SafetyinNumbers Posted February 19 Posted February 19 6 minutes ago, Txvestor said: Stock market is trading at a historically high market valuations too. That might be one reason they have been buying more companies out of the stock market at cyclically convenient times. That’s probably true but as @Vikinghas pointed out, it also reduces the volatility of earnings and increases the earnings. They can also restructure the balance sheet to improve ROI without as much reflexivity risk.
Txvestor Posted February 19 Posted February 19 5 hours ago, 73 Reds said: Again, the issue to me is buying back shares reduces available capital for other purchases/acquisitions. I'm fine with that for a company like Berkshire which [evidently] has very limited investment options and probably more capital than it needs. Fairfax is small enough that it has lots of options. Not necessarily right now but what always appealed to me most about Berkshire is Buffett thought well ahead and was patient. He could have easily repurchased shares when Berkshire was the size of present-day Fairfax but he didn't. Berkshire shareholders reaped the benefits. They reaped the benefits only proportionately not in a concentrated way. Many of their early investments like Sees candy were some serious home runs. The opposite is true too, Berkshire issued shares to buy Dexter shoes, not only did that eventually go bust, but the cost he paid for that error has compounded and will compound as long as BRKB does. So he learned and never issued shares subsequently, but he also never took it to the Henry Singleton stage and bought back either.
Txvestor Posted February 19 Posted February 19 5 hours ago, 73 Reds said: Agreed, yet coming off of a prolonged hard insurance market I just don't think that share repurchases at current prices are their best bet. Sounds like you think their shares are richly valued compared to the market and other investments available. I'm not so sure. I think their own stock should serve as the hurdle rate.
SafetyinNumbers Posted February 19 Posted February 19 6 minutes ago, Txvestor said: They reaped the benefits only proportionately not in a concentrated way. Many of their early investments like Sees candy were some serious home runs. The opposite is true too, Berkshire issued shares to buy Dexter shoes, not only did that eventually go bust, but the cost he paid for that error has compounded and will compound as long as BRKB does. So he learned and never issued shares subsequently, but he also never took it to the Henry Singleton stage and bought back either. They issued a lot more equity for operating companies after that including Dairy Queen, Net Jets, Gen Re and BNSF. I think we’ll only see FFH issue stock for insurance acquisitions or if they need to fortify the balance sheet. Both seem unlikely in the foreseeable future given the valuation and fortress like balance sheet, respectively.
Txvestor Posted February 19 Posted February 19 2 hours ago, Viking said: The hidden value piece is really interesting piece. It’s not really hidden - it just doesn’t show in accounting results - so we call it “hidden”. Even though a bunch of it can be precisely calculated. And a bunch more can be roughly calculated. And more that Fairfax will announce that will surprise us (like when they sold Eurolife). It is like a 6th income stream that will flow through to future earnings (via investment gains) - we just don’t know the timing. This should add a couple of points to future ROE (on average). Of course, it will be lumpy. As hidden value keeps blowing out (getting larger) it has the effect of increasing future ROE. The more hidden value continues grows the higher future ROE will be. ————— Fairfax’s investment portfolio is performing very well - Fairfax has amassed/curated a wonderful collection of holdings. More and more are falling in to the associate and consolidated buckets (I include the private equity holdings here like BDT, ShawKwei and Waterous III). This suggests the amount of hidden value will be increasing in future years. My knowledge of accounting is rudimentary. So I wanted to clarify something . Wouldn't that return on equity be a one time earnings event? Once those earnings hit the balance sheet wouldn't that count as equity and therefore future earning streams(all else being equal) lower the actual return on equity as the denominator goes up?
Viking Posted February 19 Posted February 19 (edited) 3 hours ago, Txvestor said: My knowledge of accounting is rudimentary. So I wanted to clarify something . Wouldn't that return on equity be a one time earnings event? Once those earnings hit the balance sheet wouldn't that count as equity and therefore future earning streams(all else being equal) lower the actual return on equity as the denominator goes up? @Txvestor, great question. The hidden value piece has a lot of layers to it. Here is how I think about it. Let’s assume hidden value is about $4.5B today. Let’s pretend it will get equally realized into earnings over the next 5 years. That would contribute $900 million per year to investment gains (in the form of realized gains). And after 5 years it would be zero. But hidden value isn’t static. It’s like a funnel - a bunch of new HV is getting poured into the top of the funnel each year. So even if you drain $900 million out of the spout at the bottom, it might keep growing in size. For the past 5 years, the amount of HV being poured into the top of the funnel has far exceeded the amount that has been draining out of the bottom of the spout (Fairfax monetizes some HV each year). Hidden value has been increasing at more than $1 billion per year in recent years. And given the improving quality, number and size of associate and consolidated holdings my guess is most years HV is likely to continue to grow in size (what is going in the top will be greater than what is draining out of the bottom). We will have some years when we get a massive investment gain - like when they start to sell down Eurobank, BIAL, Poseidon etc (like in 2022 when pet insurance was sold). This year is a good example. My estimate is Fairfax is going to report about $200 in EPS. At the same time, excess of FV over CV is going to increase by about $1.1B, or $40 per share. This estimate of increase in HV is very conservative (it only captures one source of HV). Bottom line, hidden value is not a static thing (that would be a one time thing). It’s a flow (a recurring thing). Edited February 19 by Viking
73 Reds Posted February 19 Posted February 19 9 hours ago, Txvestor said: Sounds like you think their shares are richly valued compared to the market and other investments available. I'm not so sure. I think their own stock should serve as the hurdle rate. I think that any assumption that the company will continue to grow at 15%/year in its current configuration is a mistake. They need increasingly more outside investments at this stage. When the investment universe has become largely saturated, share buybacks are more attractive. We are nowhere near that point in time.
