Time to buy Fairfax again?

[Guest longinvestor]

my holding period is not forever.  i got a day job and i am investing money to send kids to university and retire in the next 10-15

years.. So this idea of lumpy returns where you make money once every ten years dont make sense and market and i will not pay premium for that.  buy brk and i can go to sleep and not worry,  i am not sure if  most of us can say that abt ffh.

+1

My thoughts exactly. Besides, I find it amazing that BRK continues to be misunderstood. Undervalued that is. This has gone on and off over the past 40 years. Mark my word, BRK during the recent financial crisis was trading at levels that will not happen in my remaining lifetime. Mother of all value investments and sound sleep comes attached.

[petec]

my holding period is not forever.  i got a day job and i am investing money to send kids to university and retire in the next 10-15

years.. So this idea of lumpy returns where you make money once every ten years dont make sense and market and i will not pay premium for that.  buy brk and i can go to sleep and not worry,  i am not sure if  most of us can say that abt ffh.

+1

My thoughts exactly. Besides, I find it amazing that BRK continues to be misunderstood. Undervalued that is. This has gone on and off over the past 40 years. Mark my word, BRK during the recent financial crisis was trading at levels that will not happen in my remaining lifetime. Mother of all value investments and sound sleep comes attached.

 

Completely agree and I also own BRK, although a) it is not now cheap like it was then and b) I know which will do better if there is a crisis!

[SharperDingaan]

"You are comparing how someone would value a mutual fund v/s a company. Isnt that a really dumb way of viewing it? "

 

Not at all. FFH has consistently valued at a BV multiple < peers, for a very long time, because it actually is a HF - whether we like to admit it or not. FFH is just an unusual variety of HF as it chooses to invest via the direct ownership of P&C's - which make the actual investments. Very smart way of doing things (float, liability protection, etc.), but they take the risk of being so clever (insurance vs simpler direct investment approach), that nobody else can follow what they are doing. So .... they suffer a handicap for the uncertainty. The tallest poppy in the room gets cut down - to make the rest of the room look better.

 

Obviously, the FFH model does work ... but with no direct comparable using a very similar model, how do you know if FFH is returning more, or less, than they should be? The nearest comparable is conventional P&C, plus a handicap for model difference & the uncertainty of the HF model itself.

 

SD

 

 

 

[giofranchi]

FFH has consistently valued at a BV multiple < peers, for a very long time, because it actually is a HF - whether we like to admit it or not.

 

This thread is about whether 1.15 x BVPS is FFH IV. If its IV is higher or lower than that.

HFs don’t enjoy the benefit of float.

Ask WB what he thinks about the value of float.

Ask PW what he thinks about the value of float.

Why is PW going on buying insurance companies all over the world if FFH is nothing but an HF??

 

Gio

 

 

[Guest longinvestor]

No one buys a stock & sits on it forever; not even a BRK - as sh1te happens routinely.

If WEB, or HW, had a heart attack tomorrow, the smart thing would be an immediate hedge.

 

FFH is not going to receive a high BV valuation, until it gets the HW black box, & its big investments, out of its structure. The HW black box is opaque, inherently more complex ('finite' risk coverage), hard to explain, & exposes them to short attack (why the FFH raid a few years back had legs). Their hedging & the investments also make them perform like a hedge fund - not an insurance firm (& why despite a sizeable favorable reserve release, & a historically benign payout a year or two back - they lost money - when they should have been making it hand over foot).

 

Even if you hold $1000 of shares trading daily in your subs portfolios, an equity investor will haircut 5-7.5% off that value - simply to recognize the potential costs of liquidation & wind-up if they need to get their money back; take an additional 5-7.5% off the valuation if there is a possibility of mystery wind-up obligations arising from the black box. FFH traded at 85-90% of BV, not that long ago - for a reason.

 

To get a premium, your insurance ops have to be easily comparable to peers - & win the comparison. Comparable CR, & history of being able to successfully acquire & integrate various books - a routine part of industry business. Not great at either, but at least getting better.

 

The HW team does add value, but they need to add 10-15% just to get past the structural drag. Good - but not good enough.

At current pricing at 115% of book, it implies they are currently adding around 25-30%.

 

SD

 

No one buys a stock and sits on it forever..,,not even BRK...

Not true. A number of folks have done just that. Perhaps not the kind that frequent this board.

 

If WEB / PW have a heart attack tomorrow, best to hedge....

Not necessarily. I cannot speak to PW/FFH but with WEB/BRK, beyond a temporary market reaction, I trust that the hedge is already put in place. The 1.2xBV floor and the cash hoard should do it. At today's BV, trading volume they can buyback for over four years straight. And cash keeps coming in at $15 B a year.

Of course, I'd be watching how the successor does to decide if the holding should be forever. But no knee-jerk rection warranted on my side.

[frommi]

The last time we had this discussion was a good time to buy FFH. :D

I can imagine that buying both and rebalance to 50/50 every now and then resulted in very good outcomes.

[ERICOPOLY]

Anyway, it is clear to me he thinks they are worth much more than BV.

 

Gio

 

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. 

[meiroy]

 

 

ERICOPOLY, SharperDingaan thank you for your contribution on this thread and your rational focus on a valuation method.  If I ever get emotional about one of my investments like people do about this company I hope someone like you would come and just slap me out of it.

 

 

[ERICOPOLY]

 

This thread is about whether 1.15 x BVPS is FFH IV.

 

 

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%.

 

[giofranchi]

 

This thread is about whether 1.15 x BVPS is FFH IV.

 

 

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

 

[ERICOPOLY]

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?

 

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.

 

[giofranchi]

Premium for the business operations (float, float growth, and underwriting profit), meanwhile no premium above market price for the marked-to-market holdings.

