LRE.L - Lancashire Holdings Ltd

[original mungerville]

Giofranchi,

 

I am a little behind on this one as I was precluded from investing in global financials for the last 3 years due to my day job. That problem ends in about 10 days and I am interested in Lancashire. It seems it could perform well regardless of the economic/financial scenario that plays out - this is attractive to me.

 

Given you have just purchased more, I was hoping to understand your valuation thesis.

 

For the regular business, are we looking at roughly a 10% yield based on the current share price. And now to this, this new venture has been added which will add some growth. If so, how much are you expecting this new business to add to this current share price yield, for example looking 2-3 years forward but based on the current share price?

 

Any help from you or others would be appreciated as I continue to read up on Lancashire.

 

Thanks.

[giofranchi]

Giofranchi,

 

I am a little behind on this one as I was precluded from investing in global financials for the last 3 years due to my day job. That problem ends in about 10 days and I am interested in Lancashire. It seems it could perform well regardless of the economic/financial scenario that plays out - this is attractive to me.

 

Given you have just purchased more, I was hoping to understand your valuation thesis.

 

For the regular business, are we looking at roughly a 10% yield based on the current share price. And now to this, this new venture has been added which will add some growth. If so, how much are you expecting this new business to add to this current share price yield, for example looking 2-3 years forward but based on the current share price?

 

Any help from you or others would be appreciated as I continue to read up on Lancashire.

 

Thanks.

 

Hi original mungerville,

of course twacowfca is the one to ask about LRE, I only follow in his footsteps… And he knows and understands LRE much better than I do. I will try anyway to tell you my thesis.

 

First of all, and most importantly, I think about LRE as the third operating business of mine. Like the first two (engineering services and for-profit higher education), its greatest appeal to me is that LRE produces cash. In the last paper by Charles Gave (another Charles I listen to very attentively :) ), that I have just posted in the macro musings thread, he has written:

 

Charles, you will never get rich in this business using other people’s money. Do NOT leverage your positions. Leverage might be all right for fellows who deal in real estate, but for those in stock markets, it only brings misery.

 

And that is precisely why I think that to possess sources of new capital, capital that is YOURS and not borrowed, is something extremely important, yet most often undervalued. And whenever I am able to add one such source, I will always do it.

If there is trouble with the market, I will surely be grateful for a business that keeps generating cash, and gives that cash to me to scoop up great bargains!

 

Now, to the valuation question: 755 Gbp equal to 7.55 x 1.56 = $11.8, which is 1.64 x BVPS. An historical ROE of 19% gives you a current yield of 19 / 1.64 = 11.6%. Most of which will be paid out in dividends (cash generating machine), but, when the opportunity is really worthwhile, it will also be used for growth (see, for instance, the recent acquisition of Cathedral). And, reinvesting the dividends, BVPS has only to grow at a CAGR of little more than 3%, to achieve a 15% compounded annual return. Of course, taxes on dividends will be a drag on performance, but here again LRE enjoys an extremely favorable tax regime! :)

 

If Mr. Brindle & Co. keep performing, I don’t think it is too optimistic to expect a 15% compounded annual return (LRE is still relatively small, and the specialty insurance market around the world is huge). But even if I were to settle for less, I would do it: imo, to possess means that keep generating cash is just too important for investment long-term success. Also, I will gladly keep on averaging down as the market allows me to do, lowering my average cost and increasing my yield.

 

This is my view about LRE, and I hope it helps… Now, ask twacowfca! ;)

 

giofranchi

 

[twacowfca]

Giofranchi,

 

I am a little behind on this one as I was precluded from investing in global financials for the last 3 years due to my day job. That problem ends in about 10 days and I am interested in Lancashire. It seems it could perform well regardless of the economic/financial scenario that plays out - this is attractive to me.

 

Given you have just purchased more, I was hoping to understand your valuation thesis.

 

For the regular business, are we looking at roughly a 10% yield based on the current share price. And now to this, this new venture has been added which will add some growth. If so, how much are you expecting this new business to add to this current share price yield, for example looking 2-3 years forward but based on the current share price?

 

Any help from you or others would be appreciated as I continue to read up on Lancashire.

 

Thanks.

 

Hi original mungerville,

of course twacowfca is the one to ask about LRE, I only follow in his footsteps… And he knows and understands LRE much better than I do. I will try anyway to tell you my thesis.

