Fairfax Releases Q1 Financial Data; Rocked by Japan

[jegenolf]

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 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?

 

 

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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.

 

 

You are saying that buying ORH decreased the price you are willing to pay for FFH. Same for Zenith and whoever else they buy over book

. Every time this happens their tangible book value goes down. And their intrinsic value goes up (in my opinion). If you'd adjust the multiple you're willing to pay based on acquisitions, then you're implying you're doing some kind of DCF analysis or something that you're rolling into your magic TBV multiple for a given company.

 

Or maybe you're just modeling it on Fairfax's stated 15% book value growth objective (which does not subtract out goodwill), which is fine. I can think of worse ways to try to value FFH.

 

Or maybe you're just using it to model your entry point not your intrinsic value calculation. It's hard to argue that based on the last decade. There's no reason to pay over 1.5 book (if it ever got there) when you'll almost certainly get a chance at or below book. (Someday that ship will sail but it's been a long time coming already...) I just find any intrinsic value model of an insurance company that relies on a book value multiple to be incomplete.

 

I dunno. But to me the first half of what you said doesn't agree with the second half.

[niels12think]

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.

 

Problem is, the assets can't be sold without disregarding real life - the other thing is impossible fiction. None has ever promised that an asset could be sold independently just because it's listed in the accounts.

The only most realistic way to sell the goodwill asset is to sell the subs, and then buy tangible assets for the proceeds.

In this case, you might even realize a value above the stated book for the subs  ;)

But on the other hand, you would remove more tangible assets (caused by the float) than the proceeds of the sale. Of course you would also loose a lot of claims reserves, recoverables, etc. in this sale.

 

In short, neither book value nor tangible book value of a company represents the real value of the business. And this is true even if a lot of intelligent persons has spend a lot of time trying to set up rules for how to determine book value - both generally and in each specific company. And it's also true even if companies employ a lot of people that uses their skills and time on the bookkeeping in order to make it very accurate and elaborate and with no errors :o

Even in a liquidation situation, you would propably find that insurers can have a very different value than the tangible book (loss reserves, etc.) ...

 

And after all, it's better to be approximately right than precisely wrong.

 

Cheers!

 

[Myth465]

Ok, after rereading I see what you mean, I can try again.

 

I want to know what the net tangible assets of an insurance company is. Then I look at reserves, past, management, blah blah blah. Based on that I come up with some sort of earnings estimate or target. Lets take Prem at his word and go with 15% return on assets. Now every dollar I pay more than Book Value reduces that return, we also have a soft market, low yields, and a high cat year. We may enter a medium market though so who knows. Investment gains have been largely taken off the table due to hedges, but FFH is well positioned defensively. From where I sit 15% may be hard over the short term, unless things harden.

 

Based on all this I pick a multiple for Book Value and go with that. Thats IV for me, its an approximation. I obviously want to pay less than that. I think 1.5 Tangible Book Value is a fair price for FFH. I think FFH is a quality above average insurance company and deserves a decent multiple. I also have to take into account that there are several very good insurance companies trading at .95 - 1.25 book value, and finally have to consider that someone buying at 1.5 is getting a fair return but nothing specular. Thats a good price for them, but I am a value guy.

 

I guess the confusing part is that when they buy something TBV goes down if they pay more than net assets. For me its not a hard and fast rule. I dont go FFH bought a company, let me remove this and blah blah blah. I would wait and see how it goes, but as FFH drifted up to vs. tangible book I would have to look at my other options. If FFH is at 1.7 tangible book and LRE is at 1.0 book value. I am moving. If nothing is out there I may let it ride. Who knows, its just my way of thinking about things. Also for FFH I care more about the investments then the underwriting. I usually love to buy when I see giant hidden investment gains. I agree with Harry, if I am buying for underwriting. I want to see very low combined ratios and reserve releases over a decent period of time.

 

You want to give Prem credit for buying an insurer at 1.3x book value (Zenith, Mercury, pretty much any  of the deals they have done). Thats nice, but I dont want to pay 1.3x book, so I dont give much credit for it. I wouldn't sell at 1.1 book value because a take over created goodwill, and pushed up the tangible multiple, but it all gets taken into account. Before I could just take stated book, and know that ICIC was undervalued. Now its a bit more complex. I prefer to give create for the acquisitions after they start earning their keep.

