Fairfax Valuation - $430

[thepupil]

Green is rolling 12 month correlation to the S&p500, blue is to the All Country World index

[frommi]

Green is rolling 12 month correlation to the S&p500, blue is to the All Country World index

 

Since this is such a nice graphic do you have one with TLT and FFH? I have this feeling that they are more correlated, but i have no easy way to check it.

[thepupil]

Ask and Ye Shall Receive.

 

Interpret these however you will. In my opinion they aren't overly useful and it's easier to just look at what FFH owns and the bets they have on and how that might work out in a number of scenarios (which is what everyone here is already doing).

[frommi]

Ask and Ye Shall Receive.

 

Interpret these however you will. In my opinion they aren't overly useful and it's easier to just look at what FFH owns and the bets they have on and how that might work out in a number of scenarios (which is what everyone here is already doing).

 

Thanks, looks like my feelings were bullshit! :)

[Aberhound]

I remember after two 1 in 100 year hurricanes in 2004 and 2005 and the loss from 9/11 in 2001 the market placed a large discount on Fairfax. What discount do people place on Fairfax due to exposure to 1) another 9/11 2) greater risks of hurricanes, winter storms and earthquakes during deep solar minimums. All you have to do is read history and you will see we have been living in a benign period.

[vinod1]

Vinod,

 

I think it is incorrect to assume that Fairfax's CR will be 100 going forward AND interest rates will remain at very depressed levels.  Both of those are independently reasonable assumptions, but together they fail, in my view, to account for the relationship between these two metrics.  If interest rates remain at very depressed levels, then all P&C insurers will see their ROE's plummet as higher yielding bonds mature and the proceeds are plowed into new bonds at the reduced rates.  Ultimately, this will bear itself out in lower CRs as companies, in writing business, demand higher prices to offset the lowered value of the float they are underwriting.  I believe that Prem has said a 95% CR is needed by the industry at current interest levels to achieve even a single digit ROE.  With Fairfax's ability, hard earned through time, to write at better rates than the industry, i think it would be very reasonable to assume some $500 million a year in underwriting profits if the low interest rates continue -- a sum that would obviously move the needle  considerably in your valuation.

 

bluedevil,

 

It is strange addressing politely with a "devil" tag. :)

 

I did think about this and agree with you to an extent, but the time frame for this to happen might be very far off.

 

Look at the P&C industry history. The industry as a whole generates low ROE. They know they need to underwrite profitably to generate good ROE, but they do not. Industry average CR's have been above 100 for a long time.

 

So why did the industry continue to underwrite at CR above 100 when ROE is poor?

 

Industry structure and incentives pretty much explain why. Buffett has written about this a zillion times.

 

I do agree CR and investment returns are not independent, but it going to take many years before you see some change in underwriting results.

 

Vinod

 

 

 

[vinod1]

 

2) U.S. economic growth picks up and inflation with it. Fairfax waits for another 2-3 years (maybe shorter) in the face of strengthening U.S. data before determining that their deflationary thesis has been invalidated. Fairfax re-risks their portfolio for a more normalized outlook and begins generating the $85 per share that I believe they can earn.

 

 

The way Prem talks about The Great Depression, about being cautious in 1925 and waiting through 1932, suggests he is going to wait a whole lot longer than 2 or 3 years. So I think he is going to stick to deflation camp for a very long time. A couple of years of inflation would seem similar to the way he had to wait for CDS bets to come through.

 

Vinod

[vinod1]

This being said, as I have already told Vinod, I think that simply saying “well, the indices have returned X for the past 30 years and FFH has returned Y… the indices are going to return X2 for the next 20 years, therefore FFH is going to return Y2” might be greatly misleading.

Instead, to judge the future prospects for any business, you should think hard about what that business has been in the past, and about what that business could become in the future. And imo FFH is becoming a much better business than it has ever been.

 

Cheers,

 

Gio

 

Gio,

 

To me the question is, is the business becoming so much better that the past does not provide a good guide to the future? To me, the answer is no.

 

Fairfax is moving in the right direction to a better more profitable niches of the insurance market and their India investment fund is a good move, but are likely to add 1% to 2% to their ROE.

 

As you mentioned we are looking at different things. I am looking for businesses that are likely to compound at attractive rates over the next 5 to 10 years in the base case with a low chance of permanent loss of capital.