 

First of all, and most importantly, I think about LRE as the third operating business of mine. Like the first two (engineering services and for-profit higher education), its greatest appeal to me is that LRE produces cash. In the last paper by Charles Gave (another Charles I listen to very attentively :) ), that I have just posted in the macro musings thread, he has written:

 

Charles, you will never get rich in this business using other people’s money. Do NOT leverage your positions. Leverage might be all right for fellows who deal in real estate, but for those in stock markets, it only brings misery.

 

And that is precisely why I think that to possess sources of new capital, capital that is YOURS and not borrowed, is something extremely important, yet most often undervalued. And whenever I am able to add one such source, I will always do it.

If there is trouble with the market, I will surely be grateful for a business that keeps generating cash, and gives that cash to me to scoop up great bargains!

 

Now, to the valuation question: 755 Gbp equal to 7.55 x 1.56 = $11.8, which is 1.64 x BVPS. An historical ROE of 19% gives you a current yield of 19 / 1.64 = 11.6%. Most of which will be paid out in dividends (cash generating machine), but, when the opportunity is really worthwhile, it will also be used for growth (see, for instance, the recent acquisition of Cathedral). And, reinvesting the dividends, BVPS has only to grow at a CAGR of little more than 3%, to achieve a 15% compounded annual return. Of course, taxes on dividends will be a drag on performance, but here again LRE enjoys an extremely favorable tax regime! :)

 

If Mr. Brindle & Co. keep performing, I don’t think it is too optimistic to expect a 15% compounded annual return (LRE is still relatively small, and the specialty insurance market around the world is huge). But even if I were to settle for less, I would do it: imo, to possess means that keep generating cash is just too important for investment long-term success. Also, I will gladly keep on averaging down as the market allows me to do, lowering my average cost and increasing my yield.

 

This is my view about LRE, and I hope it helps… Now, ask twacowfca! ;)

 

giofranchi

 

That's a good summary.  Lancashire has almost all the important success forces going for it: A relatively young CEO who has achieved the same 19.5% returns since the mid 1980's and a select staff who have learned from the master how to do what he has done.  A solid business with lots of mini moats and the nimbleness to plug any holes in their dikes that might spring a leak or move to higher ground as necessary to adjust to conditions. 

 

The one thing lacking is,paradoxically, their motivation for success. The P&C industry isn't kind to mediocre companies. They have to keep earning their wings to be able to soar.  :)

[giofranchi]

original mungerville,

another way to look at Lancashire’s valuation:

If it keeps posting ROEs of nearly 20%, and you reinvest the dividends, and in 10 years it is still trading at 1.64 x BV, you will enjoy a CAGR of nearly 20%.

If you are more concerned about “valuation risk” than “business risk”, ask yourself: why a contraction in multiple should be justified? The S&P500 is selling for 2.54 x BV with an average ROE of 13%; Lancashire instead is selling for 1.64 x BV with an average ROE of 20%! Without a serious deterioration in their business performance, I don’t see why a contraction in multiple should come to pass. And 10 years from now Mr. Brindle at 60 will still be relatively young and at the top of his game! :)

 

giofranchi

 

[twacowfca]

original mungerville,

another way to look at Lancashire’s valuation:

If it keeps posting ROEs of nearly 20%, and you reinvest the dividends, and in 10 years it is still trading at 1.64 x BV, you will enjoy a CAGR of nearly 20%.

If you are more concerned about “valuation risk” than “business risk”, ask yourself: why a contraction in multiple should be justified? The S&P500 is selling for 2.54 x BV with an average ROE of 13%; Lancashire instead is selling for 1.64 x BV with an average ROE of 20%! Without a serious deterioration in their business performance, I don’t see why a contraction in multiple should come to pass. And 10 years from now Mr. Brindle at 60 will still be relatively young and at the top of his game!

 

giofranchi

 

Exactly.  If one can buy a business at 1.6 times BV that has 20% compounded returns on BV and hold it for a decade or more, the returns will be quite satisfactory, especially if dividends can be reinvested in a tax advantaged account.

[plato1976]

curious why we had this conclusion ?

"it could perform well regardless of the economic/financial scenario that plays out - this is attractive to me."

 

 

Giofranchi,

 

I am a little behind on this one as I was precluded from investing in global financials for the last 3 years due to my day job. That problem ends in about 10 days and I am interested in Lancashire. It seems it could perform well regardless of the economic/financial scenario that plays out - this is attractive to me.

