FFH 2023 Letter

[ValueMaven]

Should be dropping in a few hours ... no?

[Santayana]

I'm guessing next week.

[Luke]

 

Its visible to me but there is no pdf opening when i click it

[Luke]

Its live: 

 

FFH_Fairfax-Financial-Shareholders-Letter-2023.pdf

 

Edited March 8 by Luca

[Daphne]

Just click on Eng icon

[Luke]

2 minutes ago, Daphne said:

Just click on Eng icon

Yeah even when i did it it just went blank but started to work now

[Luke]

Holy S*** this is a great read, especially considering that sleezy MW shorter...Watsa seriously can be proud of what he built

[nwoodman]

53 minutes ago, Luca said:

Holy S*** this is a great read, especially considering that sleezy MW shorter...Watsa seriously can be proud of what he built

Yep, he has stepped it up this year.  Touches on just about everything that has been tossed around on this board and more.  Outstanding

[nwoodman]

Lots to digest but this comment on Atlas/Poseidon was super helpful for me

 

"Poseidon is expected to make net earnings in excess of $400 million in 2024 and $500 million in 2025. We carry our 43% ownership in Poseidon at $1.7 billion – 10x 2024 expected earnings or 8x 2025 expected earnings."

 

Any confirmation that it is going to be accretive and growing is very welcome

[ValueMaven]

This is Prem's best letter yet !!!

[nwoodman]

Really does read like closure and not just on BlackBerry…

 

“That brings me to a major mea culpa! We began investing in Blackberry in 2010 and helped John Chen become CEO in November 2013 by investing $500 million in a convertible debenture at the same time. Blackberry had come down from $148 per share (down 95%) and had $10 billion in sales. I joined the Board in 2013. Our total investment in BlackBerry early in 2014 was $1.375 billion ($500 million in the convertible and $787 million in common shares).

When John joined the company, BlackBerry reported a loss of $1.0 billion - in one quarter and most analysts were predicting bankruptcy! BlackBerry was indeed in difficulty! John saved the company by quickly bringing it to breakeven on a cash basis and then on a net income basis. No CEO worked harder but, unfortunately, John could not make it grow! Revenues for the year ending February 2023 were $656 million. John retired from the company at the end of his contract on November 14, 2023 and I retired from the Board on February 15, 2024. We got our money back on our convertible ($167 million in 2020, $183 million in 2023 and $150 million in 2024) plus cumulative interest income of approximately $200 million. Our common stock position as of 2023 ($162 million or 8% of the company) which was acquired at a cost of $17.16 per share was valued on our balance sheet at $3.54 per share. Another horrendous investment by your Chairman. To make matters worse, imagine if we had invested it in the FAANG stocks! The opportunity cost to you our shareholder was huge! Please don't do the calculation! No technology investment for me!”

 

[MMM20]

Why doesn’t Prem account for the retained earnings of their mark to market investee companies when talking about Fairfax’s normalized earnings power? Of course dividends are only a small piece of what matters. He even mentions that the $15 dividend is only about 12% of FFH’s own operating income (IIRC) but doesn’t make this point for their mark to market investees, right? Normalized earnings power should be $150-200/share and maybe he just wants to set a lower bar? Or maybe he would argue it’s captured by the idea that they’ll sell stocks for gains over time? What am I missing? Of course we can just make the adjustment ourselves, but the way he’s doing it is selling their underlying earnings power short. Anyway, that’s my one complaint about what’s otherwise a masterclass - a great letter. 

 

Edited March 9 by MMM20

[ander]

5 hours ago, MMM20 said:

Why doesn’t Prem account for the retained earnings of their mark to market investee companies when talking about Fairfax’s normalized earnings power? Of course dividends are only a small piece of what matters. He even mentions that the $15 dividend is only about 12% of FFH’s own operating income (IIRC) but doesn’t make this point for their mark to market investees, right? Normalized earnings power should be $150-200/share and maybe he just wants to set a lower bar? Or maybe he would argue it’s captured by the idea that they’ll sell stocks for gains over time? What am I missing? Of course we can just make the adjustment ourselves, but the way he’s doing it is selling their underlying earnings power short. Anyway, that’s my one complaint about what’s otherwise a masterclass - a great letter. 

