Name your best 3 undervalued equities in Canada or U.S.

[Palantir]

Well, of course you are right… as far as history is concerned! But, paraphrasing Mr. Buffett, if history were all there is about investing, librarians would be the richest people on earth. Past results are very important, far from me saying the contrary! But, they are not everything. You must also judge the business model, the management, and the price. Only then you can make a bet on the future! And I like what I see in FFH: I believe the opportunities to markedly improve their underwriting performance are there and will be exploited.

Frank, do you really think you would be able to buy one of the best capital allocator out there at book value, if it were also the best underwriter?! No way, right? Think of it this way: on the underwriting front they have much room to “surprise” the market. And I see all the necessary premises in place, to achieve that: a great underwriting philosophy, a disciplined management, and troubles inherited from the past (see, for instance, Crum & Forster) that are constantly, albeit slowly, fading away.

 

giofranchi

 

Yeah but, if you buy above book value, you will not get the benefit of investment returns....say BV is going to compound at 10% annually, but you buy at 1.1xBV, what's your return?

 

For example, look at Loews, they're trading at a 20% discount to BV....and have similar growth record as FFH. Anyways this is outside my circle of competence...I'll stick to GOOG and PH.

[giofranchi]

Well, of course you are right… as far as history is concerned! But, paraphrasing Mr. Buffett, if history were all there is about investing, librarians would be the richest people on earth. Past results are very important, far from me saying the contrary! But, they are not everything. You must also judge the business model, the management, and the price. Only then you can make a bet on the future! And I like what I see in FFH: I believe the opportunities to markedly improve their underwriting performance are there and will be exploited.

Frank, do you really think you would be able to buy one of the best capital allocator out there at book value, if it were also the best underwriter?! No way, right? Think of it this way: on the underwriting front they have much room to “surprise” the market. And I see all the necessary premises in place, to achieve that: a great underwriting philosophy, a disciplined management, and troubles inherited from the past (see, for instance, Crum & Forster) that are constantly, albeit slowly, fading away.

 

giofranchi

 

Yeah but, if you buy above book value, you will not get the benefit of investment returns....say BV is going to compound at 10% annually, but you buy at 1.1xBV, what's your return?

 

For example, look at Loews, they're trading at a 20% discount to BV....and have similar growth record as FFH. Anyways this is outside my circle of competence...I'll stick to GOOG and PH.

 

Palantir,

I don’t think I understand your point… Mr. Watsa stated goal is to compound book value at 15% annualized. In the past he achieved a 23,5% annualized return since inception… If past results are indicative, maybe he will do better than 15% in the future! Anyway, if you by at 1,4 x book value in year 1, and the stock trades at 1,4 x book value in year 10, your annual return will be exactly 15% (or higher, if Mr. Watsa outperforms). Instead, if you buy at book value in year 1, and the stock trades at 1,4 book value in year 10, your annual return will be higher than 15%.

What I meant is that a company like FFH, which grew at an annualized rate of 23,5% for more than 25 years, deserves to trade at 1,4 x book value. It’s “fair value” should be around 1,4 x book value. So, right now you are getting a substantial discount, and your margin of safety is meaningful.

 

giofranchi

[ourkid8]

Very well said and I am looking very closely at FFH to substantially add to my position!!!  It seems many individuals on this board have a 1-3 year lense instead of looking out 10+ years. 

 

Well, of course you are right… as far as history is concerned! But, paraphrasing Mr. Buffett, if history were all there is about investing, librarians would be the richest people on earth. Past results are very important, far from me saying the contrary! But, they are not everything. You must also judge the business model, the management, and the price. Only then you can make a bet on the future! And I like what I see in FFH: I believe the opportunities to markedly improve their underwriting performance are there and will be exploited.

