Fairfax Releases Q1 Financial Data; Rocked by Japan

[zarley]

Not sure that I quite understand today's price action.  Down $10 at the bell, that makes perfect sense, but it reverses and is up $1 at lunch?

 

BTW, thinking back to spring windstorms circa 2004 or 2005, the windstorms in tornado alley over the past couple of days could have a 9-digit impact on FFH....  Probably won't find out until August.

 

 

SJ

 

I was bit surprised by the $20 drop shortly after the open.  I thought:  Wow, that's a bit of an over reaction.  But, didn't think much more than that.  Back almost to even now . . . quite an odd morning.

 

 

[DynamicPerception]

Last business day of the month may be in play.

[Stone19]

I've owned FFH for many years most of the shares were bought under $100.00 on that crazy day it went to $57.00.That day myself and my father sold everything we had and put it all in FFH and to this day we have never sold a share.We have actually bought more when it got under book along the way.These type days don't really mean much.Now if it went down $100.00 this am I'd be buying again.

 

I here the stories about trading the stock but for me it's easier just hold it and let the guys at FFH do their thing and look after my money for free.Cheers

[zippy1]

Not sure that I quite understand today's price action.  Down $10 at the bell, that makes perfect sense, but it reverses and is up $1 at lunch?

 

BTW, thinking back to spring windstorms circa 2004 or 2005, the windstorms in tornado alley over the past couple of days could have a 9-digit impact on FFH....  Probably won't find out until August.

 

 

SJ

 

I was bit surprised by the $20 drop shortly after the open.  I thought:  Wow, that's a bit of an over reaction.  But, didn't think much more than that.  Back almost to even now . . . quite an odd morning.

 

 

Someone is out having  lunch in Vancouver?

[Nnejad]

Hahaha

[Liberty]

This drop was pretty predictable, so someone was probably just waiting for it to back up the truck and load up.

[ericd1]

I had the truck.....LOL...(just kidding)

[Parsad]

intersting to compare wtm's eanrnings with ffh. interestingly, wtm catastrophic losses were very much less than ffh's, & they were modeled on a higher industry loss estimate of 35 bil vs 30 bil.

 

They write far less catastrophe insurance than Fairfax.  Their combined ratio on catastrophe losses was also higher than Fairfax's.  They probably don't have as comprehensive hedges either.  Remember, Fairfax would have shown a net profit of a couple hundred million in the quarter if they did not have the equity hedges alone.  Cheers!

[link01]

They write far less catastrophe insurance than Fairfax.  Their combined ratio on catastrophe losses was also higher than Fairfax's.  They probably don't have as comprehensive hedges either.  Remember, Fairfax would have shown a net profit of a couple hundred million in the quarter if they did not have the equity hedges alone.  Cheers!

 

yes, wtm writes much less cat insurance as a whole (combined ratio 105%), but how about their white mt re division (132 CR)? they said they intentionally wrote less cat ins in japan, tho they didnt elaborate why....could have simply been the fact that its a small, densely populated country thats prone to earthquakes & typhoons and relies heavily on nuclear plants for lights & power. so wtm's estimated cat losses were not higher,tho modelled on higher est industry losses than ffh's, either in the aggregate or in their reinsurance divisions. not this time around...

 

unapologetically long ffh, cheers!

[Rabbitisrich]

I think Eric is right that you need to either multiply the ORH goodwill by 5X to be consistent (and end up with a meaningless BV number) or remove all goodwill - although I think you should also adjust upward for the value of the investments held at equity.

 

Tangible book value is the relevent metric, but are we not just dancing around the idea that FFH is worth a premium to tangible book value?

 

Reading over this thread the next day, I think that there has been a lot of talking past each other. Ericopoly uses goodwill (in the sense of discounting it) as part of his valuation process, where I do not because I view it as a contribution to earnings power. The differing uses don't make a difference so long as there is an appropriate adjustment to expected ROA and similar ending ROE.

 

It's like people arguing over an asset with 33% of equity in good will. Some people say, the bad news is that we just lost 33% of equity. The good news is that ROE just increased by 50%. Other people will say...

[ERICOPOLY]

I think Eric is right that you need to either multiply the ORH goodwill by 5X to be consistent (and end up with a meaningless BV number) or remove all goodwill - although I think you should also adjust upward for the value of the investments held at equity.

 

Tangible book value is the relevent metric, but are we not just dancing around the idea that FFH is worth a premium to tangible book value?