 

Definitely conservatism re: the $125 / share versus what should be $150+ normalized earnings. I would not want him to overcommit and disappoint.

[ValueMaven]

Stupid idea - but what if FFH liquidated its $16B equity portfolio, and tendered for 2/3rds of the company outstanding shares ?  

Yes - you'd have serious taxes, but you'd get a huge spike in BV, EPS, and Float per-share.  Plus you'd have massive income generating from the bond portfolio. 

[gfp]

36 minutes ago, ValueMaven said:

Stupid idea - but what if FFH liquidated its $16B equity portfolio, and tendered for 2/3rds of the company outstanding shares ?  

Yes - you'd have serious taxes, but you'd get a huge spike in BV, EPS, and Float per-share.  Plus you'd have massive income generating from the bond portfolio. 

 

I don't think the insurance companies have that type of dividend capacity to send the money to the holdco for repurchases.  And, of course, you couldn't successfully tender for 2/3rds of the stock at current prices and get it (or much at all).

[jeyfox]

One point I noted: Digit max ownership can be 68% against 74% in last years letter.

Maybe some moves I missed or linked to futur IPO.

Cheers!

Jeyfox

Disclaimer: I am a shareholder.

[Hamburg Investor]

Looks like we‘re heading for a double in bvps within the next three to five years again:

- minimum of 4bn / year adjusted operating income - that’s essentially what Prem writes. That’s 16+bn in 4 years. Let‘s be conservative and say 16bn.
- But don‘t forget: There‘s additional compounding happening with the yearly returns within those 4 years. So 4 times 4bn would not end with 16bn additional equity after 4 years; that would compound to 18.6bn at the end of year 4 assuming a cagr of 10% (and 20bn assuming an roe of 15%) and compounding starting after the first of the 4 years. Let‘s be conservative and say 10%. So that’s 18.6 bn after 4 years.

- Fairfax has 16.5 bn in stocks (market value). Let’s again assume a roe of 10% (yes, after paying dividends, I don’t have the exact numbers here, do you?). That‘s 9.2bn (13.4bn if invested at a roe of 15%) in additional equity after 4 years.

- Okay, so let’s put that together: We have an additional equity of 27.6bn after 4 years for a company with equity of 21.6bn at the end of 2023. That’s 128% or a cagr of 23%. Wow.

- Yes, maybe an roe of 10% on stocks excluding dividends is too optimistic. But than there are the greek and indian investments that might give way higher returns. Eurobank has a pe ratio of 6 or so. The digit IPO, Prem might come up with another pet insurance business. And we could be more conservative. Why not round the 128% down to 100%? That‘s a nice margin of safety, isn’t it? The rule of 72 still tells us,  that this would be a roe of 18% over that 4 years instead of 23%. Maybe that’s not enough margin of safety? O.K., what if it took one more year for that double, so 100% in 5 years instead of 128% in 4. That’s still 15% roe. At 940 equity, 15% roe would be 141 dollar in normalized earnings. I’d happily pay a PE ratio of 15 for a business with a roe of 15%, while the average S&P500 company has a pe ratio of 27.8. Ups, 15 times earnings… would be 2,115 dollar. Fairfax still has a normalized pe ratio of under 7 assuming not 23% cagr but 15% (141 dollar / 940 dollar).

 

O.K., let’s circle back: I assumed 10% as roe for the reinvested earnings. But if Prem would buy back his stock, and that compounds at a roe of 15% (or way more… ) at a pe ratio of 7, than this easily earns 15% and maybe even 24% or even more with that investments. But if I assume a roe of 15% as a return for the „new“ equity, than the roe for Fairfax as a whole is even better and the buybacks are even cheaper, more attractive. Okay, but Prem will not invest a lot of cash for buybacks, at present. That’s what he said. Not now. But than this only makes sense, if he’s sure finding investments with returns above 10% on equity, even north of 15%. 
 

