Watsa on share buybacks

[obtuse_investor]

For those of you who couldn't or didn't resist the food being served outside the main hall (AGM Apr 11, 2013), the very last question was on share buybacks.

 

Prem mentioned that in the past that they have bought back large amounts when the time was right. Page 188 of the 2012 annual report confirms that.

 

He said that they are "price conscious". He then seemed to strongly imply that he expects the FFH share price to be lower at some point in the future.

 

Is it just me or did someone else notice this insinuation too? I should have voice recorded the whole question/answer period.

[Guest longinvestor]

For those of you who couldn't or didn't resist the food being served outside the main hall (AGM Apr 11, 2013), the very last question was on share buybacks.

Prem mentioned that in the past that they have bought back large amounts when the time was right. Page 188 of the 2012 annual report confirms that.

He said that they are "price conscious". He then seemed to strongly imply that he expects the FFH share price to be lower at some point in the future.

Is it just me or did someone else notice this insinuation too? I should have voice recorded the whole question/answer period.

I thought that was a very good question, esp being the last one to be asked! Prem answered it, somewhat circularly but rightfully was pressed by the questioner on why there were no buybacks recently.

 

My "gut" read on Prem's answer was that a buyback is coming soon. Similar to the "soon" implied in his take on deflation, market correction and a hard insurance market. They are poised for the "kill" ;)

 

 

 

[Guest longinvestor]

For those of you who couldn't or didn't resist the food being served outside the main hall (AGM Apr 11, 2013), the very last question was on share buybacks.

Prem mentioned that in the past that they have bought back large amounts when the time was right. Page 188 of the 2012 annual report confirms that.

He said that they are "price conscious". He then seemed to strongly imply that he expects the FFH share price to be lower at some point in the future.

Is it just me or did someone else notice this insinuation too? I should have voice recorded the whole question/answer period.

I thought that was a very good question, esp being the last one to be asked! Prem answered it, somewhat circularly but rightfully was pressed by the questioner on why there were no buybacks recently.

 

My "gut" read on Prem's answer was that a buyback is coming soon. Similar to the "soon" implied in his take on deflation, market correction and a hard insurance market. They are poised for the "kill" ;)

 

If Prem is right, we will be really really happy.

 

If he is wrong, we have to continue suffering the $10 div and 5% returns ::)

[obtuse_investor]

My "gut" read on Prem's answer was that a buyback is coming soon. Similar to the "soon" implied in his take on deflation, market correction and a hard insurance market. They are poised for the "kill" ;)

 

I have a similar "gut" feel.

 

As someone who is still in the midst building a position in FFH, I am not sure if I should stay in cash or load up on FFH now. I am not looking for answers-- just thinking out loud....

 

Looking at this fork in the road:

Prong #1: Deflationary spiral returns. Market selloff starts, causing FFH stock to drop too as Mr. Market forgets about their hedges.  Prem goes for the kill and issues buyback press release; and market shrugs and stock drops anyway. And there is the little me, happily competing with FFH buying back its stock at large discounts to book.

 

Prong #2: Deflationary spiral returns. Market selloff starts, causing FFH stock to rise as Mr. Market values their CPI and stock hedges. I continue sitting on the sidelines and miss out. Buybacks are never called because the price never quite came down enough.

 

Prong #3: Status quo. Mild inflation. Financial repression. My cash reserves lose value. Stock market goes even higher and sells at even larger PEs. FFH muddles along as their hedges decay completely. FFH produces half decent returns and it is all very lackluster.

 

If it is prong #1, cash is the place to be right now. If it is prong #2, buy FFH, now. If prong #3, FFH is not a bad place to be but there are better non-cash alternatives out there.

 

As Yogi Berra once said "When you come to a fork in the road, take it".

[Yours Truly]

Out of curiousity, instead of the current dividends, why didn't he forego those payments in favour of share buybacks?

[obtuse_investor]

Out of curiousity, instead of the current dividends, why didn't he forego those payments in favour of share buybacks?

 

Watsa didn't directly compare dividends with buybacks. He was a little cagey in his answer and implied that there may be higher yielding opportunities than the buybacks are currently offering.

 

On the question on dividends, he went into why he prefers to give out dividends. He said that he collects a flat salary of $600K and any performance bonus is received as a dividend. He believes that this is an egalitarian way to treat all shareholders.

 

Looks like the dividend is here to stay-- even though they are counting on the "kindness of strangers".

[Guest longinvestor]

My "gut" read on Prem's answer was that a buyback is coming soon. Similar to the "soon" implied in his take on deflation, market correction and a hard insurance market. They are poised for the "kill" ;)

I have a similar "gut" feel.