 

Vinod

[TwoCitiesCapital]

 

2) U.S. economic growth picks up and inflation with it. Fairfax waits for another 2-3 years (maybe shorter) in the face of strengthening U.S. data before determining that their deflationary thesis has been invalidated. Fairfax re-risks their portfolio for a more normalized outlook and begins generating the $85 per share that I believe they can earn.

 

 

The way Prem talks about The Great Depression, about being cautious in 1925 and waiting through 1932, suggests he is going to wait a whole lot longer than 2 or 3 years. So I think he is going to stick to deflation camp for a very long time. A couple of years of inflation would seem similar to the way he had to wait for CDS bets to come through.

 

Vinod

 

You'd have to consider that 2-3 years on top of the years we've already been waiting which would be closer to 6-8 years at that point. The real "problem" is that the last 4-5 years have largely validated Prem's concerns.

 

*Commodities have been eviscerated

*Trillions in global stimulus still can't buy growth above 2% for the Western World

*Inflation has trended lower and lower and lower until it went negative for much of the developed world last quarter.

*Bond yields are significantly lower than they were 4-5 years ago and there are negative yields in Europe.

*The velocity of money continues to hit new lows every quarter.

*Wage growth has been totally stagnant

 

If you had a 2-3 years where inflation picked up, wage growth picked up, GDP prints at 3+%, and bonds yields begin rising then I think you have significantly more pressure to forget the deflationary thesis than you've had over the last 4-5 years where everything he was concerned about has generally occurred - and within his time-frame too as he's constantly mentioning that it took a few years for deflation to set-in during Japan's crisis.

 

I don't think that last 4-5 years of resilience and commentary in the face of confirming economic data can be used to predict how he would or wouldn't behave if that data was no longer confirming his concern.

 

 

 

 

[KinAlberta]

 

2) U.S. economic growth picks up and inflation with it. Fairfax waits for another 2-3 years (maybe shorter) in the face of strengthening U.S. data before determining that their deflationary thesis has been invalidated. Fairfax re-risks their portfolio for a more normalized outlook and begins generating the $85 per share that I believe they can earn.

 

 

The way Prem talks about The Great Depression, about being cautious in 1925 and waiting through 1932, suggests he is going to wait a whole lot longer than 2 or 3 years. So I think he is going to stick to deflation camp for a very long time. A couple of years of inflation would seem similar to the way he had to wait for CDS bets to come through.

 

Vinod

 

You'd have to consider that 2-3 years on top of the years we've already been waiting which would be closer to 6-8 years at that point. The real "problem" is that the last 4-5 years have largely validated Prem's concerns.

 

*Commodities have been eviscerated

*Trillions in global stimulus still can't buy growth above 2% for the Western World

*Inflation has trended lower and lower and lower until it went negative for much of the developed world last quarter.

*Bond yields are significantly lower than they were 4-5 years ago and there are negative yields in Europe.

*The velocity of money continues to hit new lows every quarter.

*Wage growth has been totally stagnant

 

If you had a 2-3 years where inflation picked up, wage growth picked up, GDP prints at 3+%, and bonds yields begin rising then I think you have significantly more pressure to forget the deflationary thesis than you've had over the last 4-5 years where everything he was concerned about has generally occurred - and within his time-frame too as he's constantly mentioning that it took a few years for deflation to set-in during Japan's crisis.

 

I don't think that last 4-5 years of resilience and commentary in the face of confirming economic data can be used to predict how he would or wouldn't behave if that data was no longer confirming his concern.

 

 

I don't think Watsa was soundly in the deflationary camp.  He saw it as a distinct possibility and so hedged for it.  I'd say that is a wise move - though generally costly.  Similarly holding a cash under certain market conditions is also a prudent move - though generally costly.

 

The economic conditions have indeed seemed to have revealed a deflationary bias.  Central bankers are in a big fight to offset it - though it would be very interesting to see how their books would revalue should they loose the battle.

 

 

[TwoCitiesCapital]

 

2) U.S. economic growth picks up and inflation with it. Fairfax waits for another 2-3 years (maybe shorter) in the face of strengthening U.S. data before determining that their deflationary thesis has been invalidated. Fairfax re-risks their portfolio for a more normalized outlook and begins generating the $85 per share that I believe they can earn.

 

 

The way Prem talks about The Great Depression, about being cautious in 1925 and waiting through 1932, suggests he is going to wait a whole lot longer than 2 or 3 years. So I think he is going to stick to deflation camp for a very long time. A couple of years of inflation would seem similar to the way he had to wait for CDS bets to come through.

 

Vinod

 

You'd have to consider that 2-3 years on top of the years we've already been waiting which would be closer to 6-8 years at that point. The real "problem" is that the last 4-5 years have largely validated Prem's concerns.