SafetyinNumbers Posted February 19 Posted February 19 10 minutes ago, 73 Reds said: I think that any assumption that the company will continue to grow at 15%/year in its current configuration is a mistake. They need increasingly more outside investments at this stage. When the investment universe has become largely saturated, share buybacks are more attractive. We are nowhere near that point in time. You may not appreciate how 3:1 investments:equity leverage works when interest rates are normal like they are now. With fixed income book (two thirds) doing 5%, if only takes a 10% return on the equity book (one third) to get to a 20% pre tax return on equity as long as underwriting is offsetting head office costs including financing costs which it is more than doing now. Meanwhile the equity book might do much better than 10%. Eurobank is over 10% of the portfolio at carrying value but contributes at a 20% return on investment because it’s marked at 5x earnings. That means the hurdle rate for the rest of the portfolio is lower.
73 Reds Posted February 19 Posted February 19 7 minutes ago, SafetyinNumbers said: You may not appreciate how 3:1 investments:equity leverage works when interest rates are normal like they are now. With fixed income book (two thirds) doing 5%, if only takes a 10% return on the equity book (one third) to get to a 20% pre tax return on equity as long as underwriting is offsetting head office costs including financing costs which it is more than doing now. Meanwhile the equity book might do much better than 10%. Eurobank is over 10% of the portfolio at carrying value but contributes at a 20% return on investment because it’s marked at 5x earnings. That means the hurdle rate for the rest of the portfolio is lower. I wouldn't assume interest rates will remain where they are now. Consider the tailwinds of the past five years. Here we are now in what looks like a softening insurance market and the likelihood of lower interest rates. If so, there may be a lot better investment alternatives on the horizon than Fairfax shares.
SafetyinNumbers Posted February 19 Posted February 19 5 minutes ago, 73 Reds said: I wouldn't assume interest rates will remain where they are now. Consider the tailwinds of the past five years. Here we are now in what looks like a softening insurance market and the likelihood of lower interest rates. If so, there may be a lot better investment alternatives on the horizon than Fairfax shares. The yield curve might also get steeper which means higher long term rates. Credit spreads could widen. They could invest more with KW and get higher mortgage rates or invest more in real property at higher cap rates. It also takes time for lower rates to work their way through the portfolio given duration. If the average coupon falls from 5% to 4%, then the equity portfolio has to do 12%. That still doesn’t seem like a high hurdle given how low carrying value is vs fair value for big chunks of the equity portfolio.
MMM20 Posted February 19 Posted February 19 (edited) Aren't interest rates pretty normal right now by historical standards? Yield curve has deinverted and isn't particularly flat, or high, or low, in the US and other developed markets. It seems like you'd have to make a crystal ball market call to expect something much different through cycles, and that implies that it's probably fair to capitalize interest income on these numbers as "normalized" or close to it. 5 years ago was the anomaly. Edited February 19 by MMM20
73 Reds Posted February 19 Posted February 19 2 minutes ago, SafetyinNumbers said: The yield curve might also get steeper which means higher long term rates. Credit spreads could widen. They could invest more with KW and get higher mortgage rates or invest more in real property at higher cap rates. It also takes time for lower rates to work their way through the portfolio given duration. If the average coupon falls from 5% to 4%, then the equity portfolio has to do 12%. That still doesn’t seem like a high hurdle given how low carrying value is vs fair value for big chunks of the equity portfolio. Well, good discussion and it helps to add clarity to one's thoughts even when they don't change.
SafetyinNumbers Posted February 19 Posted February 19 2 minutes ago, 73 Reds said: Well, good discussion and it helps to add clarity to one's thoughts even when they don't change. I like Annie Duke’s idea about putting it in terms of bets. So the question is how much would you bet on FRFHF NOT doubling over the next 5 years? That is, if total return hits 100% within 5 years, the bets over and you lose.
