by Travis Johnson, Stock Gumshoe | December 23, 2015 1:01 am
We originally covered a teaser ad very similar to this on October 30, 2013. The ad promising a “Next Berkshire Hathaway” is circulating again and generating more questions from our readers, so I’m re-analyzing it here for your information. The ad has been slightly updated with new numbers over the years, and this article has been updated… and my opinion has changed a bit. We have left the original comments appended to this article.
This “Retire on one stock” idea was trading for about US$440 a share when it was first teased by Mizrahi 2+ years ago, it has been fairly volatile since but as of now has risen about 7% — though in Canadian dollars it has done far better (up 42%), thanks to the soaring US$. Over the past five years, the stock has done significantly worse than its sector — perhaps partly because of its very cautious “fully hedged” investment approach in recent years.
Promises that you’ve discovered the “next Berkshire Hathaway” or the “next Warren Buffett” will get you attention, and that’s been true for a decade or more as investors have continued to seek out the opportunity to buy that “next Berkshire” before it becomes a $100,000 stock.
And who can blame investors for looking? Putting a reasonable chunk of your savings in the hands of investing Whiz Kid Warren Buffett back in the 1960s when he was starting his partnership would have been enough to create a family fortune today — assuming, of course, that you had held that investment the whole time and not sold when Warren had a bad year, as he has had on occasion, or when you’d gained 100% or 200% or even 1,000% and lightened up your position. Not many people did that, but the few who did are endowing buildings at universities now… nice, right?
But how do you find the next Berkshire Hathaway? Well, no one is is promising to find the 30-year-old Warren Buffett … but some folks are intimating that they can find the equivalent of Berkshire Hathaway in the 1970s or 1980s or even the 1990s, when the company was smaller and the growth potential more dramatic — we’ve seen teases from newsletters over the years that pitched companies as varied as Brookfield Asset Management (BAM), Greenlight Re (GLRE), Markel (MKL), Leucadia (LUK), Loews (L), Allegheny (Y), Biglari Holdings (BH), Sears Holdings (SHLD) and White Mountains Insurance (WTM) as the “next Berkshire.”
Probably none of ’em is, of course, since that kind of remarkable return depended on a lot of external factors as well as on the ability of Buffett to master the use of insurance leverage in equity investing, and to do so without getting much attention in the first few decades. Doesn’t mean that they are or were bad investments, of course, those have all been interesting and probably worthy companies in one way or another at times, and I have written about or owned several of those over the years (I currently own both Markel and Berkshire Hathaway shares, both are among my top five individual equity positions).
But if we can’t find that $100 million company that’s going to become a $200 billion company in 30 years, then we at least want to find the $10 billion company that could outpace the market and become a $200 billion company… right? That’s really the promise that newsletters are pitching, not that you can buy 1960s Berkshire but perhaps that you can buy 1990 Berkshire, when it was at about $6,000 a share on its way to the current $175,000 a share.
Which would work out quite nicely, thanks very much.
I own Berkshire shares personally and added to my position a few months ago when it dipped below 1.3X book value, not because I think it will generate 25X my investment in 20 years but because I think it’s better than the S&P 500 with less risk — today’s Berkshire is still a pretty good buy, with a fantastic collection of businesses, but it won’t be a growth rocket.
Which was a long preamble to get us to the point of today’s piece — that Charles Mizrahi is pitching another stock as the “next Berkshire” in selling subscriptions to his Inevitable Wealth Portfolio ($999 “on sale”) … and no, it’s not one of those in that long list above.
I thought it was at first, to be honest — that’s because Mizrahi a couple years earlier was touting Leucadia (LUK) with exactly the same headline, “The Next Berkshire Hathaway: How this ‘Must-Buy’ Could Help Make You a Buffett-Sized Fortune.”
That turned out not to be a “must buy” just yet, Leucadia has been through some big changes over the past five years and is now one of the worst-performing “next Berkshire” stocks — and indeed, almost every time we hear a “next Berkshire” pitch, it turns out that the old Berkshire would have been a better buy at the time than the “next Berkshire.” (Leucadia is also down sharply since I wrote positively about it in March when it was in the low $20s.)
But no, Mizrahi’s got another stock in mind — another “next Berkshire Hathaway” for your consideration. Who is it?
