROE company pays a dividend and the investor uses that to buy more shares of the 40% ROE company, even at a 35% CAGR return. This way, the better company would come to dominate the investor's portfolio more and more.

Or am I wrong?

[nwoodman]

2 hours ago, Hamburg Investor said:

Thank you! That makes sense to me. That seems perfectly reasonable and understandable to me, logical. 
 

Just one comment:

I have always found Munger and Buffett to be very forceful in their assertion that buybacks above intrinsic value are ‘capital-destroying’. But is that really the case? Isn't that oversimplifying? 
 

One example: Now let's imagine a company with a sustainable ROE of 40%. Munger would say, ‘No matter at what price you get in here, over a very long time horizon you will get roughly the ROE (assuming everything is reinvested in the company).’ 

And now let's assume that management buys significantly above intrinsic value, so that the repurchased shares ‘only’ yield 35% (instead of 40% as ROE is 40%) in the long run. I find Munger's judgement that (all) share buybacks above intrinsic value are always ‘capital-destroying’ somehow questionable. By the way, it can't be both ways: Either you get a return over the long term roughly in line with the ROE, regardless of the purchase price for the shares (in other words, regardless of whether you bought above or below intrinsic value), or purchases above intrinsic value are always ‘capital-destroying’. Or would anyone disagree that an average return of 35% per year for most of us doesn't exactly fit the definition of ‘value destruction’? To stay with the image: management would reinvest the surplus with a return of 35%; you have to achieve that yourself first (many of us would also have to pay tax on the dividends first; so we would have to achieve above 35% just to match the management).

But that's how I read your formula, @nwoodman: Share buybacks above intrinsic value do not destroy capital; they only lead to lower returns than the company's ROE. In other words, companies with very high ROEs can buy back a large amount of shares above intrinsic value, and yet these are still sensible buybacks (unless you have better reinvestment opportunities). 

You can also turn it around: If a company with a ROE of 10% buys back shares below intrinsic value, the share buybacks will hardly achieve such a high return for the investor, as in the first example. But how can that be, if Munger is right. For the investor holding both stocks (50/50), it would be better to have the company with a 40% ROE buying back shares (slightly) above intrinsic value than to have the other company with a 10% ROE buying back shares below intrinsic value. In the best case (assuming these are the only two stocks available), the 10% ROE company pays a dividend and the investor uses that to buy more shares of the 40% ROE company, even at a 35% CAGR return. This way, the better company would come to dominate the investor's portfolio more and more.

Or am I wrong?

I tend to agree.  Obviously the best case is to keep reinvesting in the company’s high ROE business but there comes a time when Capital should be returned to shareholders as cash build starts to drag on ROE or a myriad of other considerations.  We can probably draw the following conclusions on whether the capital is returned via buybacks or divs as follows:

 

•High ROE companies (30% or more) can justify buybacks above intrinsic value, provided the buyback returns remain competitive with alternative investments.

• Moderate ROE companies (10-20%) should be more disciplined, as the margin for error is smaller.

• Low ROE companies (<10%) need to focus on reinvestment or dividends instead of buybacks unless they’re deeply accretive (significantly below intrinsic value).

 

It is interesting to consider what the reasons a High-ROE Company might buy back shares above intrinsic value and investors must draw their own conclusions as to whether it is the best use of capital:

 

1. Limited Reinvestment Opportunities

• The company has few high-return projects to invest in and cannot reinvest all earnings at its high ROE.

2. Tax Efficiency

• Share buybacks are often more tax-efficient for shareholders than dividends, especially for long-term investors.

3. Signaling Confidence

• Management may repurchase shares slightly above IV to signal strong confidence in the company’s future growth.

4. Intrinsic Value is Growing Rapidly

• For high-ROE companies, what appears “above IV” today might not be overvalued if intrinsic value is expected to grow quickly.

5. Defending Against Activism

• Share repurchases can reduce the likelihood of activist investors gaining control or pressuring management.