Anyway, my main take away reading the annual report: 2023 was a third fantastic year in a row, and at least four more are coming. That will be a nice 7 year track record looking back in 4 years. Hard to imagine, Fairfax being valued at only 1.2 pb ratio. But it‘s Mr. Market, so we‘ll never know.

 

 

[Dinar]

22 minutes ago, Hamburg Investor said:

Looks like we‘re heading for a double in bvps within the next three to five years again:

- minimum of 4bn / year adjusted operating income - that’s essentially what Prem writes. That’s 16+bn in 4 years. Let‘s be conservative and say 16bn.
- But don‘t forget: There‘s additional compounding happening with the yearly returns within those 4 years. So 4 times 4bn would not end with 16bn additional equity after 4 years; that would compound to 18.6bn at the end of year 4 assuming a cagr of 10% (and 20bn assuming an roe of 15%) and compounding starting after the first of the 4 years. Let‘s be conservative and say 10%. So that’s 18.6 bn after 4 years.

- Fairfax has 16.5 bn in stocks (market value). Let’s again assume a roe of 10% (yes, after paying dividends, I don’t have the exact numbers here, do you?). That‘s 9.2bn (13.4bn if invested at a roe of 15%) in additional equity after 4 years.

- Okay, so let’s put that together: We have an additional equity of 27.6bn after 4 years for a company with equity of 21.6bn at the end of 2023. That’s 128% or a cagr of 23%. Wow.

- Yes, maybe an roe of 10% on stocks excluding dividends is too optimistic. But than there are the greek and indian investments that might give way higher returns. Eurobank has a pe ratio of 6 or so. The digit IPO, Prem might come up with another pet insurance business. And we could be more conservative. Why not round the 128% down to 100%? That‘s a nice margin of safety, isn’t it? The rule of 72 still tells us,  that this would be a roe of 18% over that 4 years instead of 23%. Maybe that’s not enough margin of safety? O.K., what if it took one more year for that double, so 100% in 5 years instead of 128% in 4. That’s still 15% roe. At 940 equity, 15% roe would be 141 dollar in normalized earnings. I’d happily pay a PE ratio of 15 for a business with a roe of 15%, while the average S&P500 company has a pe ratio of 27.8. Ups, 15 times earnings… would be 2,115 dollar. Fairfax still has a normalized pe ratio of under 7 assuming not 23% cagr but 15% (141 dollar / 940 dollar).

 

O.K., let’s circle back: I assumed 10% as roe for the reinvested earnings. But if Prem would buy back his stock, and that compounds at a roe of 15% (or way more… ) at a pe ratio of 7, than this easily earns 15% and maybe even 24% or even more with that investments. But if I assume a roe of 15% as a return for the „new“ equity, than the roe for Fairfax as a whole is even better and the buybacks are even cheaper, more attractive. Okay, but Prem will not invest a lot of cash for buybacks, at present. That’s what he said. Not now. But than this only makes sense, if he’s sure finding investments with returns above 10% on equity, even north of 15%. 
 

Anyway, my main take away reading the annual report: 2023 was a third fantastic year in a row, and at least four more are coming. That will be a nice 7 year track record looking back in 4 years. Hard to imagine, Fairfax being valued at only 1.2 pb ratio. But it‘s Mr. Market, so we‘ll never know.

 

 

You are forgetting about taxes, operating earnings are before tax.

 

 

[Hamburg Investor]

17 minutes ago, Dinar said:

You are forgetting about taxes, operating earnings are before tax.

 

 

You’re right, thank you.