 

*Commodities have been eviscerated

*Trillions in global stimulus still can't buy growth above 2% for the Western World

*Inflation has trended lower and lower and lower until it went negative for much of the developed world last quarter.

*Bond yields are significantly lower than they were 4-5 years ago and there are negative yields in Europe.

*The velocity of money continues to hit new lows every quarter.

*Wage growth has been totally stagnant

 

If you had a 2-3 years where inflation picked up, wage growth picked up, GDP prints at 3+%, and bonds yields begin rising then I think you have significantly more pressure to forget the deflationary thesis than you've had over the last 4-5 years where everything he was concerned about has generally occurred - and within his time-frame too as he's constantly mentioning that it took a few years for deflation to set-in during Japan's crisis.

 

I don't think that last 4-5 years of resilience and commentary in the face of confirming economic data can be used to predict how he would or wouldn't behave if that data was no longer confirming his concern.

 

 

I don't think Watsa was soundly in the deflationary camp.  He saw it as a distinct possibility and so hedged for it.  I'd say that is a wise move - though generally costly.  Similarly holding a cash under certain market conditions is also a prudent move - though generally costly.

 

The economic conditions have indeed seemed to have revealed a deflationary bias.  Central bankers are in a big fight to offset it - though it would be very interesting to see how their books would revalue should they loose the battle.

 

I have a hard time imagining how they'll fight it. Very few of their policies make it through to the average consumer and the causes of their inability/unwillingness to purchases at current price levels.

 

Consider that bond yields rose or were flat through every period of QE and only fell when the QE stopped? Consider that the Euro area tried to talk down their currency for a long-time before the rumors of QE did it for them - now the currency is rising again despite the actual QE being done. Consider that credit is still not generally being taken out by consumers despite insanely low interest rates. I think it's pretty clear that the Central Bankers have never had the control over the economy that the "textbook economics" would suggest which is why all of these market responses have been opposite of what you'd have imagined.

 

A sustainable increase in after-tax take home pay is probably the one reliable way to achieve what the Fed has been attempting after the near-Depression scenario that occurred and none of their polices are really able to target that. That is the fiscal side and the fiscal side is constrained with gridlock and a massive deficit/debt to deal with.

 

 

 

[giofranchi]

Gio,

 

To me the question is, is the business becoming so much better that the past does not provide a good guide to the future? To me, the answer is no.

 

Fairfax is moving in the right direction to a better more profitable niches of the insurance market and their India investment fund is a good move, but are likely to add 1% to 2% to their ROE.

 

As you mentioned we are looking at different things. I am looking for businesses that are likely to compound at attractive rates over the next 5 to 10 years in the base case with a low chance of permanent loss of capital.

 

Vinod

 

Hi Vinod,

Imo those are the things anyone can plainly see and agree on.

 

As I have already told you, I think FFH’s overall strategy might be a little less evident: as asset prices will probably deflate at one time during the next 3-5 years, FFH will be best positioned to purchase productive assets very cheaply. Better positioned than anyone else I know of, actually!

 

That might be the beginning of a transformation into a much more diversified conglomerate of high quality businesses, which will more closely resemble what Berkshire is today.

 

If successful, certainly FFH’s stock price doesn’t reflect such a scenario. And personally I don’t know of many businesses with higher opportunities of compounding capital over the next 5-10 years (if the scenario I have described comes to pass, the best case for FFH), nor with a lower risk of permanent loss of capital (if the scenario I have described never materializes, the worst case for FFH).

 

But, please, let me know which businesses you are investing in! So that I might look at them, and better understand what you mean! If I like them, as I have always said, I might decide to sell some FFH to buy those businesses. ;)

 

Cheers,

 

Gio

 

[Guest notorious546]

http://www.beyondproxy.com/insurance-companies-and-the-power-of-float/

 

 

[vinod1]

Gio,

 

To me the question is, is the business becoming so much better that the past does not provide a good guide to the future? To me, the answer is no.

 

Fairfax is moving in the right direction to a better more profitable niches of the insurance market and their India investment fund is a good move, but are likely to add 1% to 2% to their ROE.

 

As you mentioned we are looking at different things. I am looking for businesses that are likely to compound at attractive rates over the next 5 to 10 years in the base case with a low chance of permanent loss of capital.

 

Vinod

 

Hi Vinod,

Imo those are the things anyone can plainly see and agree on.