6. Preventing Dilution

• Buybacks can offset dilution from employee stock options or compensation plans, even if the shares are repurchased above IV.

7. Lack of Accurate IV Estimates

• Management may not have a precise estimate of IV, especially in high-growth scenarios, leading to buybacks at prices above calculated IV.

8. Excess Cash with No Better Alternatives

• Holding cash or reinvesting in low-return projects might be less beneficial than buying back shares, even at a premium.

9. Avoiding Poor Capital Allocation Options

• Alternatives like paying dividends, acquiring other businesses, or holding excess cash may generate even lower returns than the buybacks.

 

Probably preaching to the converted so apologies for the long answer. This topic deserves its own thread.  

Edited November 23 by nwoodman

[John Hjorth]

Absolutely awesome discusson and exchanges between @nwoodman and @Hamburg Investor here!,

 

I hope you'll in personal cooperation agree on how - on a pratical level - please be each others friends via CoBF, by collaboration - to start a new CoBF General Discussion topic about what your are discussing. The basic understanding of it, is to me, personally, very, very important.

[giulio]

Overpaying for an assets is always a bad decision and it ensures that you will earn suboptimal returns.

Whether you are an investor or a ceo allocating capital, it does not make any difference.

Munger is of course right because he's taking into account the return on incremental capital reinvested.

In your case, I think it's worth noting that:

1) if your company has excess cash for a buyback it means that it does not have enough internal opportunities for reinvestment At 40%

2) shares of such a company will hardly trade at a low price. If bv = 100, 40% roe = 40 in earnings, at 15x this equal a price of 600. A buyback at this level equates to 6.7% yield, way lower than your starting 40%.

3) if a company earning 10% roe is selling at 0.5 bv a buyback would be the best course of action as it would yield 20%.

 

You can Pay a very high entry price and still get value, it all depends on your assumptions about capital retained and roiic.

There are qualitative aspects to consider of course.

If you think high growth lies ahead don't be too conservative in your assumptions. But this does not mean that you can any price. It must incorporated in your estimate of fair value.

 

I hope I have expressed myself clearly enough. Hopes it helps, love the discussion.

 

best,

G

 

[nwoodman]

44 minutes ago, giulio said:

Overpaying for an assets is always a bad decision and it ensures that you will earn suboptimal returns.

Whether you are an investor or a ceo allocating capital, it does not make any difference.

Munger is of course right because he's taking into account the return on incremental capital reinvested.

In your case, I think it's worth noting that:

1) if your company has excess cash for a buyback it means that it does not have enough internal opportunities for reinvestment At 40%

2) shares of such a company will hardly trade at a low price. If bv = 100, 40% roe = 40 in earnings, at 15x this equal a price of 600. A buyback at this level equates to 6.7% yield, way lower than your starting 40%.

3) if a company earning 10% roe is selling at 0.5 bv a buyback would be the best course of action as it would yield 20%.

 

You can Pay a very high entry price and still get value, it all depends on your assumptions about capital retained and roiic.

There are qualitative aspects to consider of course.

If you think high growth lies ahead don't be too conservative in your assumptions. But this does not mean that you can any price. It must incorporated in your estimate of fair value.

 

I hope I have expressed myself clearly enough. Hopes it helps, love the discussion.

 

best,

G

 

 

All good points and thinking more about it reinforces the difference between good management and great management.  as I said in another thread I think the capital return process benefits from management having skin in the game.  Some final thoughts:

 

1. Overpaying Reduces Returns, But Context Matters:

I agree that overpaying for buybacks locks in lower-than-optimal returns. However, for high-ROE companies, intrinsic value grows quickly. Even buybacks slightly above intrinsic value can yield acceptable long-term returns if better reinvestment opportunities don’t exist. For instance, a 6.7% buyback yield might seem low compared to a 40% ROE, but it’s still far better than holding cash or pursuing suboptimal acquisitions.