 

I misinterpreted the following from the annual report: „We can see sustaining our adjusted operating income for the next four years at $4.0 billion … or about $125 per share after taxes, interest expense, corporate overhead and other costs.“ I didn’t expect the absolute numbers being before taxes and the per share ones after. But I should have known better. Doing the maths with 125 dollar after tax and an assumption of 10% taxes on stocks (what would be realistic?), my back-of-the-envelop maths tells me the return would be around 95% instead of 128%. Still very good and cheap.

[gurjot]

On 3/8/2024 at 1:50 PM, Luca said:

Holy S*** this is a great read, especially considering that sleezy MW shorter...Watsa seriously can be proud of what he built

agree!

[MMM20]

12 hours ago, Hamburg Investor said:

I misinterpreted the following from the annual report: „We can see sustaining our adjusted operating income for the next four years at $4.0 billion … or about $125 per share after taxes, interest expense, corporate overhead and other costs.“ I didn’t expect the absolute numbers being before taxes and the per share ones after.

Yeah I had to read that same sentence a few times. He needed an editor there.

[dartmonkey]

9 hours ago, MMM20 said:

I misinterpreted the following from the annual report: „We can see sustaining our adjusted operating income for the next four years at $4.0 billion … or about $125 per share after taxes, interest expense, corporate overhead and other costs.“ I didn’t expect the absolute numbers being before taxes and the per share ones after.

=========
Yeah I had to read that same sentence a few times. He needed an editor there.

 

Now that we're down to 22.891m shares as of March 7th, using 20m shares outstanding in rough calculation is not too far off, and the annual operating income expected for the next 4 years, $4.0b, would be about $200 per share (ok, it would be $175/share usiing the exact number.) So it is $50 less from the combined effects of taxes, interest expense and corporate overhead. And yes, it would have been much clearer if he had given the 2 numbers, and a name for the thing you get when you subtract taxes, interest and corporate overhead: "$4.0b ... or $175 per share, which is $125 in net earnings per share after taxes, interest expense, corporate overhead and other costs.“ 

 

Two other things that I would have liked to see there:

 

(1) He might as well have mentioned that this means the shares, currently trading at USD$1088, are at less than 9 times the anticipated earnings in each of the next 4 years; and

 

(2) I think Watsa is really saying that he expects $4.0b in operating income for the next 4 years based on income from current holdings. Maybe he is just putting the bar very low, but when you are expecting to earn almost $3b for 4 years, while paying out $373m in dividends (at the current $15/share rate), and you are a company that has a book value of $21.5b at the beginning, I think it is reasonable to expect that you are have at least $29b in book value after 3 years. Is Watsa really saying he expects to still be making $4.0b in operating income in the 4th year, despite starting that year with a book value that is substantially higher? I don't think so, and I think the fact that he still says he thinks he can hit the 15% return on book target means that earnings in the 4th year would be 15% of 29b, or operating income of $6b, not $4b. I believe that $4b is the income he can already see coming, but there will be other income coming from things acquired with the $7.5b or so of retained earnings in the next 3 years (without even considering compounding...) What do you guys think?

 

 

 

 

Edited March 10 by dartmonkey

[Dinar]

21 minutes ago, dartmonkey said:

Now that we're down to 22.891m shares as of March 7th, using 20m shares outstanding in rough calculation is not too far off, and the annual operating income expected for the next 4 years, $4.0b, would be about $200 per share (ok, it would be $175/share usiing the exact number.) So it is $50 less from the combined effects of taxes, interest expense and corporate overhead. But yes, it would have been much clearer if he had given the 2 numbers, and a name for the thing you get when you subtract taxes, interest and corporate overhead: "$4.0b ... or $175 per share, which is $125 in net earnings per share after taxes, interest expense, corporate overhead and other costs.“ 

 

Two other things that I would have like to see there:

 

(1) He might as well mention that this means the shares, currently trading at USD$1088, are at less than 9 times the anticipated earnings in each of the next 4 years; and

 

