Fairfax Simple Scenario's

[FlyingArrow]

Guys, I'm interested in some commentary on this analysis and in particular on the differring assumptions for growth under the low medium and high scenarios. Also, what else would you consider in a SIMPLE model. The excel file is attached. The summary is below.

 

Before reviewing and commenting please consider the following:

 

1. I created this over my Sunday morning coffee - about 30 minutes of analysis with only the recent AR

2. I have intentionally simplified many elements. Warren has been known to buy companies with back of the napkin math and no calculator. No NPV's here or assumptions about discount rates. A key assumption is that other comprehensive income is a wash over the 5 years.

3. I'd rather be approximately right than exactly wrong. The true variables and permutations look alot like the Rubiks cube I have on my desk. However, no matter how you twist it up it is still a 3x3 cube!

4. I believe one of the key macro elements to consider is the impending hard market and the fact that the industry is constrained for capital. Growth of FFH investments is in my mind a key element in any analysis as this is how FFH makes money. Investing the portfolio.

 

Disclosure: I'm as long as I can possibly be on FFH and have been accumulating since early 2000. My bogey share price for FFH is $1000 CAD ($800 US). For me it is a hold forever stock.

 

Scenario 1

Low Estimate: 5% Investment Portfolio growth, 7% return on portfolio, no share buybacks, 4% cost of float, 2.75% yield

 

Metric                                         2013

Investments                              $24,847.67

Investment Growth                             5%

Shares outstanding           17,500,000

Share Buybacks                             - 

Investments/share                          $1,419.87

Average Return on Portfolio                7.00%

Total Return                         $1,739.34

Return/Share                           $99.39

Average Float                         $11,381.62

Growth in Float                             5%

Cost of Float                             -4%

Underwriting P/L                         ($455.26)

Income & Dividend Yield               2.75%

After Tax Investment Income $683.31

After Tax Investment Income/Share $39.05

Simple After Tax Income           $1,284.07

Earnings/Share                           $73.38

Book Value Estimate           $10,806.13

Book Value/Share                         $617.49

Book Value Multiple                           1.00

Share Price Taget                           617.49

PE Ratio if stock reaches $1000/shr 13.6

 

 

Scenario 2

Medium Estimate: 7% Investment Portfolio growth, 9.8% return on portfolio, 100k/yr share buybacks, 3% cost of float, 3.25% yield

 

Metric                                         2013

Investments                       $27,306.00

Investment Growth                             7%

Shares outstanding           17,000,000

Share Buybacks                         100,000

Investments/share                         $1,606.24

Average Return on Portfolio             9.80%

Total Return                         $2,675.99

Return/Share                           $157.41

Average Float                         $12,507.68

Growth in Float                             7%

Cost of Float                           -3%

Underwriting P/L                         ($375.23)

Income & Dividend Yield             3.25%

After Tax Investment Income $887.44

After Tax Investment Income/Share $52.20

Simple After Tax Income             $2,300.76

Earnings/Share                         $135.34

Book Value Estimate           $15,062.71

Book Value/Share                           $886.04

Book Value Multiple                           1.20

Share Price Taget                         1,063.25

PE Ratio if stock reaches $1000/shr      7.4

 

 

Scenario 3

High Estimate: 10% Investment Portfolio Growth - 12% return on portfolio, 200k/yr share buybacks, 1% cost of float, 3.75% yield

 

Metric                                         2013

Investments                       $31,354.70

Investment Growth                           10%

Shares outstanding         16,500,000

Share Buybacks                         200,000

Investments/share                       $1,900.28

Average Return on Portfolio             12.00%

Total Return                       $3,762.56

Return/Share                         $228.03

Average Float                       $14,362.21

Growth in Float                           10%

Cost of Float                           -1%

Underwriting P/L                       ($143.62)

Income & Dividend Yield             3.75%

After Tax Investment Income $1,175.80

After Tax Investment Income/Share $71.26

Simple After Tax Income           $3,618.94

Earnings/Share                         $219.33

Book Value Estimate           $20,059.30

Book Value/Share                         $1,215.72

Book Value Multiple                           1.40

Share Price Taget                         1,702.00

PE Ratio if stock reaches $1000/shr 4.6

 

 

I believe the medium scenario to be a realistic outcome over 5 years. Even with the low scenario I believe we will do just fine. Thoughts?

 

[Uccmal]

Hi  Mark, Am I reading your chart wrong?  I think you forgot to take out the capital gains tax?

 

Because of this, all three scenarios seem overly optimistic. The low growth scenario has BV growth of 21% in the first year, 19% - yr. 2; 17% yr. 3

 

Medium growth:  35% yr. 1; 29% yr. 2;

 

 

I do a similar but much simpler calculation when considering buying leaps:

 

15% growth in Book

 

285;  327; 376; 432; 496; 2013 - 570.40

 

BV multiple of 1.3

370; 425; 488; 561; 644; 2013 - 741

 

 

Now, I think that the next couple of years will easily manage 20% or greater jumps in Book value due to buying distressed securities, buying back shares at 20% below book, and increasing float by 100% in the hard market.  In addition there should be underwriting gains not losses for 2 or 3 years starting mid-way through this year.