Frank, do you really think you would be able to buy one of the best capital allocator out there at book value, if it were also the best underwriter?! No way, right? Think of it this way: on the underwriting front they have much room to “surprise” the market. And I see all the necessary premises in place, to achieve that: a great underwriting philosophy, a disciplined management, and troubles inherited from the past (see, for instance, Crum & Forster) that are constantly, albeit slowly, fading away.

 

giofranchi

 

Yeah but, if you buy above book value, you will not get the benefit of investment returns....say BV is going to compound at 10% annually, but you buy at 1.1xBV, what's your return?

 

For example, look at Loews, they're trading at a 20% discount to BV....and have similar growth record as FFH. Anyways this is outside my circle of competence...I'll stick to GOOG and PH.

 

Palantir,

I don’t think I understand your point… Mr. Watsa stated goal is to compound book value at 15% annualized. In the past he achieved a 23,5% annualized return since inception… If past results are indicative, maybe he will do better than 15% in the future! Anyway, if you by at 1,4 x book value in year 1, and the stock trades at 1,4 x book value in year 10, your annual return will be exactly 15% (or higher, if Mr. Watsa outperforms). Instead, if you buy at book value in year 1, and the stock trades at 1,4 book value in year 10, your annual return will be higher than 15%.

What I meant is that a company like FFH, which grew at an annualized rate of 23,5% for more than 25 years, deserves to trade at 1,4 x book value. It’s “fair value” should be around 1,4 x book value. So, right now you are getting a substantial discount, and your margin of safety is meaningful.

 

giofranchi

[FrankArabia]

BRK has great underlying businesses. GEICO, sees, furniture mart, dairy queen etc. List of great businesses goes on and on, but nobody/or most (generalizing) is screaming about FFH because of its underlying business. People like this stock because its Prem Watsa and his amazing historical returns on the investment portfolio. Take that away and you got an average insurance operation(s).

 

FFH's underlying business (not investment portfolio) is mainly insurance from what I know. Given what I have seen, their insurance ops are not world class. I look at their combined ratios and they appear to be "average" though I did not go into all of the subs to see their peers. But I have seen combined ratios north of 100% more times than I would like.

 

Let me ask you, if you got the investment team at another insurance operation (SLF, MFC, GWO) operating at the healm of FFH would you still be bullish on FFH? of course not.

 

 

Well, of course you are right… as far as history is concerned! But, paraphrasing Mr. Buffett, if history were all there is about investing, librarians would be the richest people on earth. Past results are very important, far from me saying the contrary! But, they are not everything. You must also judge the business model, the management, and the price. Only then you can make a bet on the future! And I like what I see in FFH: I believe the opportunities to markedly improve their underwriting performance are there and will be exploited.

Frank, do you really think you would be able to buy one of the best capital allocator out there at book value, if it were also the best underwriter?! No way, right? Think of it this way: on the underwriting front they have much room to “surprise” the market. And I see all the necessary premises in place, to achieve that: a great underwriting philosophy, a disciplined management, and troubles inherited from the past (see, for instance, Crum & Forster) that are constantly, albeit slowly, fading away.

 

giofranchi

 

I think its important to look at history to see what is capable. Especially in businesses like insurance/banking, their historical record matters. unless its a situation like AIG (or other) where a turnaround is the main theme I will not pay market value for the business. LUK, L are also in similar boats and as Palantir points out is trading for even less.

 

EVERY insurance company talks about how their underwriting performance is safe, less risky, etc. Until I see evidence of this, I'm not going to assume and pay full value for it. Correct me if I am wrong but isn't the whole FFH record predicated on outsized investment returns?

 

I think at the end of the day, most people aren't buying FFH for its insurance. its the ability of Prem that is problably keeping this company from trading at 0.8 book. I agree however that improvements in the insurance is likely a free option, but I rather get AIG (0.6 TBV) for an insurance turnaround story.