As someone who is still in the midst building a position in FFH, I am not sure if I should stay in cash or load up on FFH now. I am not looking for answers-- just thinking out loud....

Looking at this fork in the road:

Prong #1: Deflationary spiral returns. Market selloff starts, causing FFH stock to drop too as Mr. Market forgets about their hedges.  Prem goes for the kill and issues buyback press release; and market shrugs and stock drops anyway. And there is the little me, happily competing with FFH buying back its stock at large discounts to book.

Prong #2: Deflationary spiral returns. Market selloff starts, causing FFH stock to rise as Mr. Market values their CPI and stock hedges. I continue sitting on the sidelines and miss out. Buybacks are never called because the price never quite came down enough.

Prong #3: Status quo. Mild inflation. Financial repression. My cash reserves lose value. Stock market goes even higher and sells at even larger PEs. FFH muddles along as their hedges decay completely. FFH produces half decent returns and it is all very lackluster.

If it is prong #1, cash is the place to be right now. If it is prong #2, buy FFH, now. If prong #3, FFH is not a bad place to be but there are better non-cash alternatives out there.

As Yogi Berra once said "When you come to a fork in the road, take it".

Just pose similar scenarios with the stock market correction and the hard market and ride with Prem for the long term and follow Yogi Berra's tip and let Prem take the fork/s in the road/s and they will all lead to $$ and much happiness.  ;D

 

 

 

[Parsad]

Out of curiousity, instead of the current dividends, why didn't he forego those payments in favour of share buybacks?

 

Watsa didn't directly compare dividends with buybacks. He was a little cagey in his answer and implied that there may be higher yielding opportunities than the buybacks are currently offering.

 

On the question on dividends, he went into why he prefers to give out dividends. He said that he collects a flat salary of $600K and any performance bonus is received as a dividend. He believes that this is an egalitarian way to treat all shareholders.

 

Looks like the dividend is here to stay-- even though they are counting on the "kindness of strangers".

 

He's talked about the dividends alot in the past.  It's not just for him, but the many employees and long-term shareholders who have invested a considerable portion of their net worth into the company.  It allows them to hold on to their shares, even pass them to another generation, without having to sell them in return for income.  Cheers! 

[T-bone1]

I think a lot of us share the same frustration with Fairfax (the stock, not the company!), which is that many of the things that would be good for FFH (deflation, falling stock market, etc.) are likely to be bad for the trading price of FFH in the near term.

 

I want to buy more FFH, but I am inclined to wait because we are likely to see a situation like 2008, where the price goes down while the IV goes up.  I think Prem may have been saying the same thing, when he said that they are likely to buy a lot of stock back at some point in the future. 

 

I think the stock is very cheap near book value, and some of the cagey comments by Prem and others certainly suggests that they view it as very cheap to.  Time will tell if their patience will be rewarded again, but if it goes to 2X book without them having a chance to buy back shares, that's okay with me too.

[ERICOPOLY]

I'm normally extremely optimistic and bullish.  However I feel extremely cautious right now.

 

I have now hedged 85% of my BAC exposure at $12 strike, 2014 expiry.  The other 15% is hedged at $10 (2015).  I have replaced the downside with FFH.  I now have more FFH exposure (in terms of number of shares) than my peak exposure in 2006! 

 

Like most people, I feel FFH will also fall during a big crash (just like last time).  However, I'm just too much of an optimist to not be invested.  Cash burns a hole in my pocket.

 

[OakvilleInvestor]

ERICOPOLY, how do you replace the BAC downside with FFH? I don't see options for FFH in yahoo finance

[ERICOPOLY]

ERICOPOLY, how do you replace the BAC downside with FFH? I don't see options for FFH in yahoo finance

 

I hedged the BAC with $12 puts 2014 in my taxable.  In my RothIRA, I bought the BAC $12 2014 calls. 

 

That freed up my buying power to head back into FFH.

 

Worst case, FFH declines and I also lose the value of the BAC put.  I'm willing to eat that additional loss because I believe in the end BAC will turn out really well -- I just may have to roll calls along for a while.

 

I also today hedged 20% of notional with Russell 2000 puts.

 

This leaves me with:

100% notional long BAC  (85% hedged at $12 strike, and 15% hedged at $10 strike)

87% notional long FFH

20% notional short IWM (Russell 2000)

 

 

I didn't do this as a reaction to the markets today.  I did this after meeting another board member yesterday.  I talked about what I was doing and went home firmly convinced that it was still too risky.  So I planned to move the majority of the BAC puts to $12 and bought more FFH.  Then I decided to add the Russell 2000 puts.