73 Reds Posted February 19 Posted February 19 1 minute ago, SafetyinNumbers said: I like Annie Duke’s idea about putting it in terms of bets. So the question is how much would you bet on FRFHF NOT doubling over the next 5 years? That is, if total return hits 100% within 5 years, the bets over and you lose. As a current shareholder that would be a fine outcome but if you're asking me whether I'd bet on it beyond stock holdings - probably not.
SafetyinNumbers Posted February 19 Posted February 19 10 minutes ago, 73 Reds said: As a current shareholder that would be a fine outcome but if you're asking me whether I'd bet on it beyond stock holdings - probably not. Just a separate bet. I guess it would be a hedge since you are long the stock.
Hamburg Investor Posted February 19 Posted February 19 7 minutes ago, 73 Reds said: As a current shareholder that would be a fine outcome but if you're asking me whether I'd bet on it beyond stock holdings - probably not. What if you could win a Fairfax stock within this context? You could either deny to bet (no win) or you could win it by being on the right side of over/under?
73 Reds Posted February 19 Posted February 19 (edited) 9 minutes ago, Hamburg Investor said: What if you could win a Fairfax stock within this context? You could either deny to bet (no win) or you could win it by being on the right side of over/under? Huh? As a shareholder the stock can be a successful investment even if the bet falls short. Today, I'd bet the under. Edited February 19 by 73 Reds missed line
Txvestor Posted February 19 Posted February 19 (edited) 3 hours ago, 73 Reds said: I think that any assumption that the company will continue to grow at 15%/year in its current configuration is a mistake. They need increasingly more outside investments at this stage. When the investment universe has become largely saturated, share buybacks are more attractive. We are nowhere near that point in time. Well I guess that's where I see the difference. If the company grows at 10% PA but due to the share buybacks the per share value grows by 15% that would be good enough for me. As long as they are taking care of the engines of growth and making selective acquisitions only when they find value exceeding their own shares. I'm not as concerned with empire size. I believe that's how Fairfax leadership sees it also. I remember Prem saying in 2017 around the time of the Allied world acquisition(a time that truly tested patience of the average shareholder) that he was issuing shares to make the acquisition but planned over time to buy back all those shares. A bit murky in my memory now but I think they were at 22.8M shares then and issued close to 5M shares. As we know now they're back and beyond and now close to 21M shares. The reason I bring that up is it's illustrative of how they can do both. I just don't think such value exists in the markets today atleast in insurance. And if you compare the size of their float to equity, it's much larger than peers. Edited February 19 by Txvestor
dartmonkey Posted February 19 Posted February 19 1 hour ago, SafetyinNumbers said: I like Annie Duke’s idea about putting it in terms of bets. So the question is how much would you bet on FRFHF NOT doubling over the next 5 years? That is, if total return hits 100% within 5 years, the bets over and you lose. My calculator says 2^(1/5)=14.9% so the bet is over/under 15% return for 5 years, and I would be a hard 'over' on that one. My only concern would be that, if there is a big market correction as part of the next 5 years, then Fairfax would be drawn down like the others, and would likely substantially outperform the market (maybe by 5% annually) but not hit the 100% return in 5 years. So to hedge the first bet, I would want a similar bet that the market will be less than 10%/year ahead, i.e. up less than 1.1^5-1=61%. IOW Fairfax makes 100% if the S&P makes 61%, or Fairfax outperforms the S&P by at least 5% p.a.
Viking Posted February 19 Posted February 19 (edited) 2 hours ago, SafetyinNumbers said: The yield curve might also get steeper which means higher long term rates. Credit spreads could widen. They could invest more with KW and get higher mortgage rates or invest more in real property at higher cap rates. It also takes time for lower rates to work their way through the portfolio given duration. If the average coupon falls from 5% to 4%, then the equity portfolio has to do 12%. That still doesn’t seem like a high hurdle given how low carrying value is vs fair value for big chunks of the equity portfolio. Another way to look at it is through the per share lens = interest income per share. Interest income = rate x size of portfolio At 5% yield, the size of the bond portfolio is increasing ~5%. Lets assume shares outstanding decline by 3%. These two items provide an 8% per share tailwind to interest income. This is before any impact from interest rates. Minority interest are important. Fairfax does not get to keep all the interest income it earns. Buying out Allied World minority shareholders in 2026 would increase interest income per share further - the amount that accrues to Fairfax shareholders. Interest rates are going to go up and down from year to year. What matters is what they do over 5 or 10 years. My guess is Fairfax will be able to earn a solid return on their fixed income portfolio moving forward - I don’t think we are going back to a zero interest rate regime. Edited February 19 by Viking
Viking Posted February 19 Posted February 19 2 hours ago, SafetyinNumbers said: I like Annie Duke’s idea about putting it in terms of bets. So the question is how much would you bet on FRFHF NOT doubling over the next 5 years? That is, if total return hits 100% within 5 years, the bets over and you lose. Annie Duke is one smart cookie…