 

2. Alternative Capital Allocation Options:

Your example highlights that high-ROE companies should prioritize reinvesting internally. However, if those opportunities are exhausted, buybacks might still be the best available option—even slightly above intrinsic value—because they are often more tax-efficient than dividends and can still generate competitive returns.

 

3. Valuation and Fair Value:

I completely agree that high growth doesn’t justify buying at any price. It’s critical to estimate fair value based on realistic assumptions about future growth and returns. For high-ROE companies, this fair value may grow rapidly, meaning today’s “above IV” price might actually be reasonable if intrinsic value is compounding quickly.

 

4. Buybacks in Low-ROE Companies:

You’re absolutely right that low-ROE companies with deeply undervalued shares can achieve outsized returns through buybacks. However, for investors with access to a high-ROE company—even buying slightly above IV—the compounding effect of high reinvestment rates can often dominate returns over time.

 

Bringing the conversation back to Fairfax, while the P/IV is closer to 1, its not difficult to make the case that buybacks are still very accretive.  What is interesting to ponder is the enduring effect of these buybacks at such a large discount.  There is an obvious ROIC benefit but there are also perceptual benefits too. The creativity of the TRS is worthy of an academic paper or two.

[Hamburg Investor]

55 minutes ago, giulio said:

Overpaying for an assets is always a bad decision and it ensures that you will earn suboptimal returns.

Whether you are an investor or a ceo allocating capital, it does not make any difference.

Munger is of course right because he's taking into account the return on incremental capital reinvested.

In your case, I think it's worth noting that:

1) if your company has excess cash for a buyback it means that it does not have enough internal opportunities for reinvestment At 40%

2) shares of such a company will hardly trade at a low price. If bv = 100, 40% roe = 40 in earnings, at 15x this equal a price of 600. A buyback at this level equates to 6.7% yield, way lower than your starting 40%.

3) if a company earning 10% roe is selling at 0.5 bv a buyback would be the best course of action as it would yield 20%.

 

You can Pay a very high entry price and still get value, it all depends on your assumptions about capital retained and roiic.

There are qualitative aspects to consider of course.

If you think high growth lies ahead don't be too conservative in your assumptions. But this does not mean that you can any price. It must incorporated in your estimate of fair value.

 

I hope I have expressed myself clearly enough. Hopes it helps, love the discussion.

 

best,

G

 

Thank you very much, I agree on your points.

 

It‘s late here in Germany, but with the resonance here, we should open a discussion separate, I think (happy, that others are interested too in this discussion!)

 

One thing came up in my mind; maybe we should focus more on the term „intrinsic value“; as you write here, at high roe companies, the iv tends to go up in value fast; I tend to agree, but than I think, if nothing really changed to the business, but iv moves up e. g. 30% from year 1 to year 2 (so 30% roe - let‘s say over decades), than iv can‘t be estimated right in year 1… But one gets to absurd levels e. g. of BRK, when you discount its value back from today to the 1970ies. And looked back from that perspective, BRK should have bought back a lot of more own stocks at every price there was, as the discount was just so absurd… But it didn‘t happen, Buffett hasn‘t bought back. But okay, let’s talk about that somewhere else…

[SafetyinNumbers]

4 hours ago, Hamburg Investor said:

Thank you very much, I agree on your points.

 

It‘s late here in Germany, but with the resonance here, we should open a discussion separate, I think (happy, that others are interested too in this discussion!)

 

One thing came up in my mind; maybe we should focus more on the term „intrinsic value“; as you write here, at high roe companies, the iv tends to go up in value fast; I tend to agree, but than I think, if nothing really changed to the business, but iv moves up e. g. 30% from year 1 to year 2 (so 30% roe - let‘s say over decades), than iv can‘t be estimated right in year 1… But one gets to absurd levels e. g. of BRK, when you discount its value back from today to the 1970ies. And looked back from that perspective, BRK should have bought back a lot of more own stocks at every price there was, as the discount was just so absurd… But it didn‘t happen, Buffett hasn‘t bought back. But okay, let’s talk about that somewhere else…

Does everyone have a different definition of intrinsic value? I think about it as the price I can earn a 10% return forever. I’m not sure what that is for Fairfax but it certainly is a lot higher than where it’s trading. I try to estimate fair value with various measure which I think of as an intrinsic value range. The simplest for FFH is BV + Insurance Float but also 15x FTM EPS or 2.5x BV all seem like reasonable fair value estimates. I’m also happy to keep the discussion here. 

