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Oooohh, the media is going to be all over this one...some of the titles of articles to come:

 

Blackberry Saviour Loses Big Betting Against Market

 

Watsa Happening at Fairfax

 

Market Bear Fairfax Growls to Big 3rd Quarter Loss

 

Should Watsa Change His Macro Views?

 

Watsa Wrong With Watsa?

 

Buffett of North's Results Go South

 

Here's to the chance to buy Fairfax under $400 again!  Cheers!

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Here's to the chance to buy Fairfax under $400 again!  Cheers!

 

I hope so.  I will be interesting to see if we get a chance to buy "cheap" tomorrow and then see what happens on Monday if FFH gets BB and reveals the consortium.  May be a short window to get in at a good price.

 

Cheers

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I'm much more focussed on the underwriting results than I am on mark to market investments. There I am very pleased to see the nine month combined ratio down a full 7 points from last year, lead by Crum and Forster (where we most need the improvement). Over the middle and long term I'm confident their investment returns will be excellent. It's the UW side where they have to demonstrate consistent good results.

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Hopefully the Conference Call tomorrow morning sheds some more light on what happened in the quarter and YTD.

 

I'm sure Prem will have some pearls tomorrow.

 

Tommm50 - there were $577M in REALIZED losses on the equity hedges.  Haven't got my head around how and why that happened, but that was surprising to me.  I am also happy with the underwriting performance.  It used to really bother me cause the float wasn't free.

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I'm a little surprised by how much money they lost in their bond portfolio. Given the maturities they're in, the rate movements there, and the fact that most positions are US treasuries and muni's (mostly insured by BRK). I don't really like the fact that they seem to be slowly, but consistently, lengthening the duration of the portfolio. I guess this is presumably part of an ALM program.

 

Anyway, insurance results are quite encouraging. Investment results continue to be disappointing which isn't a surprise.

 

I feel like the share price has gotten more volatile of late with the BBRY situation. The cynic in me doubts this interest is of the long term variety, so will be interesting to see the reaction.

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What impressed me about this group was the number of you who reported selling not long ago. Whether it was keen observation, luck, or the discipline to take gains when the valuation gets favorable there is a lesson for the rest of us. In hindsight the bond losses were mostly from the 2nd quarter and the losses from the equity hedges were expected given the strong market. Still it is a surprise that the losses were realized. Prem sold mostly Canadian Provincial government bonds and closed s&p hedges while increasing his CPI hedges about 70%. Does he expect a housing market fall in Canada or perhaps a fall in the price of oil causing a weak Canadian dollar and troubled provincial finances? The report says the hedges were closed to match equity sales to rebalance the hedge to 100%. Doing so realized $577 million losses in the quarter. So the hedge is insurance, not speculation, a cost he seeks to minimize. I suspect he must be expecting global QE to end soon or he would not have increased his CPI hedges so much. There has been lots of economics papers (see Hoisington) who have concluded that QE is ineffective causing more harm from distortions than the benefit. Does Prem expect Yellen to be a hawk instead of being the dove as expected? I hope so. Perhaps she thinks there is no point providing easy money to support harmful government economic policies?

 

If it wasn't for these losses the report would have been good because of the improved underwriting results. The stock is now 1/3rd over book so we may enjoy a buying opportunity.

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I still don't understand the CPI hedges on top of the equity hedges.  Isn't there some overlap?  If you are hedged against an equity decline why do you need to be hedged against a price decline also unless you are making a bet on a CPI decline.  Short monetary contraction or a depression, I don't see a CPI decline.  The whole system is set up for inflation as there is no anchor asset or currency unless the Fed becomes more hawkish.

 

Packer

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The bonds also benefit from deflation.

 

Doesn't answer the question, but the CPI derivatives going to zero will only cost $6.50 a share, unless they keep sinking money into it. I'm more worried about the bonds, at least the long duration ones that aren't offset by insurance liabilities.