(2) I think Watsa is not really saying that he expects $4.0b in operating income for the next 4 years based on income from current holdings. This is not what he said, so maybe he is just putting the bar very low, but when you are expecting to earn almost $3b for 4 years, while paying out $373m in dividends (at the current $15/share rate), and you are a company that has a book value of $21.5b at the beginning, I think it is reasonable to expect that you are have at least $29b in book value after 3 years. Is Watsa really saying he expects to still be making $4.0b in operating income in the 4 year, starting with a book value that is substantially higher? I don't think so, and I think the fact that he says he still thinks he can hit the 15% return on book means that earnings in the 4th year would be 15% of 29b, or operating income of $6b, not $4b. I believe that $4b is the income he can already see coming, but there will be other income coming from things acquired with the $7.5b or so of retained earnings in the next 3 years (without even considering compounding...) What do you guys think?

 

 

 

 

Agreed.  For instance, if BIAL goes public, and the market assigns value similar to GMR + real estate at the airport gets marked as well, BIAL stake could go up 3-5x over the next four years, which between 20% of the top and 40% or so ownership of Fairfax India would give you another $5bn+ uplift to book value at Fairfax Financial.

[Redskin212]

I nominate Viking to be the editor

[Hamburg Investor]

56 minutes ago, Dinar said:

Agreed.  For instance, if BIAL goes public, and the market assigns value similar to GMR + real estate at the airport gets marked as well, BIAL stake could go up 3-5x over the next four years, which between 20% of the top and 40% or so ownership of Fairfax India would give you another $5bn+ uplift to book value at Fairfax Financial.

Agreed, @dartmonkey and @Dinar. 
 

Just to be clear: the nine times earnings is without the gains on the stock portfolio, without TRS and without (maybe) gains on selling of wholly owned businesses like the pet insurance businesses or IPOs. Assuming normalized earnings of 200 dollar per share (125 dollar in OE isn’t a normalized, but a minimum number) or a little bit less in year 1 gets us to a pe ratio a little bit below 6 and an roe of 21%. If stock markets tank in year 1 it will be way less of course.
 

If Watsa doesn’t reach roe way above 15% in times like these (hard market, value beating growth), than he won’t reach an average of 15% (that 15% isn’t tied to OE, @dartmonkey, so 15% of 29bn or 6bn would be including stock gains etc… That’s your point, isn’t it?!) over the longterm. 
 

Regarding that goal of compounding at 15%, I again and again read, that Prem hasn‘t reached it and Buffett hasn‘t reached his (former) goal and that these two and Markel won‘t reach returns like in the years up to 2007/2009 again, as they are e. g. too big. I think what those people miss is, that the years following 2007/2009 until 2019/2021 were really special and giving strong headwinds to all insurers (that’s why the valuations of those three came really down compared to pre the financial crisis). Soft markets, bad returns for value versus growth, low interest rates were a toxic cocktail for those three (and others). It was a very long soft market, growth has never underperformed value by such a margin and for such a long time (am I wrong?) and interest hasn‘t been lower (especially for such a long time). And yes, in case of Fairfax Prem wasn‘t really executing well; but that’s only part of the story. BRK and MKL weren’t either shooting the lights out and even if Prem would have done a perfect job between 2010 and 2016 (which he clearly hasn’t), the returns in those years would have been subpar in relation to historical returns too. And that’s not a coincidence, that all three performed with low CAGRs in those years, it’s structural. It’s the other side of the startup boom, it’s the other side of house prices and oldtimer prices booming, the other side of the tech boom, the other side of businesses not earning a dime getting as much cash as they wanted. What’s the point of float, if you get cash everywhere and as much as you want? What’s the point of float, if you have to pay the bank for holding your cash instead of getting a return? Historical float was a driver of roe at all three businesses, but that special sause literally disappeared in the lost decade.
 

But now hopefully it again all makes sense. Without that decade Fairfax wouldn’t been valued so low. I really feel lucky having found an above average business, reinvesting at 15% (or more) at a pe ratio below 6, while the market is valued 5 times higher.