 

Now could I do this analysis with WFC, BAC, or GE?  hmmmmm?

 

 

 

[woodstove]

What about the "something goes terribly wrong" scenario?  Some (unlikely) script ideas...

 

- Litigation like another "asbestos", eg shareholders become able to recover lost equity via directors & officers insurance, or any company that ever insured a soft drink manufacturer becomes liable for health impairment due to discoveries re hazards of BPA or whatever.

 

- Targets of FFH lawsuit win, obtain punitive counter-judgement.  Possibly with collusion of legislature, etc - assume the worst imaginable.

 

- Insurance industry ranks are so thinned by collapse of insurers who placed capital at risk in foolish ways (a la AIG), that the rest of firms are forced to assume those liabilities - something like present process of good banks (and taxpayers) being strip mined to support bad banks.

 

I have no case that any of the above is probable - maybe each is only 1 pct annual possibility, ie 1-in-100 years event?

 

But it seems to me that there is some merit in diversification outside of a single industry and single firm in that industry.

 

So maybe if there are five 100-year-event scenarios that might be developed, the returns table should include a 5 pct worst case of complete wipeout.  Then can factor that into weighted expected return, and also into decision re what proportion of capital to allocate.

[Viking]

Woodstove, I agree that going 'all in' on one investment is a risky proposition; fortunately it has worked for me on multiple occasions over the years with FFH (over short timframes).

 

What is also missing from the above analysis is what low probability but wonderful events we may see from management (referred to by many over the years as 'pulling rabbits out of the hat'). I look forward to the future to see what the FFH team will do to grow shareholder value (that we do not see today). Perhaps these somewhat offset the risks to what you mention.

 

I also expect FFH to continue buying back large amounts of shares at these prices (one million plus) should the stock trade this much below book for any length of time. Look at where they have put their earnings last year... ORH, NB and FFH buybacks... then buying NB... I am not sure they will buy the remaining 30% of ORH next. Perhaps the next step will simply involve buying FFH shares to offset all the dilution that took place during the lean 7 years.

[ShahKhezri]

Viking,

 

That's interesting, your thoughts on the remaining 30% ORH.  More recently, I've contemplated the thought of ORH being FFH's version of Wesco.  However, I positive there will be 20% of ORH left by the end of year (only around 5 million shares more, almost half of the 9.5M repurchased last year).  Now that ORH < book, it becomes easier to proceed (5X normalized 3-year earnings).  The last 20% will cost around 750M (rough estimate). 

 

FFH reinsurance is going to be a really nifty operation (Pol Re, Group Re, Odyssey, Advent). 

 

 

 

[Uccmal]

I place money that FFH has been investing in Index futures of some kind to take extra advantage of any upswing from here.  400 M bet on SPY, or Dow Index futures could easily triple should things turn up.  It is fitting with their MO. 

 

I am expecting to see an announcement at some point increasing the share buyback programs at FFH and ORH.

 

Who knows, maybe Prem has his eye on repatriating ORH at some point but you can bet they will take out as much float as possible along the way.  Right now they couldn't do it without signficant balance sheet stress.  I am using 55 share price and 17.7 M shares.  There is certainly no hurry. 

 

God, I wish I had more money to buy FFH shares right now.

[woodstove]

Oh yeah some great upside potential and options for capturing value.  No doubt about that.  I also prefer to dwell upon the positive.

 

It's illogical, but in my own investing I've found comfort in taking enough profits off the table to "pay for" the balance of a holding.

 

With FFH, which is one of the larger components of my investments, the "net original cash" has all been recovered, and it does not bother me when the share price fluctuates down.  Even contemplating "disaster - goes to zero" scenario, I think, "well at least I got more money out than I put in."

 

With Berkshire, also a larger component, I've done very little trading on price movements, instead following buy and hold approach.  And now I'm annoyed because the current share price is less than my net cash cost basis.  I could have sat in bonds for past decade, gotten interest, and still picked up the same or larger Berkshire position now.

 

The two are roughly equivalent sizes of holdings, roughly similar discounts to value, and yet I am comfortable with one and self-annoyed with the other.  It is anchoring to past transaction history, not forward looking thinking what the investment/company might do in future.

 

Each has his own style.  Whatever makes him comfortable is possibly best - recognizing that for some people risk taking is style comfort.

 

Just one query re ORH - would not the tax aspects be important in determining whether to go towards 80 pct FFH ownership of ORH? What is the situation?  Can a reserve triangle tea-reader draw some inferences?  Beyond my scope - I'm just a happy passenger.