 

Reading over this thread the next day, I think that there has been a lot of talking past each other. Ericopoly uses goodwill (in the sense of discounting it) as part of his valuation process, where I do not because I view it as a contribution to earnings power. The differing uses don't make a difference so long as there is an appropriate adjustment to expected ROA and similar ending ROE.

 

It's like people arguing over an asset with 33% of equity in good will. Some people say, the bad news is that we just lost 33% of equity. The good news is that ROE just increased by 50%. Other people will say...

 

I only consider their investment returns, underwriting profits, and growth in float to be valuable.  That stuff matters -- but to me the goodwill will not help them achieve any of that because the goodwill doesn't "earn".  It just sits.  Much rather have 5% of BV in earning tangible investments than in 5% goodwill that does nothing for me.

 

My stance is that tangible assets are what make all of the above possible.  There is no problem when an insurance company has 100% of book value in tangible assets.  But when none of the assets are tangible it presents a problem.  In between, there are shades of gray.

 

Suppose some idiot payed them dollar for dollar for the asset called "goodwill", but let them keep all of the ORH operations.  Now FFH is exactly the same, but instead of goodwill they now have cash.  Dollar for dollar.

 

Should they take the deal?

[ERICOPOLY]

Not sure that I quite understand today's price action.  Down $10 at the bell, that makes perfect sense, but it reverses and is up $1 at lunch?

 

BTW, thinking back to spring windstorms circa 2004 or 2005, the windstorms in tornado alley over the past couple of days could have a 9-digit impact on FFH....  Probably won't find out until August.

 

 

SJ

 

I was bit surprised by the $20 drop shortly after the open.  I thought:  Wow, that's a bit of an over reaction.  But, didn't think much more than that.  Back almost to even now . . . quite an odd morning.

 

 

 

Mr Market read my comments that ORH goodwill is really understated by 80%.  That realization is what supported the stock today.

[Rabbitisrich]

I think Eric is right that you need to either multiply the ORH goodwill by 5X to be consistent (and end up with a meaningless BV number) or remove all goodwill - although I think you should also adjust upward for the value of the investments held at equity.

 

Tangible book value is the relevent metric, but are we not just dancing around the idea that FFH is worth a premium to tangible book value?

 

Reading over this thread the next day, I think that there has been a lot of talking past each other. Ericopoly uses goodwill (in the sense of discounting it) as part of his valuation process, where I do not because I view it as a contribution to earnings power. The differing uses don't make a difference so long as there is an appropriate adjustment to expected ROA and similar ending ROE.

 

It's like people arguing over an asset with 33% of equity in good will. Some people say, the bad news is that we just lost 33% of equity. The good news is that ROE just increased by 50%. Other people will say...

 

I only consider their investment returns, underwriting profits, and growth in float to be valuable.  That stuff matters -- but to me the goodwill will not help them achieve any of that because the goodwill doesn't "earn".  It just sits.  Much rather have 5% of BV in earning tangible investments than in 5% goodwill that does nothing for me.

 

It should come out to the same thing over time. Consider that FRFHF paid a bit over a billion to purchase ~27% of ORH, equivalent to about a billion in equity. If ORH earns 15% on book from June 30, then what difference does it make if FRFHF gets 16% on TBV or 15% on BV? ORH is a bad example because, as Nnejad pointed out, it only contributed about $100 M in intangibles.

 

If you discount the book without an accompanying increase in ROE, then you are stating that earnings power has been impaired by the acquisition. Earlier you made a comment about HWIC's contribution to ORH earnings, but I don't see the argument because the purchase price includes the benefit of the minority interest in HWIC's results.

[ERICOPOLY]

Earlier you made a comment about HWIC's contribution to ORH earnings, but I don't see the argument because the purchase price includes the benefit of the minority interest in HWIC's results.

 

Like, if I had a portfolio of stocks that I managed.  I can sell them to you for a premium to underlying asset value because you can argue that my trading skills have value.  Obviously, I don't really have trading skills but just pretend for the sake of argument.

 

Except, it gets better in the case of ORH.  It's actually your funds that I manage for you! I try to buy your portfolio of funds at 1.x tangible book value (market prices) from you, but you say not so fast, it's worth 1.3x tangible.  I ask why, and you say well, because you are so good at management.  I say, yes I am, but what the hell does that have to do with you?  I have to pay for my own expertise? WTF??