[MrB]

Palantir,

I don’t think I understand your point… Mr. Watsa stated goal is to compound book value at 15% annualized. In the past he achieved a 23,5% annualized return since inception… If past results are indicative, maybe he will do better than 15% in the future! Anyway, if you by at 1,4 x book value in year 1, and the stock trades at 1,4 x book value in year 10, your annual return will be exactly 15% (or higher, if Mr. Watsa outperforms). Instead, if you buy at book value in year 1, and the stock trades at 1,4 book value in year 10, your annual return will be higher than 15%.

What I meant is that a company like FFH, which grew at an annualized rate of 23,5% for more than 25 years, deserves to trade at 1,4 x book value. It’s “fair value” should be around 1,4 x book value. So, right now you are getting a substantial discount, and your margin of safety is meaningful.

 

giofranchi

 

I don't fault your logic in general, but I will caution on the possibility that you might be driving while looking at the rear view mirror. An increasing capital base and low interest rate environment makes it almost impossible to replicate those returns without taking on significant more risk. The historical 15 years for Fairfax looks very different to the future 15 years when you use say 2007 as the midpoint.

Just something to consider.

[racemize]

I don't fault your logic in general, but I will caution on the possibility that you might be driving while looking at the rear view mirror. An increasing capital base and low interest rate environment makes it almost impossible to replicate those returns without taking on significant more risk. The historical 15 years for Fairfax looks very different to the future 15 years when you use say 2007 as the midpoint.

Just something to consider.

 

I agree--I'm hoping for 10-15% growth (similar for my BRK).  In the same vein, I'm not sure how easy it will be to have >15% from other securities as well, other than the current turn-arounds.

[ShahKhezri]

Actually, buying it for the insurance business is a better reason than the investment acumen going forward.  There are many people here that have been involved with the FFH story a lot longer than I have (pushing 5+ years). 

 

FFH has significantly added to their insurance operations since 2007...and through 5 years of soft market, we have yet to see these operations in a hard market (we haven't seen NB, Zenith potential yet).  I think people are looking for the next CDS gain, you will be dissapointed (not saying the deflation CDS is toast, it's a hedge).

 

 

[giofranchi]

BRK has great underlying businesses. GEICO, sees, furniture mart, dairy queen etc. List of great businesses goes on and on, but nobody/or most (generalizing) is screaming about FFH because of its underlying business. People like this stock because its Prem Watsa and his amazing historical returns on the investment portfolio. Take that away and you got an average insurance operation(s).

 

FFH's underlying business (not investment portfolio) is mainly insurance from what I know. Given what I have seen, their insurance ops are not world class. I look at their combined ratios and they appear to be "average" though I did not go into all of the subs to see their peers. But I have seen combined ratios north of 100% more times than I would like.

 

Let me ask you, if you got the investment team at another insurance operation (SLF, MFC, GWO) operating at the healm of FFH would you still be bullish on FFH? of course not.

 

 

Well, of course you are right… as far as history is concerned! But, paraphrasing Mr. Buffett, if history were all there is about investing, librarians would be the richest people on earth. Past results are very important, far from me saying the contrary! But, they are not everything. You must also judge the business model, the management, and the price. Only then you can make a bet on the future! And I like what I see in FFH: I believe the opportunities to markedly improve their underwriting performance are there and will be exploited.

Frank, do you really think you would be able to buy one of the best capital allocator out there at book value, if it were also the best underwriter?! No way, right? Think of it this way: on the underwriting front they have much room to “surprise” the market. And I see all the necessary premises in place, to achieve that: a great underwriting philosophy, a disciplined management, and troubles inherited from the past (see, for instance, Crum & Forster) that are constantly, albeit slowly, fading away.

 

giofranchi

 

I think its important to look at history to see what is capable. Especially in businesses like insurance/banking, their historical record matters. unless its a situation like AIG (or other) where a turnaround is the main theme I will not pay market value for the business. LUK, L are also in similar boats and as Palantir points out is trading for even less.