[nwoodman]

1 hour ago, SafetyinNumbers said:

Does everyone have a different definition of intrinsic value? I think about it as the price I can earn a 10% return forever. I’m not sure what that is for Fairfax but it certainly is a lot higher than where it’s trading. I try to estimate fair value with various measure which I think of as an intrinsic value range. The simplest for FFH is BV + Insurance Float but also 15x FTM EPS or 2.5x BV all seem like reasonable fair value estimates. I’m also happy to keep the discussion here. 

(10 year Treasury + ERP) as a discount rate against future cash flows. However, like yourself I am chasing higher returns or greater margin of safety. Don’t want to utter those words but in an age of passive fund flows not sure it is all that helpful anwyway. I like Fairfax because i don’t have to work to hard to arrive at an answer that says low double digit returns are likely even from this point.  They have enough opportunities presenting that they aren’t wedded to SPX which is reassuring

[nwoodman]

On 11/23/2024 at 4:20 AM, Hoodlum said:

The offering has been completed. 
 

https://www.fairfax.ca/press-releases/fairfax-completes-c700000000-senior-notes-offering-11-22-2024/

AM BEST has kept their rating at bbb+ and importantly their outlook positive.  Will be interesting see if they gain a notch next year (possibly May).

 

Edited November 24 by nwoodman

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On 11/14/2024 at 7:30 PM, Parsad said:

 

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!  

Oop got to check that out. Rights expire nov 29th also.

[Viking]

Well, if you are a Canadian investor, you now have another really good reason to own Fairfax - protection from a weak Canadian $. Truth be told, the Canadian $ has been weak for a decade. But the weakness appears to be picking up a little steam.

 

What does 'protection' look like?

 

Over the past decade, US investors have made a solid return owning Fairfax. The 10-year CAGR has been 10.5% (not including dividends). 

 

Canadian investors? They have earned a much better return. The 10-year CAGR has been 13% (before dividends).

 

Fairfax has provided Canadian investors with solid protection from an ever-weakening Canadian $. 

 

 

How does Fairfax offer protection?

 

Only 11% of Fairfax's insurance revenues come from Canada. But the news is even better.

 

Guess where Fairfax's biggest revenue region is?

 

At 64%, it is the US. Fairfax is well positioned to benefit from a strong US economy in the coming years. 

 

Fairfax has many tailwinds right now. For a Canadian investor, we can add yet another - it provides solid protection from a weak C$.   

 

PS: if I was a fund manager in Canada and I HAD to own Canadian stocks (i.e. Canadian equity fund)... why would I not own Fairfax? 

 

 

Edited November 26 by Viking

[Hoodlum]

It looks like the strong reinsurance results may continue through 2026. 

Reinsurance eyes strong growth through 2026 – S&P
 

The global reinsurance sector is poised for strong earnings growth between 2024 and 2026, building on robust results in 2023, according to an analysis by S&P Global Ratings.

 

Key drivers include decade-high investment yields and consistent rate increases in property and property catastrophe lines, supported by structural changes implemented since early 2023.

 

Reinsurers have benefitted from higher attachment points, stricter terms and conditions, and the repricing of property catastrophe risks. These adjustments have strengthened the foundation of the property/casualty (P/C) reinsurance market.

 

 

Edited November 27 by Hoodlum

[Hoodlum]

Well deserved for Prem. 
 

https://www.globenewswire.com/news-release/2024/11/28/2988603/0/en/Prem-Watsa-to-receive-2024-Nation-Builder-Award-from-The-Empire-Club-of-Canada.html
 

The Empire Club of Canada is thrilled to announce Prem Watsa, Founder, Chairman and CEO of Fairfax Financial Holdings, as the recipient of the 2024 Nation Builder Award.
 