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What impressed me about this group was the number of you who reported selling not long ago. Whether it was keen observation, luck, or the discipline to take gains when the valuation gets favorable there is a lesson for the rest of us.

 

I cannot agree.

 

I feel no shame in being found still owning a share when the bottom of the

market comes. I do not think it is the business of … [a] serious investor to cut

and run on a falling market … I would go much further than that. I should say

that it is from time to time the duty of a serious investor to accept the

depreciation of his holdings with equanimity and without reproaching himself.

Any other policy is antisocial, disruptive to confidence and incompatible with the

working of the economic system. An investor is aiming, or should be aiming,

primarily at long period results and should be judged solely by these.

--John Maynard Keynes

 

I myself have written a few days ago that a correction of the stock price was very likely. Yet, I also said I haven’t sold a single share. Because long-term prospects for FFH are better today than they were yesterday: underwriting performance is really starting to provide better than free float! That’s what a long-term investor and an entrepreneur should be focused on.

 

As far as valuation is concerned, ask Mr. Tom Gayner what he thinks MKL is worth, based on its long-term business prospects: he will answer in between 1.7 and 2 x BVPS. The same imo applies to FFH. Now, FFH yesterday closed at $436, and its BVPS is $334: it is selling for 1.3 x BVPS. Furthermore, and this is very important, today’s BVPS for FFH is very conservative: after remaining flat for 3 years, now we have this quarter in which the Russell2000 increased 10%… and the following drop in BVPS for FFH. (Think of it: 10% in 3 months… not from a deeply undervalued company, but from a whole market index, that four months ago already was way overvalued! Talk about stock market bubble…!). So, not only FFH is clearly not overvalued, it is not even fairly valued… instead, it is still undervalued.

 

Of course, this is true, only if you consider its long-term business prospects. Instead, if you are able to jump in and out of FFH, like many on the board seem able to do, very good for you! You have foreseen correctly this terrible quarter and will be able to take advantage of the big drop, when the market opens today!

Simply put: it is just not my game. :)

 

giofranchi

 

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How many percentage points FFH closes down today might be one of the best “stock market barometer” I can think of:

 

If FFH stock price closes down more than 10%, this bull market might still march on undisturbed for a long time; if, on the other hand, FFH stock prices closes down less than 5%, that would be a serious warning sign for the health of the market.

 

If this bull market marches on undisturbed for a long time, I will make money; if a serious correction comes, I will make a ton of money. ;D ;D ;D

 

giofranchi

 

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YTD FFH has declared ($1,234.9) million losses, all of which are unrealized. If it were reporting earnings like banks are, it would have declared practically no losses. Though this has clearly no impact on BVPS, earnings do exert a great influence on the multiple the market is willing to put on any stock: it is much easier to pay 1.3 x BVPS for a company that seems to be profitable, than for a company that seems to be losing money.

 

Needless to say, I am very glad FFH reports earnings the way it does! :)

 

giofranchi

FASB-changes-FAS-157.bmp

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Oooohh, the media is going to be all over this one...some of the titles of articles to come:

 

Blackberry Saviour Loses Big Betting Against Market

 

Watsa Happening at Fairfax

 

Market Bear Fairfax Growls to Big 3rd Quarter Loss

 

Should Watsa Change His Macro Views?

 

Watsa Wrong With Watsa?

 

Buffett of North's Results Go South

 

Here's to the chance to buy Fairfax under $400 again!  Cheers!

Pasad, I wish you are right (new buying opportunity below BV) but I doubt the stock will move dramatically on the Q3 news.

- We should welcome the Combined Ratios improvement. But no major disaster, no hurricane, and hard market pricing are the main reasons behind it.

- On the investment side the (unrealised and realised) results continue to be awful. Who is surprised or scared on this board?