 

Given you have just purchased more, I was hoping to understand your valuation thesis.

 

For the regular business, are we looking at roughly a 10% yield based on the current share price. And now to this, this new venture has been added which will add some growth. If so, how much are you expecting this new business to add to this current share price yield, for example looking 2-3 years forward but based on the current share price?

 

Any help from you or others would be appreciated as I continue to read up on Lancashire.

 

Thanks.

[twacowfca]

curious why we had this conclusion ?

"it could perform well regardless of the economic/financial scenario that plays out - this is attractive to me."

 

 

Giofranchi,

 

I am a little behind on this one as I was precluded from investing in global financials for the last 3 years due to my day job. That problem ends in about 10 days and I am interested in Lancashire. It seems it could perform well regardless of the economic/financial scenario that plays out - this is attractive to me.

 

Given you have just purchased more, I was hoping to understand your valuation thesis.

 

For the regular business, are we looking at roughly a 10% yield based on the current share price. And now to this, this new venture has been added which will add some growth. If so, how much are you expecting this new business to add to this current share price yield, for example looking 2-3 years forward but based on the current share price?

 

Any help from you or others would be appreciated as I continue to read up on Lancashire.

 

Thanks.

 

Lancashire does have many advantages not shared by most companies or most insurers.  It is practically immune to having to pay significant income tax because it has the potential to re domicile if subjected to tax increases.  Their high quality, low duration portfolio will perform well in an increasing  interest rate regime while MTM investment losses if interest rates continue to rise will prompt other insurers to tighten up underwriting, increasing industry profitability in the domain where Lancashire makes most of their profits.  Then Lancashire could profit from increasing yields while competitors have their higher portfolio yields sapped by MTM losses.  :)

[bennycx]

"Their high quality, low duration portfolio will perform well in an increasing  interest rate regime"

 

Why is this? Might perform relatively well compared to others, but they will still suffer losses no?

[twacowfca]

"Their high quality, low duration portfolio will perform well in an increasing  interest rate regime"

 

Why is this? Might perform relatively well compared to others, but they will still suffer losses no?

 

No, with low average duration, about 1.3 years, their portfolio experiences very little MTM change with changes in interest rates. If needed, they could run off their entire portfolio in about 1.3years on average, and thus, quickly, recoup MTM portfolio losses as they potentially roll their holdings into higher yielding assets if interest rates rise.  :)

[plato1976]

But low duration also means low yield , and if rate doesn't rise or even fall again, their investment income will be quite poor, no ?

 

"Their high quality, low duration portfolio will perform well in an increasing  interest rate regime"

 

Why is this? Might perform relatively well compared to others, but they will still suffer losses no?

 

No, with low average duration, about 1.3 years, their portfolio experiences very little MTM change with changes in interest rates. If needed, they could run off their entire portfolio in about 1.3years on average, and thus, quickly, recoup MTM portfolio losses as they potentially roll their holdings into higher yielding assets if interest rates rise.  :)

[twacowfca]

But low duration also means low yield , and if rate doesn't rise or even fall again, their investment income will be quite poor, no ?

 

"Their high quality, low duration portfolio will perform well in an increasing  interest rate regime"

 

Why is this? Might perform relatively well compared to others, but they will still suffer losses no?

 

No, with low average duration, about 1.3 years, their portfolio experiences very little MTM change with changes in interest rates. If needed, they could run off their entire portfolio in about 1.3years on average, and thus, quickly, recoup MTM portfolio losses as they potentially roll their holdings into higher yielding assets if interest rates rise.  :)

 

 

Yes, In a perpetual low yield regime, their yield  would continue to be lower than most of their competitors, but they still benefit as competitors are forced to try to make money off their underwriting to compensate for their historically low investment returns. 

 

If investment yields rise, their competitors with much longer duration and more credit risk will suffer substantial MTM losses and defaults that will force them to continue trying to make some money on underwriting, thus keeping policy premiums high and especially benefitting Lancashire who make 80% of their profits off underwriting. 

 

With rising yields, Lancashire has optionality to quickly roll their quickly maturing portfolio into higher yielding assets of the same quality without experiencing significant MTM losses.  Very few competitors are in that same,  enviable situation.

 

Lancashire is in a situation termed convexity, meaning that they benefit disproportionately no matter what happens in most future scenarios for interest rates and defaults.