 

"From his incredible work ethic and business success to his commitment to philanthropy, volunteerism and opportunity creation, Prem Watsa is an inspiring leader who represents the best of our country. The Empire Club of Canada is delighted to celebrate his contributions and impact,” said Jenna Donelson, Board Chair of the Empire Club of Canada.

The January awards ceremony will offer attendees the unique opportunity to hear directly from Mr. Watsa as he reflects on his remarkable journey and the milestones that have defined his career. Following Mr. Watsa's address, Andrew Willis, Business Columnist for The Globe and Mail, will engage Mr. Watsa in a fireside chat.

 

The event will also feature important testimonials from esteemed colleagues, such as The Right Honourable David Johnston, former Governor General of Canada and Kathleen Taylor, Chair of the SickKids Foundation Board of Trustees.

[Hoodlum]

We don’t always get to hear about what goes on behind the scene with Fairfax and their employees. Here is one article from yesterday outlining a visit to Ukraine by Canadian officials at the request of The Global Initiative on Psychiatry and Fairfax Financial.
 

https://qcna.qc.ca/dallaire-and-michaud-visit-ukraine-to-push-mental-health-resources-for-military-families/

 

At a meeting of Fairfax employees and families involved in the war, Michaud said, “When I talked to them, a lot of them started to cry because I was explaining to them what it was like to be a military spouse when you have a loved one fighting and being away from home.”

…

 

Armed with what they learned from the Ukraine visit, where they met with a variety of people, including government leaders, the Canadian ambassador and the staff and patients at a rehabilitation centre, Michaud and Dallaire will prepare a plan to present to a meeting in Toronto next week.

 

The pair hopes to have Fairfax employees in Ukraine affected by the war serve as participants in a pilot project on dealing with mental health issues for wider implementation.

 

Edited November 28 by Hoodlum

[Viking]

Fairfax Financial and Index Investors
 

Hat tip: this post was inspired by @SafetyinNumbers many posts on this topic over the past year.

 

Financial markets are constantly evolving. One of the big changes over the past 30 years has been the wide adoption of index investing. 

 

How exactly is index investing changing how the stock market works? 

 

This is where things get really interesting. The short answer is we don’t really know what impact index investing is having on the stock market or individual stocks. It’s like we are in the middle of a big science experiment and we aren’t sure yet exactly what is going on - how index investing is affecting the stock prices and valuations of individual companies.

 

We likely will have much better answers in another decade or two. But that doesn’t really help us today. 

 

What does indexing have to do with Fairfax?

 

There is speculation that Fairfax may be added soon to the big Canadian index, the S&P/TSX 60. With the announcement coming perhaps as soon as December 6, 2024 (with the official add to the index coming 2 weeks later).

 

If Fairfax is added to the S&P/TSX 60 index, will it impact the company’s stock price? And/or its valuation?

 

That is the question we will explore today.

 

What is the best way to look at index investing and understand its impact on a stock’s price?

 

Let’s get out of our comfort zone a little. We are not going to focus on earnings or the fundamentals of a company. Today, we are going to go in a very different direction - we are going to look at the stock price of a company through the lens of supply and demand for its shares. 

 

Supply and demand

 

We were all taught in Econ 101 about the law of supply and demand:

• Supply is the amount of something that is available for sale.
• Demand is the amount something that people want to buy.
• The clearing mechanism (how much is actually bought and sold at a point in time) is price.

 

If demand is higher than supply, prices should rise (and vice versa). If supply is higher than demand, prices should fall (and vice versa). The critical assumption built into all of this - is the belief that markets work (and are relatively efficient).

 

The law of supply and demand can be explained simply with a graph, with price on the X-axis and supply on the Y-axis. Where the demand and supply curves intersect on the graph determines the quantity supplied and the price paid. 
 