 

Pretend in this example that we're not talking about an insurer, just investment management.  If it seems at all strange to be charged a premium for your own abilities, then that's my position regarding the ORH buyout.  I think it was fair at 1.3x book because outside of investment prowess, I'm not so sure ORH would be worth more than 1.3x book if the average manager were running the investments..

 

[ERICOPOLY]

 

Suppose some idiot payed them dollar for dollar for the asset called "goodwill", but let them keep all of the ORH operations.  Now FFH is exactly the same, but instead of goodwill they now have cash.  Dollar for dollar.

 

Should they take the deal?

 

Sorry to quote myself.

 

But lets say the offer is only $1 for every $2 of goodwill.  Should the still take the deal?  Of course!

Or how about only $1 for every $5 of goodwill.  Should they still take the deal?  Of course!

Even at $1 of cash for every $100 of goodwill.  Does it still make good economic sense to make the deal?  Of course!

 

So that's why it's worth practically nothing -- compared to the other components of book value, such as CASH!!!

 

[Rabbitisrich]

 

 

Except, it gets better in the case of ORH.  It's actually your funds that I manage for you! I try to buy your portfolio of funds at 1.x tangible book value (market prices) from you, but you say not so fast, it's worth 1.3x tangible.  I ask why, and you say well, because you are so good at management.  I say, yes I am, but what the hell does that have to do with you?  I have to pay for my own expertise? WTF??

 

 

If the target were simply an investment manager utilizing your investment activities, then you could simply replicate the portfolio (for the purposes of this hypothetical) and recieve a higher return than the target's ask.

 

If the company is an insurance operation whose growing float you manage, then you would compare the "replicability" of the business + portfolio--either purchasing or creating a similarly sized operation with comparable management, relationships, data, and so forth--to ask of the target. In this case, you may well pay a premium.

 

Instead of an investment manager comparison, imagine being a CEO of a target insurance company with good insurance operations but mediocre investment results. Fairfax signals its interest and Watsa bluntly tells you that he will replace your investment team post-acquisition. You read the annual report and notice the 15% BV bogie. So now you know that if the math works out you might receive above TBV as long as the purchase price return meets the bogie.

 

The above situation is similar to the ORH logic, because in both cases FRFHF is purchasing future earnings which include HWIC results.

[Rabbitisrich]

 

Suppose some idiot payed them dollar for dollar for the asset called "goodwill", but let them keep all of the ORH operations.  Now FFH is exactly the same, but instead of goodwill they now have cash.  Dollar for dollar.

 

Should they take the deal?

 

Sorry to quote myself.

 

But lets say the offer is only $1 for every $2 of goodwill.  Should the still take the deal?  Of course!

Or how about only $1 for every $5 of goodwill.  Should they still take the deal?  Of course!

Even at $1 of cash for every $100 of goodwill.  Does it still make good economic sense to make the deal?  Of course!

 

So that's why it's worth practically nothing -- compared to the other components of book value, such as CASH!!!

 

 

Goodwill is the equity stake in assets above the tangible BV of the asset. So when you say $1 of goodwill you are saying 1% of an asset composed of $50 of widget and $50 of goodwill. This makes sense when you consider that goodwill is a function of an asset's going concern value, which may be different from its saleable value. Going back to my original point, the legitimacy of the goodwill will be proven or disproven by the earnings power of the asset under the acquirer's operations.

 

The going concern value can be seen by considering $100 million sitting in a bank account, available for sale. The sale price will likely be $100 million. Now consider a sum of money attached to Warren Buffett's investment management (at a flat fee for simplicity) discounted so that the present value TBV of the combination is $100 million. You might then be willing to pay above TBV so long as you meet your personal bogie. But if you liquidate your TBV, then the goodwill would fade away, unless Warren Buffett went with the cash, in which case you may recover some, all, or above your goodwill depending on the purchaser's expectations and return requirements.

 

 

 

[ERICOPOLY]

I am going to keep on looking at this the way I presently do, and acknowledge that it's not the best method for all people.

 

[link01]

lol, you guys are chasing a chimera here. but the accounting concept of goodwill is no more or less subjective or scientifically accurate that other accounting measures. what about instances of aggressively acqusitive co's that habitually take "the big accounting bath" & write off the value of their goodwill? no more intangible goodwill fluff on the balance sheet now to mess up our favorite analytical tools now, right? and, wow, look at their current ROE! for every dollar of equity employed they're earning 20 shiny cents! that's a 20% roe, what a gem!!