[giofranchi]

Hi Plato1976,

I suggest to reread Warren Buffett 2008 AL, where he explains how and why insurance had been their best performing business that year... You don't get out of bed and try to do business without insurance, even in a depression!

Lancashire increased BVPS 7.5% in 2008, when the market tanked more than 30%... That's my idea of outperformance!

And Lancashire is the insurance company which enjoys the largest percentage of its earnings derived from underwriting operations (as you can see from its leatest presentation for investors).

Hope this helps!

 

giofranchi

[bennycx]

But low duration also means low yield , and if rate doesn't rise or even fall again, their investment income will be quite poor, no ?

 

"Their high quality, low duration portfolio will perform well in an increasing  interest rate regime"

 

Why is this? Might perform relatively well compared to others, but they will still suffer losses no?

 

No, with low average duration, about 1.3 years, their portfolio experiences very little MTM change with changes in interest rates. If needed, they could run off their entire portfolio in about 1.3years on average, and thus, quickly, recoup MTM portfolio losses as they potentially roll their holdings into higher yielding assets if interest rates rise.  :)

 

 

Yes, In a perpetual low yield regime, their yield  would continue to be lower than most of their competitors, but they still benefit as competitors are forced to try to make money off their underwriting to compensate for their historically low investment returns. 

 

If investment yields rise, their competitors with much longer duration and more credit risk will suffer substantial MTM losses and defaults that will force them to continue trying to make some money on underwriting, thus keeping policy premiums high and especially benefitting Lancashire who make 80% of their profits off underwriting. 

 

With rising yields, Lancashire has optionality to quickly roll their quickly maturing portfolio into higher yielding assets of the same quality without experiencing significant MTM losses.  Very few competitors are in that same,  inviable situation.

 

Lancashire is in a situation termed convexity, meaning that they benefit disproportionately no matter what happens in most future scenarios for interest rates and defaults.

 

:X Isn't this a very complicated way of saying they make money from underwriting and not from investing?

[ASTA]

giofranchi, twacowfca

Just wanted to say thanks as I have 12% in this stock and both of you have been of great help.

I see this investment as a bond similar to brk.b or ffh. And always nice to partner with the best :D

[twacowfca]

But low duration also means low yield , and if rate doesn't rise or even fall again, their investment income will be quite poor, no ?

 

"Their high quality, low duration portfolio will perform well in an increasing  interest rate regime"

 

Why is this? Might perform relatively well compared to others, but they will still suffer losses no?

 

No, with low average duration, about 1.3 years, their portfolio experiences very little MTM change with changes in interest rates. If needed, they could run off their entire portfolio in about 1.3years on average, and thus, quickly, recoup MTM portfolio losses as they potentially roll their holdings into higher yielding assets if interest rates rise.  :)

 

 

Yes, In a perpetual low yield regime, their yield  would continue to be lower than most of their competitors, but they still benefit as competitors are forced to try to make money off their underwriting to compensate for their historically low investment returns. 

 

If investment yields rise, their competitors with much longer duration and more credit risk will suffer substantial MTM losses and defaults that will force them to continue trying to make some money on underwriting, thus keeping policy premiums high and especially benefitting Lancashire who make 80% of their profits off underwriting. 

 

With rising yields, Lancashire has optionality to quickly roll their quickly maturing portfolio into higher yielding assets of the same quality without experiencing significant MTM losses.  Very few competitors are in that same,  inviable situation.

 

Lancashire is in a situation termed convexity, meaning that they benefit disproportionately no matter what happens in most future scenarios for interest rates and defaults.

 

:X Isn't this a very complicated way of saying they make money from underwriting and not from investing?

 

Generally that's true, but it could get even better.  If yields increased substantially, they would likely continue to have the same outstanding underwriting returns or even better as described above.  But their investing returns likely would increase dramatically, again as described above.

 

Their historical average underwriting returns give them an edge as if they are the low cost producer or the company with the highest profit margin in their industry.  Think of their long term average combined ratio as being sort of like their cost of goods sold . . . As if they were selling something for  $1.00 that only cost them $0.60 to purchase, process and distribute to their customers.  Meanwhile, their competitors are barely breaking even or actually losing a little money on their sales of similar products, while trying to make up for those losses and squeeze out a small profit entirely from the float they get as customers make advance deposits far in advance of the delivery of the value of the product.