-Bbry, is the only source of concern, not only for the distraction, not only bcse FFH initial theories  were totally wrong and could continue to be but because they are now facing huge pressures (media - political - credibility) and scrutiny. Not exactly the best way to work in a " disciplined , no ego, no vanity" atmosphere.

They had faced much bigger challenges in the past :-) but as usual with their Q report they are quick to point out what goes "well" and quite slow to admit what went "wrong" , our job and pleasure to sort it out ....

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What impressed me about this group was the number of you who reported selling not long ago. Whether it was keen observation, luck, or the discipline to take gains when the valuation gets favorable there is a lesson for the rest of us.

 

I cannot agree.

 

I feel no shame in being found still owning a share when the bottom of the

market comes. I do not think it is the business of … [a] serious investor to cut

and run on a falling market … I would go much further than that. I should say

that it is from time to time the duty of a serious investor to accept the

depreciation of his holdings with equanimity and without reproaching himself.

Any other policy is antisocial, disruptive to confidence and incompatible with the

working of the economic system. An investor is aiming, or should be aiming,

primarily at long period results and should be judged solely by these.

--John Maynard Keynes

 

I myself have written a few days ago that a correction of the stock price was very likely. Yet, I also said I haven’t sold a single share. Because long-term prospects for FFH are better today than they were yesterday: underwriting performance is really starting to provide better than free float! That’s what a long-term investor and an entrepreneur should be focused on.

 

As far as valuation is concerned, ask Mr. Tom Gayner what he thinks MKL is worth, based on its long-term business prospects: he will answer in between 1.7 and 2 x BVPS. The same imo applies to FFH. Now, FFH yesterday closed at $436, and its BVPS is $334: it is selling for 1.3 x BVPS. Furthermore, and this is very important, today’s BVPS for FFH is very conservative: after remaining flat for 3 years, now we have this quarter in which the Russell2000 increased 10%… and the following drop in BVPS for FFH. (Think of it: 10% in 3 months… not from a deeply undervalued company, but from a whole market index, that four months ago already was way overvalued! Talk about stock market bubble…!). So, not only FFH is clearly not overvalued, it is not even fairly valued… instead, it is still undervalued.

 

Of course, this is true, only if you consider its long-term business prospects. Instead, if you are able to jump in and out of FFH, like many on the board seem able to do, very good for you! You have foreseen correctly this terrible quarter and will be able to take advantage of the big drop, when the market opens today!

Simply put: it is just not my game. :)

 

giofranchi

 

 

Macro Investing now Gio?  What evidence do you have that the Russell 2000 is overvalued?

 

In general this was a dismal quarter for FFH.  As mentioned above underwriting results were okay, in The absence of any significant cat losses.  One event and you would have seen losses for the quarter closing on a billion dollars. 

 

Those hits to book value were real, not unrealized.  8% is not an insignificant drop, in one quarter, no less.  To increase book value back up you now need a 16% gain from somewhere else.

 

I am generally a medium/long term investor.  I have been in BAc for 3 plus years, and SSW for 5 years, and was in FFh for 15 years (still hold a tiny number of shares).  I simply dont see FFh being able to get their mojo back in the foreseeable future.  The FFh team is great, but this is business, not a marriage. 

 

I even sold 50% of my holdings from my kids RESP, which I wont need to access for 9 years.  That is: I dont believe their returns will be as good as those of my other holdings over a 9 year period.

 

Alot of people here make too many excuses for FFH.  Now, I await Sanjeev's rebuttal.

 

 

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Macro Investing now Gio?  What evidence do you have that the Russell 2000 is overvalued?

 

No Al, I am certainly not macro investing. Comparing prices with real earnings is not macro investing… even if you use a bunch of 2000 companies, instead of 10-15… It might be less precise, of course… but it is not macro investing.

And at the end of Q2 2013, as you can see in attachment, US small caps were already priced to deliver negative returns on a 7-years time horizon…

 

giofranchi

GMO_7-Year_Asset_Class_Real_Return_Forecasts_June_2013.pdf

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The FFh team is great, but this is business, not a marriage. 