 

These are great acquisitions, which feature what FFH lacks. Solid underwriting. Between them, ORH, and the Asian subs things will get better. I predict they are solid buys, but I personally dont want to pay up for them. I didnt own any of them at book (except for ORH), wouldn't have bought them at 1.3x BV. Prem gets control, and headache free float. You can pay up due to future earnings, and as a buy and holder it makes perfect sense, but the environment is a bit off for me, and I dont have the capital to buy and hold for a lumpy 15%. I want bigger fish, and will likely be burned for it lol.

 

Finally, the qualitative factors weigh on me much more than the quantitative factors. I simply dont like the environment and it doesnt make sense to me to walk around saying FFH is worth 2x BV when you have great insurers available for much cheaper.

 

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Im used to FFH having a stated book value of $250, and actually book value due to unknown gains of $300, a none event hurricane season, and a stock price of $240. Thats a fat pitch. Thats what I want again. We also had leaps to boot.

 

 

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You guys kill me with this nothing represents the intrinsic value of the company stuff. Give me a break, plenty of ways to fry an egg. We all just want to eat. Pick one and get to cooking. I feel like some folks can get too theoretical in the value investing community. IV is unknowable, pick a method and move on inmo. But you are right FFH is worth precisely its future cash flows properly discounted at an accurate / conservative rate. Since all of those variables are unknowable, I will stick with my approximation  ;D.

 

[Packer16]

The biggest issue I have with using goodwill & intangibles is internally generated ones are not on the books.  If FFH was a collections of acqusitions whose collective goodwill was marked to market then it would be a good measure.  In addition, the intangibles are amortized over thier lives and not revalued after an acquisition unless thier value is impaired.  That is why I like use tangible BV as it provides a consistent metric across insurers.  You can then make your judgement on multiple of TBV based upon historical/projected growth in TBV, quality of underwriting, etc.  In my opinion, including goodwill in times BV calc has alot of drawbacks due to consistancy issues historically and across insurers.  If someone has a way make this adjustment, I would be interested in hearing it.  TIA

 

Packer

[jegenolf]

Ok, after rereading I see what you mean, I can try again.

 

I want to know what the net tangible assets of an insurance company is. Then I look at reserves, past, management, blah blah blah. Based on that I come up with some sort of earnings estimate or target. Lets take Prem at his word and go with 15% return on assets. Now every dollar I pay more than Book Value reduces that return, we also have a soft market, low yields, and a high cat year. We may enter a medium market though so who knows. Investment gains have been largely taken off the table due to hedges, but FFH is well positioned defensively. From where I sit 15% may be hard over the short term, unless things harden.

 

Based on all this I pick a multiple for Book Value and go with that. Thats IV for me, its an approximation. I obviously want to pay less than that. I think 1.5 Tangible Book Value is a fair price for FFH. I think FFH is a quality above average insurance company and deserves a decent multiple. I also have to take into account that there are several very good insurance companies trading at .95 - 1.25 book value, and finally have to consider that someone buying at 1.5 is getting a fair return but nothing specular. Thats a good price for them, but I am a value guy.

 

I guess the confusing part is that when they buy something TBV goes down if they pay more than net assets. For me its not a hard and fast rule. I dont go FFH bought a company, let me remove this and blah blah blah. I would wait and see how it goes, but as FFH drifted up to vs. tangible book I would have to look at my other options. If FFH is at 1.7 tangible book and LRE is at 1.0 book value. I am moving. If nothing is out there I may let it ride. Who knows, its just my way of thinking about things. Also for FFH I care more about the investments then the underwriting. I usually love to buy when I see giant hidden investment gains. I agree with Harry, if I am buying for underwriting. I want to see very low combined ratios and reserve releases.

 

Finally, the qualitative factors weigh on me much more than the quantitative factors. I simply dont like the environment and it doesnt make sense to me to walk around saying FFH is worth 2x BV when you have great insurers available for much cheaper.

 

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You want to give Prem credit for buying an insurer at 1.3x book value (Zenith, Mercury, pretty much any  of the deals they have done). Thats nice, but I dont want to pay 1.3x book, so I dont give much credit for it. I wouldn't sell at 1.1 book value because a take over created goodwill, and pushed up the tangible multiple, but it all gets taken into account. Before I could just take stated book, and know that ICIC was undervalued. Now its a bit more complex. I prefer to give create for the acquisitions after they start earning their keep.