Well, our favorite Irregulars already know the answer because of our handy dandy “quick take” box above, but the rest of you have to sit through just a few more paragraphs of my blather first (Not an Irregular yet? “Sign up now!” he suggests shamelessly).
“I’m about to reveal the details of a company that looks remarkably similar to what Berkshire Hathaway looked like 40 years ago when they were making huge double digit returns.
“For the better part of the last three decades, this company has been run by a man known as ‘Canada’s Warren Buffett’ – and he’s used the same value-oriented strategies Buffett favors to deliver remarkable returns.
“In fact, in the 29 years since the company began in 1985, this company’s book value has grown at a compounded rate of 21.1% per share each year.
“And their common stock price has compounded at 19.8% annually.
“$10,000 invested in this stock back in 1985 would now be worth more than $1.6 million, not including dividends.
“Simply put…this company has delivered exceptional returns for investors. But right now – for reasons I’ll explain in a moment – you can buy its shares at a ridiculously low price.”
OK, so that will sound a little familiar to some of you — particularly the “Canada’s Warren Buffett” bit, … but let’s share just a few more clues from the ad to build the suspense a little:
- “This company focuses on buying well-managed companies…
- They buy them below their intrinsic value…
- They diversify their holdings…
- The stock – which has compounded its book value at a rate of 21.1% per year – is trading at a ridiculously cheap price…
- And—most importantly—this company makes money for its investors. Lots of money.
“Right now—at this very moment—the company has a whopping total of more than $2.2 billion in cash and short term investments sitting on their balance sheet…keeping their powder dry for the next opportunity that comes their way.
“Want another reason to love this stock?
“The company’s founder puts his money where his mouth is—owning roughly 8% of his company’s stock.—about 85% of his net worth is in the stock.”
And we’re told that one of the main reasons it’s a better bet than Berkshire Hathaway is because it’s “just 3% the size of Buffett’s Berkshire… and that’s a position Warren Buffett would love to be in” …
… which would mean it could still be pretty big, in the $10 billion neighborhood (Berkshire Hathaway’s market cap is $325 billion or so at the moment).
So who is Mizrahi’s “next Berkshire Hathaway?” Thinkolator confirms that yes, this is Fairfax Financial Holdings (FFH in Toronto, FRFHF on the pink sheets), a Canadian insurance conglomerate run by Prem Watsa, who has many times been referred to as the “Canadian Warren Buffett.”
We’ve mentioned Fairfax before, when it was pitched by Dan Ferris (back when he ran the 12% Letter) as “Canada’s 13% Income Secret” — and it is certainly still a much-discussed stock in value investing circles and has generated some headlines over the years, mostly because of Prem Watsa’s attempts to “rescue” Blackberry a few years back, and because of his very bearish stance on the markets.
Fairfax Financial has indeed been around since 1985, when Watsa recapitalized what had been the faltering Canadian division of Markel (that was just before Markel went public), and Watsa has been a devotee of Warren Buffett’s “buy cheap stocks, buy quality hated or misunderstood stocks, and hold for a long time” strategy and generated returns similar to Buffett’s — compounding book value and share value at roughly 20% a year.
Which doesn’t sound sexy in a newsletter tease, where we’re accustomed to seeing someone promise 500% gains in a year, but is really quite spectacular. He is still running the big picture show at Fairfax and makes the big investment decisions, like Buffett does at Berkshire Hathaway, but he’s 20 years younger than Buffett so the succession talk hasn’t come up to a large degree just yet.
Watsa appears more aggressive than Buffett — seemingly more willing to take calculated risks and make large bets, which paid off spectacularly well in the financial crisis. Over the last five years, though, he has been cautious about stock valuations and Fairfax’s investments have failed to keep up with the bull market. Fairfax owns a handful of insurance companies and reinsurance companies who account for essentially all of their cash flow and operating earnings (they also own a few oddball little businesses, not unlike the early Berkshire Hathaway), so pretty much all of their employees are spread out around the globe working for subsidiaries like OdysseyRe and Northridge, they have only 30 or so employees at corporate HQ — again, like Berkshire Hathaway.