[giofranchi]

giofranchi, twacowfca

Just wanted to say thanks as I have 12% in this stock and both of you have been of great help.

I see this investment as a bond similar to brk.b or ffh. And always nice to partner with the best :D

 

Hi ASTA!

Of course, twacowfca is the one to thank! The work he has done building this awesome thread about Lancashire is just wonderful and gives the clear idea of how much he really has followed the company through its first years until today. How much he knows and understands its business.

As I have already said, I just follow in his steps!

 

What I find amazing about business and investing is that you don’t have to be Nole Djokovic, to achieve extraordinary results… You just have to learn how to recognize the Djokovices of this world and follow in their steps! ;)

 

Cheers!

 

giofranchi

 

[plato1976]

Thanks a lot ! Now I understands better...

btw, what happened to this great small insurer before 2009 - seems their stock were basically until late 2009 and they it began a steady rising. If they were compounding 20% per year but issuing a div of 10% per year how could the share price had no move....  maybe a stupid question :)

 

But low duration also means low yield , and if rate doesn't rise or even fall again, their investment income will be quite poor, no ?

 

"Their high quality, low duration portfolio will perform well in an increasing  interest rate regime"

 

Why is this? Might perform relatively well compared to others, but they will still suffer losses no?

 

No, with low average duration, about 1.3 years, their portfolio experiences very little MTM change with changes in interest rates. If needed, they could run off their entire portfolio in about 1.3years on average, and thus, quickly, recoup MTM portfolio losses as they potentially roll their holdings into higher yielding assets if interest rates rise.  :)

 

 

Yes, In a perpetual low yield regime, their yield  would continue to be lower than most of their competitors, but they still benefit as competitors are forced to try to make money off their underwriting to compensate for their historically low investment returns. 

 

If investment yields rise, their competitors with much longer duration and more credit risk will suffer substantial MTM losses and defaults that will force them to continue trying to make some money on underwriting, thus keeping policy premiums high and especially benefitting Lancashire who make 80% of their profits off underwriting. 

 

With rising yields, Lancashire has optionality to quickly roll their quickly maturing portfolio into higher yielding assets of the same quality without experiencing significant MTM losses.  Very few competitors are in that same,  enviable situation.

 

Lancashire is in a situation termed convexity, meaning that they benefit disproportionately no matter what happens in most future scenarios for interest rates and defaults.

[rjstc]

giofranchi, twacowfca

Just wanted to say thanks as I have 12% in this stock and both of you have been of great help.

I see this investment as a bond similar to brk.b or ffh. And always nice to partner with the best :D

 

Hi ASTA!

Of course, twacowfca is the one to thank! The work he has done building this awesome thread about Lancashire is just wonderful and gives the clear idea of how much he really has followed the company through its first years until today. How much he knows and understands its business.

As I have already said, I just follow in his steps!

 

What I find amazing about business and investing is that you don’t have to be Nole Djokovic, to achieve extraordinary results… You just have to learn how to recognize the Djokovices of this world and follow in their steps! ;)

 

Cheers!

 

giofranchi

 

++1

[twacowfca]

Thanks a lot ! Now I understands better...

btw, what happened to this great small insurer before 2009 - seems their stock were basically until late 2009 and they it began a steady rising. If they were compounding 20% per year but issuing a div of 10% per year how could the share price had no move....  maybe a stupid question :)

 

But low duration also means low yield , and if rate doesn't rise or even fall again, their investment income will be quite poor, no ?

 

"Their high quality, low duration portfolio will perform well in an increasing  interest rate regime"

 

Why is this? Might perform relatively well compared to others, but they will still suffer losses no?

 

No, with low average duration, about 1.3 years, their portfolio experiences very little MTM change with changes in interest rates. If needed, they could run off their entire portfolio in about 1.3years on average, and thus, quickly, recoup MTM portfolio losses as they potentially roll their holdings into higher yielding assets if interest rates rise.  :)

 

 

Yes, In a perpetual low yield regime, their yield  would continue to be lower than most of their competitors, but they still benefit as competitors are forced to try to make money off their underwriting to compensate for their historically low investment returns. 

 

If investment yields rise, their competitors with much longer duration and more credit risk will suffer substantial MTM losses and defaults that will force them to continue trying to make some money on underwriting, thus keeping policy premiums high and especially benefitting Lancashire who make 80% of their profits off underwriting. 