 

As I have already told you, I think FFH’s overall strategy might be a little less evident: as asset prices will probably deflate at one time during the next 3-5 years, FFH will be best positioned to purchase productive assets very cheaply. Better positioned than anyone else I know of, actually!

 

That might be the beginning of a transformation into a much more diversified conglomerate of high quality businesses, which will more closely resemble what Berkshire is today.

 

If successful, certainly FFH’s stock price doesn’t reflect such a scenario. And personally I don’t know of many businesses with higher opportunities of compounding capital over the next 5-10 years (if the scenario I have described comes to pass, the best case for FFH), nor with a lower risk of permanent loss of capital (if the scenario I have described never materializes, the worst case for FFH).

 

But, please, let me know which businesses you are investing in! So that I might look at them, and better understand what you mean! If I like them, as I have always said, I might decide to sell some FFH to buy those businesses. ;)

 

Cheers,

 

Gio

 

Hi Gio,

 

It could be we differ in our expectations.

 

In a deflation/stock market crash scenario, I fully agree that Fairfax would be a tremendous beneficiary. This seems to be your base case.

 

But what if this does not take place? In such a case, Fairfax would not even be compounding at high single digits. This is my base case since I do not have any particular view of the future.

 

Vinod

[vinod1]

 

But, please, let me know which businesses you are investing in! So that I might look at them, and better understand what you mean! If I like them, as I have always said, I might decide to sell some FFH to buy those businesses. ;)

 

Cheers,

 

Gio

 

I am invested in big banks and smaller positions that span the spectrum - but hardly the owner operator type you are looking. Even these I am slowly reducing my positions as they appreciated, so not super attractive right now.

 

Vinod

[giofranchi]

Hi Gio,

 

It could be we differ in our expectations.

 

In a deflation/stock market crash scenario, I fully agree that Fairfax would be a tremendous beneficiary. This seems to be your base case.

 

But what if this does not take place? In such a case, Fairfax would not even be compounding at high single digits. This is my base case since I do not have any particular view of the future.

 

Vinod

 

Fortunately, we can put together a “portfolio” of investments… And certainly I am not saying FFH is my only investment!

But I disagree with your base scenario “because you don’t have any particular view of the world”… Instead, to be invested in big banks you must have a very clear view of how the world is going to be 10 years from now… Because in a deflationary environment big banks will suffer much!

I on the contrary own both investments that I think will do well if a muddle through scenario goes on, and an investment in FFH that will do well in case of deflation. In other words, I believe FFH has a place especially in the portfolios of those who claim not to have “any particular view of the world”! ;)

 

Cheers,

 

Gio

 

[vinod1]

Hi Gio,

 

It could be we differ in our expectations.

 

In a deflation/stock market crash scenario, I fully agree that Fairfax would be a tremendous beneficiary. This seems to be your base case.

 

But what if this does not take place? In such a case, Fairfax would not even be compounding at high single digits. This is my base case since I do not have any particular view of the future.

 

Vinod

 

Fortunately, we can put together a “portfolio” of investments… And certainly I am not saying FFH is my only investment!

But I disagree with your base scenario “because you don’t have any particular view of the world”… Instead, to be invested in big banks you must have a very clear view of how the world is going to be 10 years from now… Because in a deflationary environment big banks will suffer much!

I on the contrary own both investments that I think will do well if a muddle through scenario goes on, and an investment in FFH that will do well in case of deflation. In other words, I believe FFH has a place especially in the portfolios of those who claim not to have “any particular view of the world”! ;)

 

Cheers,

 

Gio

 

Gio,

 

I am comfortable enough to hold the big banks under a variety of scenarios. So I really do not have a view on how deflation/inflation plays out in future.

 

I understand portfolio part, but just focusing on Fairfax. I am not saying Fairfax does not make sense for you or someone else who wants part of the portfolio to do well in a deflation scenario sort of like a hedge. All I am saying is, if deflation scenario does not play out, the returns from Fairfax are likely to be unattractive. Since I do not have any particular view of the future, I see no reason to weigh the deflation scenario heavily, as you seem to be doing.

 

You repeatedly point out how Fairfax is going to make billions in a deflation scenario that it gets to deploy when asset prices collapse. That a very specific view of the future.

 

Vinod

 

 

[giofranchi]

You repeatedly point out how Fairfax is going to make billions in a deflation scenario that it gets to deploy when asset prices collapse. That a very specific view of the future.