 

EVERY insurance company talks about how their underwriting performance is safe, less risky, etc. Until I see evidence of this, I'm not going to assume and pay full value for it. Correct me if I am wrong but isn't the whole FFH record predicated on outsized investment returns?

 

I think at the end of the day, most people aren't buying FFH for its insurance. its the ability of Prem that is problably keeping this company from trading at 0.8 book. I agree however that improvements in the insurance is likely a free option, but I rather get AIG (0.6 TBV) for an insurance turnaround story.

 

Frank,

I don’t invest in turnaround… FFH grew at an annualized rate of 23,5% since inception… AIG was bailed out by the US government just 4 years ago… I have not done my homework on AIG, so I cannot judge it (almost anybody on this board knows much more about AIG than me!), but I think I can agree with you, if you define AIG as a turnaround situation, while I could never agree with you, if you put FFH on the same level.

If you think of how an insurance company increases shareholders equity, the following formula applies:

 

T/S = (I/A)(1+R/S) + (U/P)(P/S)

 

Define:

T = Total after-tax return

I = Investment gain (or loss)

U = Underwriting profit (or loss)

P = Premium income

A = Total Assets

R = Reserves & Other Liabilities

S = Shareholders’ Equity

T/S = Total Return on Equity

 

(1 + R/S) is the “investment leverage factor”, while P/S is the “underwriting leverage factor”. For FFH, the “investment leverage factor” is more or less 2,2, while the “underwriting leverage factor” is less than 1… Anyone can understand why for almost any insurance and/or reinsurance company investment results are much more important than underwriting results (of course, there are the exceptions such as LRE…).

So, FFH has a proven track record of being one of the shrewdest capital allocator out there, which is, as I hoped I have shown, the most relevant part of its business; while being an average underwriter, with good opportunities to become also an above average underwriter in the near future. Do you really want to call it a turnaround situation?!

 

giofranchi

[tombgrt]

Giofranchi, first year BV increase was 180% in 1986 if I remember correct. The last 20 years was something of 16,xx% including a massive gain from the CDS bet and that was with a capital base that was a lot smaller.

 

I do believe FFH currently is positioned exactly as it should and with a lot of potential in increasing the volume in its insurance operations. But don't just assume 15% CAGR going forward is a given.

[giofranchi]

The historical 15 years for Fairfax looks very different to the future 15 years when you use say 2007 as the midpoint.

Just something to consider.

 

Yes, I agree MrB! And the first thing I pointed out is that Mr. Watsa stated goal is to compound book value at 15% annualized, far from what he achieved in the past. As racemize said, it could be even lower. Sincerely, I don’t know and I don’t even really care. I invest in businesses, because I like the business model, I like the management, and I like the price. Then, as they say, I let future returns take care of themselves.

 

giofranchi

[tombgrt]

The historical 15 years for Fairfax looks very different to the future 15 years when you use say 2007 as the midpoint.

Just something to consider.

 

Yes, I agree MrB! And the first thing I pointed out is that Mr. Watsa stated goal is to compound book value at 15% annualized, far from what he achieved in the past.

 

I just looked it up; 1,3% difference from the last 20 years. Just trying to be critical here giofranchi, I'm a big fan of Prem Watsa and his team. ;)

[racemize]

The historical 15 years for Fairfax looks very different to the future 15 years when you use say 2007 as the midpoint.

Just something to consider.

 

Yes, I agree MrB! And the first thing I pointed out is that Mr. Watsa stated goal is to compound book value at 15% annualized, far from what he achieved in the past.

 

I just looked it up; 1,3% difference from the last 20 years. Just trying to be critical here giofranchi, I'm a big fan of Prem Watsa and his team. ;)

 

Sorry, I didn't quite follow, what's the 1.3% difference apply to?

[tombgrt]

16,3% CAGR in BV in last 20 years for FFH against stated goal of 15% CAGR in the future. The difference is only 1,3% and not "far from what Prem achieved in the past" as giofranchi stated.

