ERICOPOLY

Probably the same thing he's been saying for years, that the value is multiples of the current price and that he's been adding every single quarter. In prior years he talked about Sears making a whole lot of money from appliance sales... he said those sales were only temporarily depressed by the housing market. Well, he's been proved dead wrong but he hasn't admitted to it. Instead, he just talks about future positive things that can't yet be proved wrong.

You are dead right. Just toss out the accounting goodwill. Recreate the "true" goodwill by looking at the size of the float, the anticipated rate of increase of the float, and the underwriting profit. That's all worth a premium for sure and it's economic goodwill. The accounting goodwill is just a subset of the economic goodwill. Nothing gets missed by tossing out the accounting goodwill -- it all gets recaptured when looking at economic goodwill.

The double counting is when you are fixated at the low P/B... yet the "low" P/B isn't that low at all. So by looking at something that makes the premium invisible, your mind is being tricked by an optical illusion. You are then trying to put a premium on something that has already had a premium put on it... without regard for measuring the premium that is already there (that's the double counting).

Fairfax is one of those stocks that makes me think of the Buffett comment about making sure you are buying a business that even an idiot could run. My point in saying that is the HWIC portion is clearly not of the "idiot proof" type. It does not have lasting "special" value beyond the current management. So it is not to be valued accordingly. In other words, not at it's intrinsic value. The "magic hat" is not where the value is, the value is in the seer. You can't purchase a person, but you can pay them for their services. Pay for the seer, not the magic hat. The seer is not a perpetuity. Think of the employees of a company -- any company. They are paid for their labor, and hopefully paid fairly. They are not purchased at a capitalized DCF premium to the expected value of all their future labor.

That's exactly right. Double counting.

;D ;D Gio The Dhandho pay model is better. He gets paid for performance. This idea of yours to pay HWIC via a huge premium is broken -- because when you pay a premium for the stock, it doesn't go into HWIC's pocket. You are paying the wrong people. Good management should be paid. Mohnish isn't getting paid simply because he has a magic hat with a "seer stone" in it. Sure he has one, but he'll be paid for the results it produces. So he will be paid directly in line with the value he adds.

Ok, thank you. If I haven't overpaid for a business, why should I strip-out the goodwill on my balance sheet to compute what I truly own? Gio Because you are double counting. You want a premium on top of the premium.

Acquisitions are made at 1.3x book and then you bitch continually that the market only rewards 1x book post acquisition (including the goodwill). I explain to you the concept of goodwill, and how it can obscure the optics of what that 1x book really means, and then you ignore this and say you would only strip out intangibles if you disagreed with the price paid. It's pretty exhausting to read what you are saying here.

I guess you forgot management... Are you willing to pay to partner with a good entrepreneur? Gio They aren't paid? I believe their pay is subtracted out of earnings, so we are paying for them.

IV is partly reflected by the premium that FFH pays when it purchases wholly-owned insurance businesses. Why? I think PW buys wholly owned insurance companies only if he thinks he is paying less than IV, don’t you? Even when he is paying 1.3 x BV. Gio He is paying the private market value. It's what arms-length transactions transact at. That's pretty much the top of what you can expect for valuation from Mr. Market. However once HWIC get their hands on the portfolio, they reinvest fairly-valued securities into undervalued securities. They squeeze more juice from the lemon with their best-in-class lemon squeezer. But they pay fair market price for the lemon itself.

You are comparing how someone would value a mutual fund v/s a company. Isnt that a really dumb way of viewing it? You are completely misunderstanding me. I am valuing the insurance operations as insurance operations, and I am valuing the portfolio of market-marked assets at market value. Other people are saying we should pay an above-market price for FFH's portfolio of bonds and equities. But that price is way above the market. I'm merely saying that you should be paying market price for those holdings. Premium for the business operations (float, float growth, and underwriting profit), meanwhile no premium above market price for the marked-to-market holdings.

IV is partly reflected by the premium that FFH pays when it purchases wholly-owned insurance businesses. That premium is called "goodwill". You need to strip goodwill off the balance sheet before you comment on whether the current price to book at 1.15x is low or high. For example, if they held only one company (wholly owned) and payed 2x book value for it... then in that example the shares post-acquisition would only trade at 1x book.... even thought it's really 2x tangible book. In truth, about 20% of book value is comprised of goodwill and intangibles. So you are vastly understating the premium that the market is rewarding the company with -- major difference is 20%.

You could just get the information from me because I keep repeating it. There is business value in the float, the float growth, and the underwriting profits. That's the operating company that commands a premium. However even after you pay that premium, the shares should still be under intrinsic value because the equities he holds (if he is truly a value investor) are valued on the books at mark-to-market, and market price is below intrinsic value (if he is truly a value investor). So the shares should reflect the value of the insurance operations... but even that value will always be below intrinsic value. Right now the shares trade higher than 1.3x tangible book. That's pretty close to the value that Fairfax has been purchasing wholly-owned insurance companies for.