 

I am certainly not married to FFH, or any other company that I hold. I constantly look at my holdings and ask myself if they make strategic sense in my organization. They are only a part of it, so they must fit strategically. If they no longer do, I sell them. I simply don’t think that a very bad quarter means FFH doesn’t fit anymore… For instance, I got much more worried when the piece of news about the consortium for taking BBRY private came out, because I thought that investing more capital in BBRY now was strategically flawed… Until I knew that Mr. Watsa actually had no intention to use new capital that way! :)

 

giofranchi

 

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"Alot of people here make too many excuses for FFH". 

 

 

Hey Uccmal,  I always appreciate your thoughts (along with everyone else who contributes) and you may well be right.  This quarterly loss certainly caught me off guard, so if you saw it coming then well done.  I figured a wash to a small loss for this quarter, so my modelling needs some revising  :-[  However even after the biggest quarterly loss I have experienced as an owner, they are still only trading at 1.3 x's book and will probably trade  somewhat lower shortly.  I have my view that this company is undervalued at 1x's book and fair value at 1.5x's book.  How do you value them especially in a hardening market for insurance and where the broader market is stretched?

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Macro Investing now Gio?  What evidence do you have that the Russell 2000 is overvalued?

 

No Al, I am certainly not macro investing. Comparing prices with real earnings is not macro investing… even if you use a bunch of 2000 companies, instead of 10-15… It might be less precise, of course… but it is not macro investing.

And at the end of Q2 2013, as you can see in attachment, US small caps were already priced to deliver negative returns on a 7-years time horizon…

 

giofranchi

 

Isn't that exactly what macro investing is? You look at the average of 2000 company valuations and you base your investment decisions on that, instead of looking for individual securities.

 

On a sidenote, I've been thinking a bit about the following: lots of forum members don't 'do' macro investing. However, some of us do invest a lot of money with owner/operators who happen to have identical views on the economy as we have (including me). Gio, isn't one of the reasons you invest in Fairfax that you like their cautious view of the economy? So if Fairfax loses 8% of book value during a quarter because of their hedges and your portfolio loses value because of that , aren't you effectively macro-investing?

 

Are we sometimes deluding ourselves about the reasons we invest in specific companies? I.e. a bullish forum member might invest in Berkshire, a bearish member in Fairfax and we both try to rationalize it by looking at completely different metrics afterwards.

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"Alot of people here make too many excuses for FFH". 

 

 

Hey Uccmal,  I always appreciate your thoughts (along with everyone else who contributes) and you may well be right.  This quarterly loss certainly caught me off guard, so if you saw it coming then well done.  I figured a wash to a small loss for this quarter, so my modelling needs some revising  :-[  However even after the biggest quarterly loss I have experienced as an owner, they are still only trading at 1.3 x's book and will probably trade  somewhat lower shortly.  I have my view that this company is undervalued at 1x's book and fair value at 1.5x's book.  How do you value them especially in a hardening market for insurance and where the broader market is stretched?

 

Nwoodman, Back at you re: appreciate your thoughts and Giofranchi's as well.

 

I dont make any claim to seeing this quarter coming.  I have been slowly selling FFH for years as the underlying investment business has deteriorated. 

 

BKIR is fully valued, imo.  I ran the numbers when they first bought, and got 0.30 cents per share upside, if everything returned to normal.  So, they have made that money.  Resolute leaves me unimpressed.  The equity hedges have been a disaster.... I dont know why they didn't collar these somehow, but they didn't.  BBRY was truly the final kicker.  I sold all my BBRY by the end of 2011.  If I could figure out it was done for why couldn't FFH?

 

I am sure that there will be a market drop at some point that will show me wrong, at which point FFh will realize some gains on the remaining hedges.  However, it is unlikely these will yield all that much.  As others have noted, if things go south that badly, there will be better deals to be had than FFh at that time. 