 

Supply and demand - and shares outstanding

 

We can use supply and demand for shares to explain the stock price of a company at a point in time: a stock price is simply an equilibrium point where both the buyers and sellers of a stock are in agreement.

 

If demand for shares is higher than supply, the stock price should rise (and vice versa). If supply of shares is higher than demand, the stock price should fall (and vice versa).

 

How does index investing impact a stock’s price?

 

There are two basic ways index investing can impact a stock’s price. 

1. When a stock is in an index.
   • Ongoing impact.
2. When a stock is added (or removed) from an index.
   • One time impact.

Let’s now look at each of these.

 

1.) What happens to a stock that is in a popular index?

 

Growing demand for shares

 

ETF/index investing has been growing in popularity for the past 30 years and it has now become mainstream, especially in the US. This growth looks structural. As a result, this asset class is poised to continue its torrid growth in the coming years. 

 

The growth of this asset class will provide a steady source of new demand for shares of the companies that are in the main indexes like the S&P500 and the S&P/TSX 60. 

 

Decline in supply of shares (float)

 

The big broad based ETF/index funds are not market timers. They are largely ‘buy and hold’ investors. As long as the company remains in the index and its weighting remains roughly the same (the business is performing well).

 

As a result, the shares they own are essentially removed from the market. This shrinks the share float for a company - it reduces the supply of shares that are available for sale to the rest of the market.

 

Price agnostic

 

When indexes buy shares they are largely price agnostic - the valuation of the stock doesn’t matter to these buyers. What matters to them is getting their weighting right.

 

This is important. Price is supposed to be the clearing mechanism. But that is not the case for this large and growing group of investors.

 

Let’s now look at the second way index investing can impact a stock’s price. 

 

2.) What happens when a stock gets added to a popular index?

 

The big indexes usually make changes (additions/deletions) each quarter. The winners get added. And the losers get removed. 

 

Getting added to an index results in a one-time spike in demand for shares from index funds as they add the stock to get it to the designated weighting. 

 

Summary

 

Index investing impacts a stock in many important ways.

 

Short term - When a stock is added to index.

• One-time increase in demand of shares - price insensitive.
• Reduction in float (supply of shares available to other investors).

Long term - For stocks in an index.

• Steady demand of shares - price insensitive. 
• Reduction in float (supply of shares available to other investors).

The growth outlook for index funds is outstanding. As its popularity grows its impact on financial markets (and individual stocks) will only increase. 

 

All things being equal, what do you think this should do to the price of a stock over time? 

 

For stocks that are in the big indexes, this set-up looks like a tailwind.

 

How big? 

 

Of course, that is the million dollar question. We don’t know. But my guess is the impact is likely greater than most investors realize today. 

 

—————-

 

Let’s now expand our analysis a little to include a couple of other factors.

 

Share buybacks

 

Guess what happens if the company is also aggressively buying back its stock? 

 

Aggressively reducing the supply of shares (float) at the same time demand is increasing? 

 

All things being equal, yes, that should result in a higher price.

 

Quantitative analysis / momentum investing

 

In addition to index investing, one of the other big changes in financial markets over the past 30 years has been the explosion of quantitive analysis / momentum investing. 

 

This crowd loves stocks that go up. And that keep going up for years. 

 

Guess what stocks get added to an index? 

 

Yes, stocks that have already been going up for years (and growing in market cap). 

 

People describe index investing as passive investing. It’s not. In how it impacts financial markets, index investing looks an awful lot like another form of momentum investing. And that is because winners are added and losers are subtracted. And within the index, new cash flows disproportionately to best ‘performing’ stocks (with performance measured by market cap).

 

Guess what happens when both the index crowd and the momentum crowd start buying a stock at the same time? And the company is buying back large amounts of stock?

 

The law of supply and demand suggests we should see the stock price increase. This is when we see multiple expansion. Importantly, this process can play out for years. Especially if the company is performing well (is growing earnings and has improving fundamentals). 

 

Let’s add one last wrinkle.