[txitxo]

Prem and his people show an exceptional understanding of how terrible this historical period is for investing. Have a look at this plot:

 

http://www.gurufocus.com/shiller-PE.php

 

Grass is green, the sky is blue, and in all major bear markets the Shiller P/E got close to 6 before the next bull market started. We are into the 13th year of a secular bear, with the US Shiller P/E at 22.7. Just do the numbers. Even with inflation it will take a long time to increase the denominator significantly, so stock prices will have to come down by 60-70% before this is over.

 

If you've read Ray Dalio or Richard Koo you know that it is extremely difficult to generate inflation in a major deleveraging like this, even creating lots of new money. The tendency is to have deflation. But imagine that at some point the Fed prints so much cash that they do provoke inflation. Even in that case stocks will still go down sharply for a couple years (like in 73-74) before they start to rebound and act as an inflation hedge.

 

So you can stay in cash, earning 1%, waiting for stock Armageddon, but in mortal fear of inflation. Or you can put a significant chunk of your portfolio into FFH, knowing that they will keep making you money due to their float leverage and investing abilities, and if the sky does fall down, they will know better than anybody when and how to change their long/short exposure. FFH is just the best hedge I know of against a next major >50% crash, specially in an environment with inflationary risks where you can't just sit on cash for years.

 

 

[giofranchi]

16,3% CAGR in BV in last 20 years for FFH against stated goal of 15% CAGR in the future. The difference is only 1,3% and not "far from what Prem achieved in the past" as giofranchi stated.

 

Of course, you are right tombgrt! But these things fluctuate! If you check just the year before (end of 2010), the 20 years CAGR in BV per share was 17,6%. At the end of 2009, it was surely even higher. Mr. Watsa is not dancing to the tune of the Central Banks of the world! So, right now we are suffering! It remains to see, if he and his team will be proven right or wrong: if they are right, returns will be satisfactory. No doubt about it.

 

giofranchi

[giofranchi]

Prem and his people show an exceptional understanding of how terrible this historical period is for investing. Have a look at this plot:

 

http://www.gurufocus.com/shiller-PE.php

 

Grass is green, the sky is blue, and in all major bear markets the Shiller P/E got close to 6 before the next bull market started. We are into the 13th year of a secular bear, with the US Shiller P/E at 22.7. Just do the numbers. Even with inflation it will take a long time to increase the denominator significantly, so stock prices will have to come down by 60-70% before this is over.

 

If you've read Ray Dalio or Richard Koo you know that it is extremely difficult to generate inflation in a major deleveraging like this, even creating lots of new money. The tendency is to have deflation. But imagine that at some point the Fed prints so much cash that they do provoke inflation. Even in that case stocks will still go down sharply for a couple years (like in 73-74) before they start to rebound and act as an inflation hedge.

 

So you can stay in cash, earning 1%, waiting for stock Armageddon, but in mortal fear of inflation. Or you can put a significant chunk of your portfolio into FFH, knowing that they will keep making you money due to their float leverage and investing abilities, and if the sky does fall down, they will know better than anybody when and how to change their long/short exposure. FFH is just the best hedge I know of against a next major >50% crash, specially in an environment with inflationary risks where you can't just sit on cash for years.

 

txitxo,

remember that you are talking to Americans and Canadians! They haven’t experienced a depression since the ‘30s!! But I am Italian, and you are Spanish: we know much better what depressions really are!!!  ;D ;D ;D

Ok, just joking! Anyway, I agree with all you have written.

 

giofranchi

[txitxo]

 

txitxo,

remember that you are talking to Americans and Canadians! They haven’t experienced a depression since the ‘30s!! But I am Italian, and you are Spanish: we know much better what depressions really are!!!  ;D ;D ;D

Ok, just joking! Anyway, I agree with all you have written.

 

giofranchi

Oh yes, we are world powers in that area :)

[FrankArabia]

Spanish and Italian babes are still the hottest.....Russian babes too....