 

With rising yields, Lancashire has optionality to quickly roll their quickly maturing portfolio into higher yielding assets of the same quality without experiencing significant MTM losses.  Very few competitors are in that same,  enviable situation.

 

Lancashire is in a situation termed convexity, meaning that they benefit disproportionately no matter what happens in most future scenarios for interest rates and defaults.

 

There were six Bermuda Re IPO's after rates for wind catastrophe (re)insurance spiked six times higher after four cat 5 hurricanes hit the US in 2005.  They all had capable CEO's, but Mr. Market ignored the fact that only one of those leaders had a long underwriting record during a difficult time at Lloyd's that was an extraordinary outlier.  The stocks of those IPO's that were  publicly traded made no allowance for Brindle's unequaled  record until Lancashire surprised the market with superior returns after Hurricane Ike and the financial meltdown of 2008. :)

 

It's gratifying to see the recent interest in Lancashire.  Don't forget, however , that there will come a time when they will have a worse year than their peers by the luck of the draw.

[plato1976]

Nice. So the market ignored them for 4 years from 2005-2009 despite of their performance ?

Amazing...

twacowfca, you must have noticed this opp way before others -

what attracted your eyes ? It's a small corp after all. Just their performance (and then you dig into details), or you know this CEO is unusual from the very beginning...

 

 

Thanks a lot ! Now I understands better...

btw, what happened to this great small insurer before 2009 - seems their stock were basically until late 2009 and they it began a steady rising. If they were compounding 20% per year but issuing a div of 10% per year how could the share price had no move....  maybe a stupid question :)

 

But low duration also means low yield , and if rate doesn't rise or even fall again, their investment income will be quite poor, no ?

 

"Their high quality, low duration portfolio will perform well in an increasing  interest rate regime"

 

Why is this? Might perform relatively well compared to others, but they will still suffer losses no?

 

No, with low average duration, about 1.3 years, their portfolio experiences very little MTM change with changes in interest rates. If needed, they could run off their entire portfolio in about 1.3years on average, and thus, quickly, recoup MTM portfolio losses as they potentially roll their holdings into higher yielding assets if interest rates rise.  :)

 

 

Yes, In a perpetual low yield regime, their yield  would continue to be lower than most of their competitors, but they still benefit as competitors are forced to try to make money off their underwriting to compensate for their historically low investment returns. 

 

If investment yields rise, their competitors with much longer duration and more credit risk will suffer substantial MTM losses and defaults that will force them to continue trying to make some money on underwriting, thus keeping policy premiums high and especially benefitting Lancashire who make 80% of their profits off underwriting. 

 

With rising yields, Lancashire has optionality to quickly roll their quickly maturing portfolio into higher yielding assets of the same quality without experiencing significant MTM losses.  Very few competitors are in that same,  enviable situation.

 

Lancashire is in a situation termed convexity, meaning that they benefit disproportionately no matter what happens in most future scenarios for interest rates and defaults.

 

There were six Bermuda Re IPO's after rates for wind catastrophe (re)insurance spiked six times higher after four cat 5 hurricanes hit the US in 2005.  They all had capable CEO's, but Mr. Market ignored the fact that only one of those leaders had a long underwriting record during a difficult time at Lloyd's that was an extraordinary outlier.  The stocks of those IPO's that were  publicly traded made no allowance for Brindle's unequaled  record until Lancashire surprised the market with superior returns after Hurricane Ike and the financial meltdown of 2008. :)

 

It's gratifying to see the recent interest in Lancashire.  Don't forget, however , that there will come a time when they will have a worse year than their peers by the luck of the draw.

[twacowfca]

Nice. So the market ignored them for 4 years from 2005-2009 despite of their performance ?

Amazing...

twacowfca, you must have noticed this opp way before others -

what attracted your eyes ? It's a small corp after all. Just their performance (and then you dig into details), or you know this CEO is unusual from the very beginning...

 

 

Thanks a lot ! Now I understands better...

btw, what happened to this great small insurer before 2009 - seems their stock were basically until late 2009 and they it began a steady rising. If they were compounding 20% per year but issuing a div of 10% per year how could the share price had no move....  maybe a stupid question :)

 

But low duration also means low yield , and if rate doesn't rise or even fall again, their investment income will be quite poor, no ?

 

"Their high quality, low duration portfolio will perform well in an increasing  interest rate regime"

 

Why is this? Might perform relatively well compared to others, but they will still suffer losses no?