 

I don't know, I just suddenly got extremely bearish.  Normally, I'm the most optimistic.  But I thought about how I'm usually the last to lose my nerve during bull markets, so I used that logic to convince myself that if I'm getting this nervous then it's time to do more than just worry about it.

 

[stahleyp]

When you guys talk about notional values, I'm not totally clear what you mean (I'm ashamed I don't know this...but hey, gotta ask to learn).

 

Would the notional value of 10 calls of BAC 2015s with a strike of $15 have a notional value of about $12,000 ($12 for current common price x 100 shares x 10 contracts). So, the calls are trading at $1. So the "real" cost is $1,000 and the notional is $12,000 value. Is that how that works?

[ERICOPOLY]

When you guys talk about notional values, I'm not totally clear what you mean (I'm ashamed I don't know this...but hey, gotta ask to learn).

 

Would the notional value of 10 calls of BAC 2015s with a strike of $15 have a notional value of about $12,000 ($12 for current common price x 100 shares x 10 contracts). So, the calls are trading at $1. So the "real" cost is $1,000 and the notional is $12,000 value. Is that how that works?

 

I don't know what the phrase is when they are out-of-the-money like the $15s are.  Maybe it's still "notional value" -- not sure.

 

I picked up the term from reading the Fairfax annual reports.

 

But just so you understand me, I bought the $100 strike IWM puts (Jan 2014 expiry).  For every 10 contracts I bought, it hedges $90,110 notional value because the index closed at $90.11.

 

 

[stahleyp]

cool. makes sense. As always, thanks Mr. Opoly! :)

[twacowfca]

ERICOPOLY, how do you replace the BAC downside with FFH? I don't see options for FFH in yahoo finance

 

I hedged the BAC with $12 puts 2014 in my taxable.  In my RothIRA, I bought the BAC $12 2014 calls. 

 

That freed up my buying power to head back into FFH.

 

Worst case, FFH declines and I also lose the value of the BAC put.  I'm willing to eat that additional loss because I believe in the end BAC will turn out really well -- I just may have to roll calls along for a while.

 

I also today hedged 20% of notional with Russell 2000 puts.

 

This leaves me with:

100% notional long BAC  (85% hedged at $12 strike, and 15% hedged at $10 strike)

87% notional long FFH

20% notional short IWM (Russell 2000)

 

 

I didn't do this as a reaction to the markets today.  I did this after meeting another board member yesterday.  I talked about what I was doing and went home firmly convinced that it was still too risky.  So I planned to move the majority of the BAC puts to $12 and bought more FFH.  Then I decided to add the Russell 2000 puts.

 

I don't know, I just suddenly got extremely bearish.  Normally, I'm the most optimistic.  But I thought about how I'm usually the last to lose my nerve during bull markets, so I used that logic to convince myself that if I'm getting this nervous then it's time to do more than just worry about it.

 

 

We bought a sizeable SPY put last week as a hedge.  We do this periodically when the market reaches a possible turning point.  Sometimes we win big on these, but more than half the time we have to eat a modest loss.

 

Why now?

 

1) "Sell in May, and go away",draws nigh.

 

2) higher taxes plus spending cuts are starting to bite.

 

3) the "Illustrious Ruler" demigod of N Korea may let the genie of war out of his bottle.  It's been quite some time since we've had a nuclear war.

 

4) The Fed is between a rock and a hard place.

 

5) 90% of portfolio managers who make decisions by anticipating what The Fed will do are between a rock and a hard place.

 

6) Valuations are high, entirely sustained by the biggest spigot of liquidity ever in the US.

 

7) etc. etc. etc.

 

 

[enoch01]

Doesn't anybody just plain sell stuff and hold cash nowadays!?  Every time I've thought about buying puts to hedge I think I must be making this too hard.  ;D

 

Currently sitting at 70% cash.

[ERICOPOLY]

Doesn't anybody just plain sell stuff and hold cash nowadays!?  Every time I've thought about buying puts to hedge I think I must be making this too hard.  ;D

 

Currently sitting at 70% cash.

 

Easy -- I am getting taxed at about 52% on the sale of my warrants.  So effectively, the puts are on sale for half off.

 

And what if BAC keeps rising to $15?  So the decision to go to cash is not so simple.

[LC]

I think the only reason to sell these days is #6 on twacowfca's list. I'm about 20% cash, but I want to increase that to about 30-40%. 

 

 

[obtuse_investor]

Doesn't anybody just plain sell stuff and hold cash nowadays!?  Every time I've thought about buying puts to hedge I think I must be making this too hard.  ;D

 

Currently sitting at 70% cash.

 

I am with you Enoch01. Whenever I have looked at hedging I don't like the price of the insurance and also the added complexity.