 

In terms of insurance, I dont see an real evidence of a hard market.  If anything, these few quiet cat seasons are going to cause the opposite.  The jury is still out here.

 

So, it is really FFHs underlying investment business that bothers me.  They have had ample opportunity to buy really good businesses, a al Buffett.  They just dont.  They seem to be caught in a nether world between Graham and Buffett.  They are using Ben Graham asset based principles for huge positions.  Buffett makes sure the businesses he buys are immediately accretive to cash flow.  He then uses the cash flow as his hedge against a market correction. 

 

I am sure it is not this simple, but the first thing I would do if I were in charge would be to buy cash generating businesses with a lesser cyclical component.  But thats me.  I could be very wrong as well.

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The results were awful, plain and simple.  It was foreseeable in the sense that anytime you have a financial such as a bank or insurance company selling at a premium to book they have to keep performing at an optimum level.  Any little speed bump and it can get nasty.  The only person I've ever seen who has performed almost impeccably for years and years and years is Buffett.  I know, I know, everyone patterns themselves after him, but that's where the error lies.  It's like growing your hair into an unmanageable mane, wearing fuzzy slippers and making strange faces by sticking out your tongue and saying you're like Einstein. 

 

Combining for a second with the micro cap thread, I have to chuckle at the people who would be "satisfied" with 20% returns.  Good lord.  Sure, any mook can do that for a period of time, but to do it for an extended basis puts your in the rarified air of the greats like Buffett and yes, Graham and Schloss.  I would also strongly disagree with the statements that diversifying is for those who don't know what they're doing.  That's total bullshit.  It's simply that what's being done is different and for some unknown reason that is not acceptable.

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"Alot of people here make too many excuses for FFH". 

 

 

Hey Uccmal,  I always appreciate your thoughts (along with everyone else who contributes) and you may well be right.  This quarterly loss certainly caught me off guard, so if you saw it coming then well done.  I figured a wash to a small loss for this quarter, so my modelling needs some revising  :-[  However even after the biggest quarterly loss I have experienced as an owner, they are still only trading at 1.3 x's book and will probably trade  somewhat lower shortly.  I have my view that this company is undervalued at 1x's book and fair value at 1.5x's book.  How do you value them especially in a hardening market for insurance and where the broader market is stretched?

 

Hi nwoodman,

I will let you know what I call “My 7 lean years model for FFH”… don’t tell anybody, please! ;D ;D ;D

 

Ok, we all know that FFH increased BVPS by 146% during the 3 years of 2007, 2008, and 2009. That equates to a 35% CAGR in BVPS. So, let’s just see what will happen if two more cycles of 7 lean years + 3 roaring years will unfold. I have assumed in my model that FFH doesn’t grow BVPS at all during the 7 lean years, then increases its BVPS at a CAGR of 35% for the next 3 roaring years.

2013 has been the fourth year of the 7 lean years that will go on until 2016. 2017, 2018, and 2019 will be the 3 roaring years. Then from 2020 until 2026 we will experience another 7 lean years. Finally, 2027, 2028, 2029 will be the 3 roaring years that close the second and last cycle.

As you can see in the files attached, with these assumptions BVPS will grow at a CAGR of 12% for the next 16 years, and that equates to a Present Value of Equity equal to 1.54 x BVPS at 2013 year end.

 

You might think I must be joking, but this model of mine follows Mr. Munger’s idea that “you have to do very few things right in your whole career, to achieve great financial results, as long as you avoid too many stupid things”. And that’s what great financial minds past and present have always done: to have ready cash, when everybody else is panicking. Even though those moments don’t come that often, I think you should plan and prepare for them. And that exactly what FFH is doing.

 

giofranchi

My-7-lean-years-model-for-FFH.xls

FFH_Present_Value_of_Equity.xls

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