 

From value play to quality play

 

What happens when a stock shifts from being a value play to being a quality play? 

 

This happens when Mr. Market falls in love with a stock. This results in another new source of demand for stock. 

 

Let’s try and bring this long post to a close.

 

What is the perfect set up for a stock?

 

High and growing demand for shares. With buyers willing to pay up (largely price agnostic). With, at the same time, the supply of shares (float) shrinking. 

 

With demand coming from the following sources:

• Value investors
• Index investors
• Momentum investors
• Quality investors

Shrinking supply (float):

• Index investors.
• Company is buying back stock.

 

This will push the stock price higher. In turn, this will result in an increase in the market cap of the company. This will result in increased demand for its shares. 

 

It becomes a virtuous circle. And it can take years to fully play out. 

 

—————-

 

What does all of this  to do with Fairfax?

 

There is speculation that Fairfax may be added soon to the big Canadian index, the S&P/TSX 60. With the announcement coming perhaps as soon as December 6, 2024 (with the official add to the index coming 2 weeks later).

 

Fairfax is not in the index today. It is currently the 26th largest publicly traded company in Canada based on market cap. 

• https://companiesmarketcap.com/cad/canada/largest-companies-in-canada-by-market-cap/

If Fairfax is added to the S&P/TSX 60 index it will increase demand for shares. And it will reduce the supply of stock (float) available to other investors.  This will be another (of many) tailwind for the stock - and one that should last for years. 

 

On October 1, 2024, here is what CIBC had to say in a research note:

 

“After attending the annual advisory panel meeting last week, our internal view is that the likelihood of Fairfax being included in the S&P/TSX 60 has increased significantly. The company’s size now outweighs any obstacles or impediments related to sector balance in S&P’s index methodology. An our view, the prospect of FFH’s inclusion has become a matter of when, not if, and we believe the event could bring close to 1MM shares of demand into the stock (representing 15x its 30-day average daily volume).”

 

On December 1, 2024, the following was reported by the Globe and Mail:

 

“Insurance company Fairfax Financial Holdings Ltd. is likely to replace Algonquin Power in the S&P/TSX 60 Index, as it’s the largest S&P/TSX Composite name not in the 60, Mr. Gauthier said (analyst with Scotia). However, he said the index committee might opt to pick trucking company TFI International Inc. over Fairfax, as it comes from a logistics sector that is under-represented in the large-cap index, which is already heavily weighted toward the financial services industry.”

 

“Adding Fairfax would mean demand for 600,000 shares, or 9.5 days of trading.”

• https://www.theglobeandmail.com/business/article-tmx-expected-to-add-aecon-drop-algonquin-power-in-index-update/

—————-

 

S&P/TSX 60 Index

 

The S&P/TSX 60 is designed to measure the large-cap segment of the Canadian equity market and is structured to reflect the sector weights of the S&P/TSX Composite. The Toronto Stock Exchange (TSX) serves as the distributor of both real-time and historical data for this index.

• https://www.spglobal.com/spdji/en/indices/equity/sp-tsx-60-index/#overview

Criteria for index inclusion

 

The S&P/TSX 60 advisory panel recently met with analysts to review the criteria they use when making changes to the index. It appears the key factor used is size (market cap). Sector weighting is less important as a factor. 

 

S&P/TSX Canadian Indices Methodology

• https://www.spglobal.com/spdji/en/documents/methodologies/methodology-sp-tsx-canadian-indices.pdf

-----------

 

Buy on the rumour and sell on the news

 

Fairfax shares are up more than 10% since the S&P/TSX 60 advisory panel met with analysts (and CIBC released its report). So perhaps Mr. Market is buying shares in anticipation of Fairfax being added and that is what has been driving the stock price higher over the past month. 

 

Perhaps we see Fairfax sell off in the immediate aftermath of what happens on December 6th? Regardless of what we see in the short term, getting added to the S&P/TSX 60 index should be a tailwind for Fairfax's share price in the coming years.

 

Edited December 2 by Viking