 

not!

 

really, tangible book value is is only a useful measure of a co's probable worth in liquidation, not as an on going concern. and with an insurance co even tangible book has serious limitations because there's so much subjectivity involved in estimating the liablities. it seems to me that value, like goodwill, is in its very essence an intangible thing.

 

goodwill & its amortization over x years may be imperfect at capturing the nuances & the 1000 different changing variations of reality, but so are many other accounting measures. i still we are better off with it than without it, and i dont see anything better being offered in its place.

[ERICOPOLY]

i still we are better off with it than without it, and i dont see anything better being offered in its place.

 

How about banning it and just focusing on earnings power?  Then the people who actually know how to value companies will not be missing out on anything, and people who get misled by management playing games boosting ROE after writing off goodwill will not be misled either.  Everyone will be happy.

 

[niels12think]

 

Suppose some idiot payed them dollar for dollar for the asset called "goodwill", but let them keep all of the ORH operations.  Now FFH is exactly the same, but instead of goodwill they now have cash.  Dollar for dollar.

 

Should they take the deal?

 

Sorry to quote myself.

 

But lets say the offer is only $1 for every $2 of goodwill.  Should the still take the deal?  Of course!

Or how about only $1 for every $5 of goodwill.  Should they still take the deal?  Of course!

Even at $1 of cash for every $100 of goodwill.  Does it still make good economic sense to make the deal?  Of course!

 

So that's why it's worth practically nothing -- compared to the other components of book value, such as CASH!!!

 

 

Sorry to continue, but I see the goodwill as the price to be paid in order to take over the (remaining) insurance operations, which include (minority interests in) insurance contracts, organisation, management, claims reserve, float, brand, customers, etc.

 

If you sell the goodwill, then logically you have to also to include in the sale,

• the (tangible) assets that were part of the float
  
• the loss reserves
  
• the organisation, customers, management
  
• etc.
  

that were bought for this goodwill.

 

In other words, you will sell a future income stream if you sell this goodwill.

And I, for one, would be very happy to buy what effectively is 25% of ORH's future income stream at US$ 1  ;D

 

You may even argue that the goodwill part should in reality be "more valuable" than the tangible assets.

Example: which is best  ?

• buy tangible assets for $100, which yields maybe $6 a year
  
• buy a minority interest in an insurer for $100, which may be composed of $50 goodwill, $250 tangible assets and $200 loss reservs and debt earning $15 a year
  

 

 

apparantly, the goodwill part of $50 was in reality earning $9 a year in the example (the earnings over the non-levered tangible asset) and compunding very rapidly.

 

Or rephrased, would you sell for $50 (or 50 cents), an earnings stream of $9 a year, compounding at 20%?

 

Or in other words, is the goodwill worthless?

 

In my mind - of course not, in fact there should be a lot more goodwill than what appears from the books, and it is compounding at a very nice clip ;)

 

Cheers!

 

[ERICOPOLY]

 

Suppose some idiot payed them dollar for dollar for the asset called "goodwill", but let them keep all of the ORH operations.  Now FFH is exactly the same, but instead of goodwill they now have cash.  Dollar for dollar.

 

Should they take the deal?

 

Sorry to quote myself.

 

But lets say the offer is only $1 for every $2 of goodwill.  Should the still take the deal?  Of course!

Or how about only $1 for every $5 of goodwill.  Should they still take the deal?  Of course!

Even at $1 of cash for every $100 of goodwill.  Does it still make good economic sense to make the deal?  Of course!

 

So that's why it's worth practically nothing -- compared to the other components of book value, such as CASH!!!

 

 

Sorry to continue, but I see the goodwill as the price to be paid in order to take over the (remaining) insurance operations, which include (minority interests in) insurance contracts, organisation, management, claims reserve, float, brand, customers, etc.

 

If you sell the goodwill, then logically you have to also to include in the sale,

• the (tangible) assets that were part of the float
  
• the loss reserves
  
• the organisation, customers, management
  
• etc.
  

that were bought for this goodwill.

 

In other words, you will sell a future income stream if you sell this goodwill.

And I, for one, would be very happy to buy what effectively is 25% of ORH's future income stream at US$ 1   ;D

 

You may even argue that the goodwill part should in reality be "more valuable" than the tangible assets.