Txvestor Posted February 19 Posted February 19 8 hours ago, Viking said: @Txvestor, great question. The hidden value piece has a lot of layers to it. Here is how I think about it. Let’s assume hidden value is about $4.5B today. Let’s pretend it will get equally realized into earnings over the next 5 years. That would contribute $900 million per year to investment gains (in the form of realized gains). And after 5 years it would be zero. But hidden value isn’t static. It’s like a funnel - a bunch of new HV is getting poured into the top of the funnel each year. So even if you drain $900 million out of the spout at the bottom, it might keep growing in size. For the past 5 years, the amount of HV being poured into the top of the funnel has far exceeded the amount that has been draining out of the bottom of the spout (Fairfax monetizes some HV each year). Hidden value has been increasing at more than $1 billion per year in recent years. And given the improving quality, number and size of associate and consolidated holdings my guess is most years HV is likely to continue to grow in size (what is going in the top will be greater than what is draining out of the bottom). We will have some years when we get a massive investment gain - like when they start to sell down Eurobank, BIAL, Poseidon etc (like in 2022 when pet insurance was sold). This year is a good example. My estimate is Fairfax is going to report about $200 in EPS. At the same time, excess of FV over CV is going to increase by about $1.1B, or $40 per share. This estimate of increase in HV is very conservative (it only captures one source of HV). Bottom line, hidden value is not a static thing (that would be a one time thing). It’s a flow (a recurring thing). Thanks @Viking. That's helpful to conceptualize. IV tends to consistently grow ahead of the equity base.
Txvestor Posted February 19 Posted February 19 (edited) 3 hours ago, 73 Reds said: I wouldn't assume interest rates will remain where they are now. Consider the tailwinds of the past five years. Here we are now in what looks like a softening insurance market and the likelihood of lower interest rates. If so, there may be a lot better investment alternatives on the horizon than Fairfax shares. That is certainly a reasonable view to take, although I think most here would disagree. Firstly Fairfax's insurance operations are much more widely diversified, both geographically as well as in lines of business compared to most peers. The other day I was searching for Canada's top insurers by underwritten premiums. Fairfax wasn't even on the list. Whereas I think they are number two in Chile by market share. They're very spread out. re: Interest rates: That's why I was surprised when they shortened their average bond maturity duration last year. That said, they have an eagle's eye on the market and historically have executed shifts in this market quite expertly. Aside from that, losses are tremendous not on the duration shortening, but rather on the lengthening side. So whereas they may lose out on potential future earnings, they're mitigating any potential losses, if there is a sell off. They may also be finding greater opportunities in commercial real estate lending and other secured commercial paper that we don't know about. Certainly the average yield of 5.1% means they have not struggled in this area. And as others have pointed out, even 4% is a quite a handsome return. As Viking said, I too believe that with current geopolitics etc ZIRP is not coming back. So we shall see, but I'm in the camp that $200/share which exceeds 15% ROE is doable for the next 5yrs. And any volatility would help not hurt them. Edited February 19 by Txvestor
Junior R Posted February 19 Posted February 19 3 hours ago, SafetyinNumbers said: I like Annie Duke’s idea about putting it in terms of bets. So the question is how much would you bet on FRFHF NOT doubling over the next 5 years? That is, if total return hits 100% within 5 years, the bets over and you lose. either 5 years 15% growth which should be easy based on the dividends / interest + insurance business higher multiple
73 Reds Posted February 19 Posted February 19 1 hour ago, Txvestor said: That is certainly a reasonable view to take, although I think most here would disagree. Firstly Fairfax's insurance operations are much more widely diversified, both geographically as well as in lines of business compared to most peers. The other day I was searching for Canada's top insurers by underwritten premiums. Fairfax wasn't even on the list. Whereas I think they are number two in Chile by market share. They're very spread out. re: Interest rates: That's why I was surprised when they shortened their average bond maturity duration last year. That said, they have an eagle's eye on the market and historically have executed shifts in this market quite expertly. Aside from that, losses are tremendous not on the duration shortening, but rather on the lengthening side. So whereas they may lose out on potential future earnings, they're mitigating any potential losses, if there is a sell off. They may also be finding greater opportunities in commercial real estate lending and other secured commercial paper that we don't know about. Certainly the average yield of 5.1% means they have not struggled in this area. And as others have pointed out, even 4% is a quite a handsome return. As Viking said, I too believe that with current geopolitics etc ZIRP is not coming back. So we shall see, but I'm in the camp that $200/share which exceeds 15% ROE is doable for the next 5yrs. And any volatility would help not hurt them. Perhaps you are right (again, as a shareholder I'm rooting for you). But as a betting man, they literally did everything right for the past 5 years with a lot of macro help; what are the odds of that repeating over the next five years?
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