 

These are great acquisitions, which feature what FFH lacks. Solid underwriting. Between them, ORH, and the Asian subs things will get better. I predict they are solid buys, but I personally dont want to pay up for them. I didnt own any of them at book (except for ORH), wouldn't have bought them at 1.3x BV. Prem gets control, and headache free float. You can pay up due to future earnings, and as a buy and holder it makes perfect sense, but the environment is a bit off for me, and I dont have the capital to buy and hold for a lumpy 15%. I want bigger fish, and will likely be burned for it lol.

 

Im used to FFH having a stated book value of $250, and actually book value due to unknown gains of $300, a none event hurricane season, and a stock price of $240. Thats a fat pitch. Thats what I want again. We also had leaps to boot.

 

 

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You guys kill me with this nothing represents the intrinsic value of the company stuff. Give me a break, plenty of ways to fry an egg. We all just want to eat. Pick one and get to cooking. I feel like some folks can get too theoretical in the value investing community. But you are right FFH is worth precisely its future cash flows properly discounted at an accurate / conservative rate. Since all of those variables are unknowable, I will stick with my approximation  ;D.

 

I'm not sure if these strawmen are directed at me. All I'm saying is I think price to book is a pretty bad approximation of an insurance company. It ignores float, underwriting and investment returns. And I'm saying tangible book value only helps if your model is more complex than just a price to book ratio. Otherwise, I'd say plain old price to book is a better approximation. At least you have a shot of including some additional value.

 

 

 

 

[Myth465]

But you are forgetting the X in Parker's and my example. Its TBV x X = Where x takes into account all of those items you listed. You have a point though, I should have quoted you to make it more clear, I missed that in my long winded tirade. The comments were partially addressed to you, but were really more about the community in general.

[Packer16]

You are right about float.  The amount of float and investment returns is one factor is use to determine what the correct P/BV to pay (assuming a break-even underwriting - for which I take a look at the historical underwriting and excess reserves to ensure).

 

Packer

[bluedevil]

Myth,

 

A small point:

 

I think that Prem targets 15% return on book value, not tangible book, when he makes acquisitions.

 

Thus, when he buys Zenith at 1.4 book, for example, I think he believes he can return a 15% compound return on the money spent over time.

 

(Hard to do, but with Zenith, you have two factors that make that bogey reasonable.  One, a 95% long-term underwriting record.  Two, a 95% long-term underwriting record IN workers' compensation, the longest of the long-tail lines.  Thus, Zenith provides a type of float that should be an especially good marriage with Hamblin-Watsa's asset management capabilities.  Otherwise, I don't think you would see Fairfax pony up that type of money to tangible book for most acquisitions.)

[Guest Bronco]

We could make it so that all acquisitions were carried over at cost, with any excess charged to equity.

 

But the big 4 would lose a lot of money on audit and valuation fees.

 

That is the truth.  Goodwill?  What a joke

[ERICOPOLY]

I think that Prem targets 15% return on book value, not tangible book, when he makes acquisitions.

 

They seem to do better than 15% just investing in equities without taking on any insurance risk.  Perhaps not after taxes.

 

Just an observation.  I'd better duck the rotting food now.

[jegenolf]

But you are forgetting the X in Parker's and my example. Its TBV x X = Where x takes into account all of those items you listed. You have a point though, I should have quoted you to make it more clear, I missed that in my long winded tirade. The comments were partially addressed to you, but were really more about the community in general.

 

That's pretty much what I guessed. That the mechanism for determining X includes what you have to include even if it's more qualitative than quantitative. I wasn't thinking you ACTUALLY ignored float, underwriting etc. But to end up putting a price to book ratio on the stock is misleading. The price to book is just a final simplification not really the main part of the valuation. What goes into X is how you'd really learn to value an insurance company. The final ratio is more noise than signal unless you know what went into it.

 

I just think it's a bad lesson for people to learn to 'buy insurers below book' when that is such a small piece of the puzzle. Some insurers should never be bought and some are a bargain well over book. LRE and FFH are good examples of the latter, and the reasons will never show up in BV or TBV except in the rear view mirror.

[Myth465]

I just think it's a bad lesson for people to learn to 'buy insurers below book' when that is such a small piece of the puzzle. Some insurers should never be bought and some are a bargain well over book. LRE and FFH are good examples of the latter, and the reasons will never show up in BV or TBV except in the rear view mirror.

 

This is actually a good point, and you are right, It could prove to be disastrous for someone if they ignored alot of the other items. Its tough. We have so many different types of people on the board right now.