 

No, with low average duration, about 1.3 years, their portfolio experiences very little MTM change with changes in interest rates. If needed, they could run off their entire portfolio in about 1.3years on average, and thus, quickly, recoup MTM portfolio losses as they potentially roll their holdings into higher yielding assets if interest rates rise.  :)

 

 

Yes, In a perpetual low yield regime, their yield  would continue to be lower than most of their competitors, but they still benefit as competitors are forced to try to make money off their underwriting to compensate for their historically low investment returns. 

 

If investment yields rise, their competitors with much longer duration and more credit risk will suffer substantial MTM losses and defaults that will force them to continue trying to make some money on underwriting, thus keeping policy premiums high and especially benefitting Lancashire who make 80% of their profits off underwriting. 

 

With rising yields, Lancashire has optionality to quickly roll their quickly maturing portfolio into higher yielding assets of the same quality without experiencing significant MTM losses.  Very few competitors are in that same,  enviable situation.

 

Lancashire is in a situation termed convexity, meaning that they benefit disproportionately no matter what happens in most future scenarios for interest rates and defaults.

 

There were six Bermuda Re IPO's after rates for wind catastrophe (re)insurance spiked six times higher after four cat 5 hurricanes hit the US in 2005.  They all had capable CEO's, but Mr. Market ignored the fact that only one of those leaders had a long underwriting record during a difficult time at Lloyd's that was an extraordinary outlier.  The stocks of those IPO's that were  publicly traded made no allowance for Brindle's unequaled  record until Lancashire surprised the market with superior returns after Hurricane Ike and the financial meltdown of 2008. :)

 

It's gratifying to see the recent interest in Lancashire.  However, there will come a time when they will have a worse year than their peers by the luck of the draw.

 

In 2006 our investment record in common stocks and bonds had been perfect, too perfect, no significant permanent losses of capital on any holding over many years.  That's not as good as it seems as the market had generally been up, and we went entirely to cash before the market sold off in. 2000. 

 

Perfection is not necessarily optimal, so we began to test making investments that didn't meet every qualification on our strict value investing checklist. We discovered easy ways to lose money, but also a few ways to make money that we never would have tried before.  Lancashire was something we would not have bought before because it was an IPO, a disqualification under our formerly strict standards.

 

The story of how we came to make that purchase and add to that holding is available earlier on this thread.

[original mungerville]

Giofranchi and twacowfca,

 

Thank you very much for your responses, they were very helpful - in line with my thinking to a large degree. I really like the low exposure to financial markets / asset values and the low-cost producer position on the underwriting side.

 

At an 11.6% yield, its not bad in terms of future returns. I am wondering what kind of growth we can get from this new venture. I guess I have to analyze if book value can indeed grow 3-4% per year - as I would like to invest with a minimum 15% return. If you have views/analysis on whether this is possible going forward based on the current strategy, I would of course be very interested.

 

Very related to this, Giofranchi, I would point out that the below statement is incorrect:

 

"If it keeps posting ROEs of nearly 20%, and you reinvest the dividends, and in 10 years it is still trading at 1.64 x BV, you will enjoy a CAGR of nearly 20%."

 

This is not correct and is only true if the company reinvests retained earnings at book value (ie by definition this is how retained earnings are invested) or if you reinvest the dividend received at book value (which is unlikely to happen every year especially where the multiple to book is 1.64 at both the beginning and end of the 10 year period).

 

Rather, if you receive the 11.6% yield now and reinvest that dividend at 1.64X book value (or at an 11.6% yield relative to the share price), your return will always be 11.6% if you sell at 1.64x book in 10 years - not 20%. The only ways to get more than an 11.6% return buying at today's price is either 1) for ROE to increase further, 2) for book value to grow over time, 3) for you to sell at a higher price to book in 10 years, or 4) when you reinvest the dividend yields in the next 10 years, the share price is lower providing you with greater incremental yield, and then in the 10th year the price to book goes back to 1.64x. #2 is the one we should be analyzing in detail as the others are far less certain.

 

In summary, the math you cited only works when the dividends are reinvested at book value - by the company or by you.

 

 

 

 

[twacowfca]

Giofranchi and twacowfca,

 

Thank you very much for your responses, they were very helpful - in line with my thinking to a large degree. I really like the low exposure to financial markets / asset values and the low-cost producer position on the underwriting side.