 

I wouldn’t call it “a very specific view of the future”… That imo is a fact! ;)

 

Instead, how big banks are going to do very fine, if interest rates stay low and asset prices deflate, is more difficult for me to understand… But I admit I don’t follow them closely, and therefore I might be missing something important.

 

Cheers,

 

Gio

 

[tombgrt]

As someone else stated before (and others probably have before as well), the deflation bet wasn't as much a bet as a hedge. Without them, they would suffer horribly in a protracted deflation scenario. Watsa wanted insurance against that happening and only later seemed to have taken on more because he believed it to be more likely. I don't believe they would recoup all their opportunity cost of the last 5 years. The same is true for the equity hedges. Again not a bet but more a very conservative stance because things could (emphasis on could here...) get ugly and that would be a serious treat to the further existence of Fairfax as a whole.

 

I don't agree that someone who is agnostic about the future should buy Fairfax. If you follow that reasoning, you could just as well also buy something that is bound to do well in very inflationary periods but mediocre/poor in a low inflation/deflation environment. So all you are doing then is diversificating macro risks that might happen by buying securities that will do mediocre at best if nothing extraordinary happens. And if something extraordinary does happen and one of your positions does great, your others will falter. You are essentially creating the risk that your portfolio will do mediocre in most scenario's if you ask me. Betting on those very specific views of the future (as vinod1 called it) is bound to lower returns on average. Isn't it more sensible to just buy cheap stuff and learn to stop worrying? ;) That or you can take a ballsy call in either macro direction but we were talking about agnostic investors on a macro level. So to conclude, this is kinda my point: you don't take a meaningful position in Fairfax now if you are a macro agnostic, that doesn't make sense.

[giofranchi]

1) I have great businesses that will do very well in a muddle through scenario or in an inflationary scenario, and will behave satisfactorily in a deflationary scenario;

2) I have at least one great business that will do very well in a deflationary scenario, and will behave satisfactorily in a muddle through scenario (like the last 5 years during which I have made enough money in FFH!).

 

To acknowledge the possibility of a deflationary scenario with financial assets that might deflate in the future is as much macro as not acknowledging such a possibility. But imo it is much more cautious!

 

While:

Isn't it more sensible to just buy cheap stuff and learn to stop worrying?

Is simply wishful thinking... if you ask me! ;)

 

Gio

[cwericb]

Just my two cents worth. Fairfax represents a significant part of my investments.

 

They have done quite well under present conditions and I see no reason why they shouldn’t continue to do so. They are expanding and diversifying constantly with both their insurance business and their investments.

 

Certainly there will always be other companies who will do better going forward, but Fairfax should continue to do well.

 

However, should we encounter a period of deflation, many of those other companies may suffer and give up their gains. Since I'm a bit lazy and don’t consider myself an astute enough investor to hedge my investments, I allow Fairfax to do this for me.

 

I’m not banking on Fairfax making billions with deflation, but I am thinking that if we hit a period of inflation the hedges will, at worst, help protect FFH’s value and at best perhaps help make up for potential losses in my other investments.

 

 

[giofranchi]

They have done quite well under present conditions and I see no reason why they shouldn’t continue to do so.

 

+1!

 

That's what I meant too.

 

Cheers,

 

Gio

[cwericb]

I might also add that FFH also acts as a hedge against the U.S. dollar.

[vinod1]

You repeatedly point out how Fairfax is going to make billions in a deflation scenario that it gets to deploy when asset prices collapse. That a very specific view of the future.

 

I wouldn’t call it “a very specific view of the future”… That imo is a fact! ;)

 

Instead, how big banks are going to do very fine, if interest rates stay low and asset prices deflate, is more difficult for me to understand… But I admit I don’t follow them closely, and therefore I might be missing something important.

 

Cheers,

 

Gio

 

I was probably not clear. The specific view of the future is the deflation scenario playing out in the next few years. You seem to think that as likely and having that view, I can completely understand why Fairfax would be attractive.

 

As far as big banks are concerned, sure they would not make as much money in a deflation scenario, but they would come our alright. Their capital levels are in the best shape possible, they are furiously reducing expenses, revenues are depressed not just from interest rates but from a lots of other factors, so they have lots of room to do reasonable well come what may.

 

Vinod

[giofranchi]

As far as big banks are concerned, sure they would not make as much money in a deflation scenario, but they would come our alright. Their capital levels are in the best shape possible, they are furiously reducing expenses, revenues are depressed not just from interest rates but from a lots of other factors, so they have lots of room to do reasonable well come what may.

 

Ok! Nothing to argue with that!

 

Cheers,

 

Gio