This is nuts, and should have clued you in that your logic is flawed. It doesn't make sense to someone who can't make sense of it. So I'll lob it in low and slow to see if you can hit it one last time... Example: Fairfax could liquidate everything and just buy one stock with the proceeds because they believe it trades at 50% of intrinsic value. Furthermore, let's say that you also agree with Fairfax's assessment of this single holding. You very plainly see now that Fairfax has become a holding company with only one stock in it. Are you still going to argue that it's nuts for Fairfax to trade at 50% of intrinsic value? Or will you continue to maintain that it should trade closer to intrinsic value, where that's DOUBLE the value of what you can readily purchase that asset for on the open market. Okay... so let's skip to the obvious conclusion to that one... Therefore, if they are value investors then they should NEVER trade for intrinsic value. Never! It's just so easy for me to see this. Sorry it isn't for you.

Fairfax should always, always, always, always! Always be trading under intrinsic value. Otherwise, they aren't value investors. This is because the very market that values Fairfax also values their various holdings. And the market is saying their various holdings are only worth X. They are not saying X+some future premium. Just X. Do you really think the very same market that says each stock in their portfoio worth X is going to pay more for it merely because Fairfax owns them? No way. It's the same market! Think about it. How is that even remotely rational what you are saying? The market has a firm belief that the portfolio of Fairfax's is only worth X. The market gets to decide that price. And on the same day, the market also gets to decide the price that FFH should trade at. You are confusing today's pricing of their portfolio with your expectations that it will appreciate a whole lot in excess of the market's expectations. The market already priced in the future appreciation when it priced the individual holdings of Fairfax. So for you to expect the market to then disagree with itself when it looks at those very same holdings in the Fairfax portfolio -- it's just totally illogical to conclude that the market will say "okay, my bad... if Fairfax owns them then they are worth a ton more and thus a big premium for Fairfax is in order". If the market believed that... well then it would just price the individual holdings in that way to begin with. Yet it doesn't price the individual holdings that way to begin with. And so it doesn't believe they are worth a premium to their market value. And therefore it doesn't believe FFH shares should trade at any premium whatsoever above the mark-to-market for those assets. And therefore the market does not agree with your view on this topic. The market does however value the company at a fairly large premium to tangible book because of the value of the float, it's growth, and the anticipated underwriting profit. But expectations of above-normal capital gains? No way, because if the market thought those capital gains were coming down the line... why then the individual holdings would already be trading at levels that reflect it. But they don't trade at that level, and so there is no expectation from the market for these capital gains, and so therefore there is no such premium in anticipation of them. It's all very logical. It makes sense to just use whatever the standard assumptions are for a portfolio return -- stripping out all expectations for above-market returns. So even if you think FFH will earn 7%, you only use 4% (or whatever) if that's what this interest rate environment dictates. They don't have any special investment skill in the opinion of the market -- because the market already priced the individual portfolio holdings efficiently (in the market's view) and the market is the one that prices FFH. So it's not like it's logical to expect the market to disagree with itself.

Equities in their portfolio are marked to market. The market already values those individual equities using DCF, presumably. You are assigning an additional value on top of that for look-through DCF given that you disagree with the market. That's putting the cart before the horse. You are trying to pay intrinsic value for them, in other words, yet they aren't yet trading for intrinsic value. The whole point is to buy them for today's price and then sell them in the future after they trade in line with their intrinsic value. Yet you want to rush out and pay the premium already... today... merely because FFH holds them. That's just crazy. You can reason that FFH is undervalued because of look-through DCF, but it needs to remain that way unless you've fallen off your horse on top of your head. Over time, the market will rise for those shares, and FFH will take the gains. It's just a process that you need to be patient for... what's the point of buying the shares today at a price that already reflects all those future gains? Why not pick any portfolio manager and say... well that guy is going to crush the market by a huge amount... So let's see about figuring out a way to invest with him that pays for all those future gains upfront, discounted to the present. That's what you are arguing for.

I'm not valuing the equities at a premium. I'm valuing a business which is more than just assets. The fact that the business involves investing is irrelevant. I think Dhandho, just like every other business, should trade at multiple that is dependent on its discounted future free cash flows. If you think that Dhandho is going to greatly outperform the returns of the market, then you're saying is the equivalent to saying that Dhandho should trade greatly below the value of its future cash flows. And if you believe in DCF for other companies, but not for investing companies, you're saying that Dhando should be cheaper than those other companies that you do value using DCF. To me, that's a pretty bad idea. (This is the funny thing about this discussion. If you follow through your reasoning to the natural conclusions, you very quickly reach a contradiction that should indicate to you that your premise is faulty. Well, unless you want to throw out DCF entirely.) That said, if you don't agree that future cash flows are a good way to value a business, that's fine. Not everyone is a value investor. For what it's worth, the market also doesn't believe you. Closed-end funds generally don't trade at NAV. Richard Speculation is a business? Speculation has free cash flow? Huh, I never saw it that way. I still don't agree. So how much of a multiple can Fairfax sell it's equity portfolio to you for? Are you saying the equity portfolio is a business with free cash flow? Can you buy my BAC shares for more than their market value? Please? I figure it's worth a try if you're willing -- you never know, perhaps you will.