 

I am about 50% cash at this point.

 

 

[enoch01]

Doesn't anybody just plain sell stuff and hold cash nowadays!?  Every time I've thought about buying puts to hedge I think I must be making this too hard.  ;D

 

Currently sitting at 70% cash.

 

Easy -- I am getting taxed at about 52% on the sale of my warrants.  So effectively, the puts are on sale for half off.

 

And what if BAC keeps rising to $15?  So the decision to go to cash is not so simple.

 

Good point about the taxes.  My situation is different than yours.

 

I still have BAC common, also some MSFT and SD.  I sold all my BAC calls when they spiked recently.  I don't think it will act like a coiled spring as much as it did when it was below, say, $10.

 

 

[meiroy]

6) Valuations are high, entirely sustained by the biggest spigot of liquidity ever in the US.

 

 

Right. Did this change yesterday? No. Will it change in the near future? Very unlikely. Where will all those people who sold gold going to put the money? Yan? Yuan? Euro? Bitcoin? Commodities? Everyone starting to realize the real China story and its implications. US stocks are IT.

 

There is not going to be a real crash just yet, maybe a quick dip.

 

I'm still holding on.

 

[Fairfaxnut]

I can't predict markets, and I don't have as much cash available as mentioned above, but FFH accounts for 30% of our port.  I'm sleeping well.

[ERICOPOLY]

Doesn't anybody just plain sell stuff and hold cash nowadays!?  Every time I've thought about buying puts to hedge I think I must be making this too hard.  ;D

 

Currently sitting at 70% cash.

 

Easy -- I am getting taxed at about 52% on the sale of my warrants.  So effectively, the puts are on sale for half off.

 

And what if BAC keeps rising to $15?  So the decision to go to cash is not so simple.

 

Good point about the taxes.  My situation is different than yours.

 

I still have BAC common, also some MSFT and SD.  I sold all my BAC calls when they spiked recently.  I don't think it will act like a coiled spring as much as it did when it was below, say, $10.

 

You are right about it not being a coiled spring anymore.

 

I think BAC will earn (the earnings per share) more than those puts cost me.  Then as the stock rises, it gets cheaper to roll those $12 puts along and thus the earnings easily overpower the cost of the puts.  Then it trades at a multiple to book, more tailwind.  This might take several years to play out. 

 

Meanwhile, I have FFH plodding along.  Perhaps something exciting will happen. 

 

I like it.  Not for everyone, but I like it.  Could hold them both for the long term, picking up a few extra percent per year.  Nice tax losses accumulating as well as those puts get rolled along.

 

It seems funny to me that one of them is under tangible book and will be able to earn 13%-15% on tangible equity, and the other trades at only 3% premium to book.  Both could see a 50% pop in how they are priced (not counting earnings) in let's say, 5 years time.  Now that could be sweet! 

 

It's like I've created a 50 cent dollar from rubbing two 70 cent dollars together.  In a sense.  Not quite, but a little bit like that.  Anyways, the downside seems not too bad given that the one unhedged is the one that itself is armed to the teeth with hedges.

[finetrader]

You are right about it not being a coiled spring anymore.

 

I think BAC will earn (the earnings per share) more than those puts cost me.  Then as the stock rises, it gets cheaper to roll those $12 puts along and thus the earnings easily overpower the cost of the puts.  Then it trades at a multiple to book, more tailwind.  This might take several years to play out. 

 

Meanwhile, I have FFH plodding along.  Perhaps something exciting will happen. 

 

I like it.  Not for everyone, but I like it.  Could hold them both for the long term, picking up a few extra percent per year.  Nice tax losses accumulating as well as those puts get rolled along.

 

It seems funny to me that one of them is under tangible book and will be able to earn 13%-15% on tangible equity, and the other trades at only 3% premium to book.  Both could see a 50% pop in how they are priced (not counting earnings) in let's say, 5 years time.  Now that could be sweet! 

 

It's like I've created a 50 cent dollar from rubbing two 70 cent dollars together.  In a sense.  Not quite, but a little bit like that.  Anyways, the downside seems not too bad given that the one unhedged is the one that itself is armed to the teeth with hedges.

 

 

I've hedged my BAC position differently.

I believe that market risk is the biggest risk for BofA. With earnings in the rise because of lower expenses, operational risk seems much lower that market risk to me. So I've hedged the Fairfax way. I bought deep ITM SPY put as I don't like to pay big premium and this takes much less margin than shorting SPY. I've just started my hedging program so I have only 25% of my BAC long exposure that are hedged this way. Waiting for the BOJ effect to fade before hedging more.