Fairfax is also fairly hard to figure out from a quick scan of the balance sheet — they do indeed have investments and assets of more than $30 billion, but most of that is balanced by liabilities in their insurance contracts … so like any insurance company, they don’t really “own” most of their portfolio because they haven’t earned the insurance premiums they’re holding, and won’t earn a big chunk of it (they’ll have to pay claims or otherwise settle contracts to cover a large portion)… but while they hold that cash they get to profit from the investment returns they receive by using the cash. The market cap of the company is less than $10 billion, so in some ways you get the earnings from $2.50 or so of a Watsa-managed portfolio for every dollar you invest.
That’s the glory of being an insurance company, but there are also heavy costs to being an insurer so it means you need to pretty consistently break even — or at least not lose too much money — on the insurance side of the business unless you’re really spectacular on the investing side.
That’s true for all insurance companies, not just Fairfax, and Fairfax has learned that lesson the hard way with some really bad years in the past as they tried to turn around some of the insurance firms they acquired — over the last decade, though, it’s been mostly pretty good performance all around from Fairfax and Watsa, with the boom years around the financial crisis further bolstering his reputation. The last two years, in particular, have been excellent underwriting years, and when an insurance company makes money on underwriting that’s like getting paid to take a loan that you can use for your investment portfolio… which is lovely when the portfolio goes up in value.
Is it a good buy today? Well, I can’t say for sure, but these days it appeals to me a bit more as somewhat of a hedge against deflation or market collapse. Watsa’s very worried about deflation and is betting big on it, with a huge derivatives position that could be worth ~$100 billion if the US and Europe face a “30s style” deflation crisis. As of last year that position was still losing money for them, and it’s a stance he’s held more or less steadily since 2010 (which is why Fairfax has missed much of the bull market over the last few years)… but that position probably looks a lot better on their books now than it did a year ago.
Fairfax, in US dollar terms, has been a worse-than-average insurance company investment over the last five years — up about 18% in five years, versus a gain of 86% for the PowerShares KBW Prop & Casuality Insurance ETF (KBWP). Markel (MKL), my favorite insurer, has been better than that with a 130% gain, Greenlight Re (GLRE), another stock I liked and owned (but have since sold) did far worse, losing 35% (mostly this year). Berkshire itself, though not so overwhelingly insurance-driven anymore, was fairly close to the insurance average with a 65% return.
But time period matters. Fairfax and Watsa were washed in glory in the 2008-2009 crisis, when most stocks were crushed, and their strong performance then means that over ten years they were the victors, over that time period the stock gained 225%… versus about 175% for Markel and 125% for Berkshire (the index wasn’t around back then). So if you think that Watsa’s right about the next crisis, since he’s essentially been betting on it since we emerged from the last crisis, perhaps you’ll want to expose a bit of your portfolio to his strategy.
Most insurance companies are valued by investors based largely on book value, with bad insurers or breakeven reinsurers trading for a discount to book and great specialty insurers getting a decent premium of up to as much as 1.5 to 2X book value. FFH has over the last five years been gradually trending up, but mostly trading between 1X book and 1.4X book, and it’s right near the top of that range now with the book value at an all-time high in Canadian terms (C$500 per share)… but unfortunately, a lot of that increase in book value is because of the loss of value of the Canadian dollar, in US$ terms Fairfax has about the same book value per share that it did five years ago (about $370).
It also does pay a dividend, which is paid annually in January and has been US$10 for the past three years — presumably that will continue (it does look like growth in Canadian dollar terms, but it’s not actually growing — Watsa has said he likes “a stable dividend”). So it’s likely to yield 2% or so.
Watsa also emulates Buffett in his communication with shareholders — if you’re interested in the stock you might want to read a few of his annual letters to shareholders, which tend to be folksy and informative. I would particularly urge you, if you’re considering Fairfax as a way to get into the insurance sector but also “hedge your bets” a bit on a market decline or deflationary crisis, to read the 2014 letter, particularly pp. 19-20 where Watsa goes into some detail in how they’ve used hedging and derivatives to prepare for the possible crisis he sees coming, and compares that to the similar “hedging” they did in the years leading up to the 2008 collapse that helped them excel during the last downturn.
Sound like a worthy “next Berkshire” or a buy to you? Prefer a different member of the long list of anointed “next Warren Buffetts?” Let us know with a comment below.
Disclosure: as noted above, I own shares of Berkshire Hathaway (BRK.B) and Markel (MKL) personally, but don’t own any of the other stocks mentioned above. I won’t trade any of those or any other stock mentioned above for at least three days.
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