This argument that capital gains shouldn't impact valuation makes no sense. The value of a business is the discounted value of its free cash flow. Suppose you were confident that Fairfax, without insurance operations, was able to reliably compound its book value at 1000% a year through investing. Saying, "that stock is worth book value" makes no sense because its future free cash flows are worth far more than that. It's irrelevant if you choose to value other companies in the industry on a sum of parts valuation. Given a choice between buying an index mutual fund at book value, and this "compounding 1000% every year" company at 4 times book value, I would take the latter every time. Richard Me thinks you are putting the cart before the horse. You value equities on FFH's books at a premium to what they trade for on the open market. You value the bonds on FFH's books at a premium to what they trade for on the open market. You do this because you think they have higher intrinsic value than what the market believes. You say, "Hey, if Fairfax thinks they're worth more... then I'll pay more today... even though the market doesn't yet see that value". Hey, do you want to buy some FAIRX at a premium to it's NAV while you are at it? Listen dude, you are supposed to enjoy the capital gains as they come in -- not pay for them ahead of time. Maybe Pabrai should have priced Dhandho at a premium to the very money that he was raising. Because, don't you know, they will be invested in undervalued stocks and therefore are worth a premium based on anticipated capital gains in the future. Uh huh... I don't agree.

So there is a chart in that article where the "projected cost" for batteries is $400 in 2014. It shows how the cost dropped below $500 two years ago. However, in the third paragraph of the article they say that "currently" they cost $500. How do they manage to print mistakes like this in Fortune magazine?

It isn't 1. Book value itself is a multiple to common equity of about 1.2x. Strip out the goodwill and intangibles and book value is $322 at latest report. So the USD price of $447 is 1.39x book value (after stripping out intangibles). I believe that's not too far off from the multiples they have been paying when they acquire wholly-owned insurance businesses from owners who know their operations really well. So perhaps it's close to the private-party valuation.

Maybe… But those insurance operations are here to stay. Actually, they are getting bigger and bigger (the majority of operating companies they have bought recently are in fact insurance companies). And the truth is they have $24 billion in assets with only $8 billion in equity, and a Total Debt / Total Capital ratio of merely 25%. And a 15% increase in equity is achievable with just a 6%-7% return on their portfolio of investments. This is a result of their insurance operations. Gio "just" a 6-7% return... I suppose the investment portfolio looks similar in makeup and management to that of a pension fund. Are pensions valued based on a 7% investment return right now? What rate is Sears Holdings allowed to use for it's pension fund?

Sum of the parts valuation, in other words. What sort of a premium will you pay for their fractional ownership in company X, when company X's shares trade on the open market. Zero. Let's say they invest all of their equity into just one company -- Bank of Ireland shares for example. Are you going to pay 1.3x book value for FFH (while arguing they are good at stock picking and thus it's a "business") when you could just pay 1.0x for Bank of Ireland shares directly instead?

Imo a business is nothing but a machine to generate earnings. If those earnings are retained, they go to increase equity. And at the end of the next 40 years all that matters is how much equity will have grown. What will be the source of those retained earnings that go to increase equity is irrelevant – IMO. Gio It would be a lot easier to explain the concept if we had them divest of the insurance operations and just invested the cash on the balance sheet. They would be making lots of money from capital gains, and you would be arguing that it was worth a huge premium to book value because after 20 years, you would say, all that would matter is how much the equity had grown over time. However everyone else could plainly see that it was just a portfolio of equities and would just price it as such. The market prices those equities every single day, and yes... to the market they are worth exactly what the market says they are worth. They are not worth a penny more simply because they are on the balance sheet of FFH.

Much of FFH's BV growth comes from capital gains -- which don't deserve a multiple IMO. I mean... suppose you find a mutual fund or hedge fund that grows "book value" at supernormal clip because the investor behind the scenes is generating a lot of capital gains. Well, those gains are not priced at a premium -- you invest in that fund for book value, no matter what... it doesn't matter what the past record of the investor is, it's still done at book value. So for what reason would you pay a premium for capital gains if it's a company instead of a mutual fund? There is no such reason. Thus, you need to strip out the capital gains from FFH's book value growth before you decide on a multiple -- IMO. You are paying a premium for a business -- and capital gains is not a business. Underwriting profit is a business. Investment income from float is a business. Capital gains is not.

In other words, why would they put a credit card balance on their books but not a secured mortgage?