 

At an 11.6% yield, its not bad in terms of future returns. I am wondering what kind of growth we can get from this new venture. I guess I have to analyze if book value can indeed grow 3-4% per year - as I would like to invest with a minimum 15% return. If you have views/analysis on whether this is possible going forward based on the current strategy, I would of course be very interested.

 

Very related to this, Giofranchi, I would point out that the below statement is incorrect:

 

"If it keeps posting ROEs of nearly 20%, and you reinvest the dividends, and in 10 years it is still trading at 1.64 x BV, you will enjoy a CAGR of nearly 20%."

 

This is not correct and is only true if the company reinvests retained earnings at book value (ie by definition this is how retained earnings are invested) or if you reinvest the dividend received at book value (which is unlikely to happen every year especially where the multiple to book is 1.64 at both the beginning and end of the 10 year period).

 

Rather, if you receive the 11.6% yield now and reinvest that dividend at 1.64X book value (or at an 11.6% yield relative to the share price), your return will always be 11.6% if you sell at 1.64x book in 10 years - not 20%. The only ways to get more than an 11.6% return buying at today's price is either 1) for ROE to increase further, 2) for book value to grow over time, 3) for you to sell at a higher price to book in 10 years, or 4) when you reinvest the dividend yields in the next 10 years, the share price is lower providing you with greater incremental yield, and then in the 10th year the price to book goes back to 1.64x. #2 is the one we should be analyzing in detail as the others are far less certain.

 

In summary, the math you cited only works when the dividends are reinvested at book value - by the company or by you.

 

Great reply.  Lancashire isn't the incredible buy at 1.64 * BV now that it was at BV only yesterday.  But its still about the same relative great value now as then as equity prices have risen a lot.  With the average P/B and P/E for the S&P500 being well above LRE's P/B and P/E, should LRE's multiples  rationally be lower . . . Or higher than the average company in all industries?

 

Mr. Market thinks LRE's P/B should be lower because it's in an industry that has experienced mediocre returns in recent years.  Is it not more reasonable to think that Lancashire should have a higher P/B or P/E than the average company because they have had better returns than almost all other stocks DESPITE being handicapped by being in an industry that has not performed very well until recently?

 

Don't bet the farm on Mr. Market's suddenly becoming a reasonable person. But, if Mr Market should decide that P&C Insurers deserve multiples that are merely average for all industries, it isn't a stretch to think that he might think that the best in that industry deserve above average multiples compared to the entire market.

[original mungerville]

I agree that relative to the overall market, Lancashire is cheap.

 

But I am wondering if I can get 15% return buying at this price (and not assuming price to book expansion over the next decade). For that, I need to figure out how much the business can grow over time (ie book value growth) and then add that to the dividend yield at today's price.

 

Any ideas how much this new venture could move the book value growth needle?

[twacowfca]

I agree that relative to the overall market, Lancashire is cheap.

 

But I am wondering if I can get 15% return buying at this price (and not assuming price to book expansion over the next decade). For that, I need to figure out how much the business can grow over time (ie book value growth) and then add that to the dividend yield at today's price.

 

Any ideas how much this new venture could move the book value growth needle?

 

Nothing definite. The new venture enhances optionality for making investments with high rates of return. Presently, they have two windows open to spot and participate in what Brindle calls, "lovely business", London (ex Lloyds) and Bermuda. Soon, they will be part of the inner sanctum of "The Club", the most interesting market of all, full of a large number of prospects from poor to mediocre to sweet.

 

Brindle knows the streets of The City and all the warrens of Lloyds. That is where he learned his craft.  Imagine someone who had been playing  at the highest level of World of Warcraft taking a sabattical and then returning to play, equipped with all the bells and whistles necessary for competing at the highest level. 

 

I think the expansion into Lloyds will provide opportunity to grow their business without lowering their historical ROE of about 19.4% per annum.  If they retain substantial earnings instead of paying all of them out as dividends and reinvest those funds at an average return of 19.4%, that would be a much greater benefit to shareholders than receiving all of the earnings as dividends and using those funds to buy more LRE shares at 1.6 * BV that might produce an owners earnings yield of about 12%.

 

If this happens, the intrinsic value of Lancashire will increase as retained earnings are reinvested at high rates of return and the market comes to understand that the number of udderly bovine cash cows in their dairy herd is increasing.    :)