 

I guess you forgot management... Are you willing to pay to partner with a good entrepreneur?

 

Gio

[ERICOPOLY]

 

This thread is about whether 1.15 x BVPS is FFH IV.

 

 

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.

 

 

 

[ERICOPOLY]

Premium for the business operations (float, float growth, and underwriting profit), meanwhile no premium above market price for the marked-to-market holdings.

 

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.

[giofranchi]

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.

 

Mmm… Ok, let’s say he pays IV… even though you teach me a value investor always looks for a discount to IV, right?

Anyway, I don’t think he pays more than IV. And I would strip out intangibles and goodwill only if acquisitions wre made above IV.

 

Gio

 

[giofranchi]

They aren't paid?  I believe their pay is subtracted out of earnings, so we are paying for them.

 

;D ;D

 

Gio

[watsa_is_a_randian_hero]

This is my first post to this thread.  A pool/fund of investments can be worth more that their current market value to the extent (a) their is an expectation the manager will generate alpha, (b) the manager's fees are low enough that their is an expectation that the investor will enjoy the alpha generated on a "net of fees" basis, © the pool/fund of investments is closed to new investment (ie, not an open-ended mutual fund), and (d) the specific investments in the pool/fund are not disclosed and therefore cannot be replicated.

 

With regard to Fairfax:

 

A - Over the long term, the manager will likely generate alpha; however, over the short term this is uncertain (I happen to personally not believe in the hedges and sold off the majority of my equity position years ago because of this)

B - Fairfax management "fees" are below market for their services.  I would say this condition is satisfied.

C - Fairfax is technically closed for new investment on a day-to-day basis.  That said, the management has a history of frequently issuing new stock and it would not surprise me to see this done if a significant P/B multiple occurred.

D - Only the stocks are disclosed, and this only occurs on a quarterly basis; therefore this condition is partially satisfied. 

 

Considering all of the above, I would say there is not much reason that FFH should trade at a significant P/TBV based on its asset management track record alone.  Additionally, combining this with their track record on underwriting, a multiple of 1.1x to 1.25x on tangible book is the most I would pay until they remove their hedges or some other significant event happens. 

[ERICOPOLY]

Anyway, I don’t think he pays more than IV. And I would strip out intangibles and goodwill only if acquisitions wre made above IV.

 

Gio

 

 

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.

 

 

 

[giofranchi]

It's pretty exhausting to read what you are saying here.

 

Sorry, Eric, clearly don’t want to annoy you! ;)

I simply don’t understand why, if I haven’t overpaid for a business, I should strip-out the goodwill on my balance sheet to compute what I truly own.

 

Gio

 

[arbcon]

Gio...possibly another way of thinking this through is to say that eric is doing an invested capital analysis to better understand the sources of returns, or, if you will economic goodwill.

[giofranchi]

Gio...possibly another way of thinking this through is to say that eric is doing an invested capital analysis to better understand the sources of returns, or, if you will economic goodwill.

 

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

[Rabbitisrich]

 

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.

 

What if, instead of FFH, you were talking about the Medallion Fund? Would you refuse to pay more than the SOTP snapshot from a given day? It's likely that you would pay up until you felt you were getting your risk adjusted expected return, even if that meant paying for a premium over the day's portfolio value. In that case, management is not easily replaceable, and the strategies are not easily duplicable. Management quality has a value, and the accounting treatment looks like you apply it to the NAV, even though you are economically valuing future behavior.

 

That said, the above logic is totally consistent with refusing to pay a premium for FFH. It's just that rather than insisting that management behavior is always a neutral value, you value it at zero. Maybe you feel that Hamblin-Watsa is "replaceable", in the sense that you can replicate them in your own portfolio, as a free-rider or through alternative investments. But why would you assume that all potential management candidates are equivalent and neutral with respect to the potential pathways of NAV?

[arbcon]

gio....deciding whether you have paid or overpaid for a business is a decision made after you work through economic goodwill, not before.

[giofranchi]

gio....deciding whether you have paid or overpaid for a business is a decision made after you work through economic goodwill, not before.

 

And don't you think PW works through economic goodwill diligently enough?

 

Gio

[petec]

My views for what they are worth:

 

I agree with Gio that goodwill should not be stripped out unless you think PW overpaid, but I agree with what I think Eric is getting at, which is that if an asset (e.g. Zenith) is on Fairfax's balance sheet at 1.3x already (tangible+goodwill) then you shouldn't pay 1.3x *that* number for Fairfax unless you think PW *underpaid* for Zenith.  In other words, you're in danger of paying 1.3*1.3=1.69x for Zenith.  (Obviously this argument diminishes over time as Zenith'as earnings get capitalised, but this will be seen as goodwill decreasing as a % of Fairfax's BV unless more acquisitions are done.)

 

Sorry if I have misrepresented your views Eric.

 

On the issue of whether market holdings should be valued at market I also take a halfway position.  Clearly they should be valued at market because I could laboriously replicate the portfolio if I wanted, but equally I'm willing to pay not to have to do that, and for Watsa's ability to buy things for less than they are worth.  So I'll pay a small premium to book value for those securities, but not a big one because if I paid a big one I'd be paying up front and in full for future anticipated gains as Eric says.

 

I'm broadly of the opinion that today's BV is roughly fair value and beyond that I don't care much.  I think IV will rise over time, and rise a lot if there is a crisis, so I'm happy to keep adding on dips.  I'd love to say that I value it more thoroughly than that, but I don't.  My investing philosophy suits my mentality and it is to buy compounders for the very long term at roughly fair value and keep some cash for the occasional epic 5-year value trade when I see one.