Example: which is best  ?

• buy tangible assets for $100, which yields maybe $6 a year
  
• buy a minority interest in an insurer for $100, which may be composed of $50 goodwill, $250 tangible assets and $200 loss reservs and debt earning $15 a year
  

 

 

apparantly, the goodwill part of $50 was in reality earning $9 a year in the example (the earnings over the non-levered tangible asset) and compunding very rapidly.

 

Or rephrased, would you sell for $50 (or 50 cents), an earnings stream of $9 a year, compounding at 20%?

 

Or in other words, is the goodwill worthless?

 

In my mind - of course not, in fact there should be a lot more goodwill than what appears from the books, and it is compounding at a very nice clip ;)

 

Cheers!

 

 

Nope, only the goodwill is for sale.  Martians have landed in Toronto and have taken over the head office.  They decide they could boost Fairfax's earnings power by selling off some assets that aren't performing well.  The goodwill doesn't seem to be throwing off any cash so they figure it's #1 on the chopping block.

 

Maybe it's like this:  perhaps I want to mark the goodwill asset to market.  Look, they could pay "fair" arms length value for a common stock on the market, but when it falls in price they're not allowed to keep it at that value.  Goodwill is similar to marking those assets to model.  You buy a portion of a company and your balance sheet goes up and down with the market value of that stock.  You buy the whole company and it no longer fluctuates.  Useful!

 

Marking the stocks to market also tells you pretty much nothing about their future earning power, yet it's commonly done and nobody questions the practice.

 

 

[jegenolf]

I am going to keep on looking at this the way I presently do, and acknowledge that it's not the best method for all people.

 

 

Goodwill is necessary for people that want to slap a price/book ratio on a company to determine value. If, as you're saying, your valuation model includes earnings power, I think you'd absolutely want to subtract out goodwill. It's just noise at that point.

 

I see lots of people (on this board) attempting to assign a price/book ratio to FFH to determine value though. If that's your method, it would be confusing if buying ORH lopped value off of FFH. Goodwill just provides that balance sheet continuity assuming that the acquiring company paid the correct price for acquired company. It makes book value seem much cleaner than it actually is.

 

So I guess that's a long-winded way of saying exactly what you said.

[Guest Bronco]

Goodwill is shit.  Let's make this simple, b/c it is.

 

A business, or a stock with an underlying business(es), is worth the NPV of the FCF or earnings plus any liquid assets over liabilities (i.e. Apple with its cash hu-ward).

 

Not that hard. 

[Myth465]

I haven't gone back and read the entire thread but I also agree w/ Eric if the issue is the value of goodwill.  It is worth zero to me when assessing any business.  It is accounting bullshit, and this is coming from a CPA.  

 

 

I knew this day would come. I agree, with Bronco (we tend to be on opposite sides in alot of discussions) and Eric and feel like some of you guys are making this way to complicated. TBV is a good way to compare insurers. After that you look at Management, reserving, track record, and what not and then pick your multiple. Goodwill used to be canceled out by the Indian Sub which is on the books for peanuts. With FFH buying 3-5 insurers at 1.3 BV, I dont think thats the case now. Goodwill is piling up with every acquisition.

 

TBV can be useful. I dont think anyone is saying its intrinsic value. They seem to be saying the plug value of Goodwill is just accounting noise, and screws up BV calcs.

 

Goodwill is literally just a plug because debits have to equal credits and entries have to balance. Literally. It means nothing. FFH is worth whatever you are willing to pay for it, but goodwill is BS. Google Goodwill to see how its determined, then tell me how you can get any real investment insights from it. All this theory stuff, is nonsense. Have a look at the Goodwill Accounting entry.

 

If FFH bought An Insurer for 6 times BV, they would have a ton of Goodwill. Perhaps that info is useful (from a what the hell are they doing perspective) but why should they get credit for that when you are looking for a hard bookvalue?

 

 

-------

 

My method for valuing insurers is simple. TBV x X. X being what I feel is the right multiple for the company given all qualitative and quantitative aspects. For me FFH is 1.5 tangible. I wouldnt buy for over book, but would sell at 1.5. I wouldnt buy over book because there are tons of insurers at or under book with decent records, we have a ton of cats out there, and I just dont see spectacular returns given the capital I would have to invest. Thats just me. If FFH earns a lumpy 15% to get that 15% compounded you have to buy at Book Value.