Charles Mizrahi has moved over to Angel Publishing, so we’re probably going to see a lot more ads for his Inevitable Wealth Portfolio. And the latest one, which I’ve been seeing for a couple weeks, pretty well bangs us over the head with the huge promises… including that “make 109 times your money” bit, which is a dramatic promise to make even if you’re willing to be patient and let your investment work for “decades.”
What, then, is that stock?
This excerpt will make it pretty clear:
“The good news is you no longer need a million bucks to learn my strategy.
“And it all starts today with one company that EVERY investor needs to own.
“It’s beaten Berkshire… and the gains that come rolling in could amount to 109 times your money.
“Let me explain…
“This ONE STOCK is the ‘Next Berkshire’
“It’s a story straight from a Horatio Alger novel…
“In the ’70s, a then-unknown man immigrated to Canada with $8 in his pocket.
“Today, he heads a multinational holding company that pays out insane profits, makes piles of cash on companies no one else cares about, and has outperformed just about everyone else in the stock market since 1985.
“Oh, and he’s also a multibillionaire.
“So it’s no surprise many call him the ‘Warren Buffett of Canada.’
“The man even named his son after Buffett’s mentor, Benjamin Graham.
“Though for all of his success, he’s remained largely out of the public eye.
“As the Toronto Star puts it, he’s “the richest, savviest guy you’ve never heard of.”
“So who is this guy? And how could investing with him today mean you could earn up to 109 times your money over the next decade?”
And he makes the point that this “Warren Buffett of Canada” made a huge bet that paid off during the financial crisis:
“His intake when the house of cards tumbled down? More than $2 billion.”
So who is this?
Yes, Mizrahi is again teasing Fairfax Financial (FFH in Toronto, FRFHF OTC in the US), which is a large Canadian insurance conglomerate. And yes, Fairfax and Markel (MKL) probably share the title for “most times being compared to Berkshire Hathaway.”
And it’s been a hugely successful company, thanks both to Prem Watsa’s ability to acquire insurance companies at decent prices and, recently, improve their operations… and to Watsa’s investing strategy, which is very aggressive and targeted compared to most insurance companies.
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I think the big reason for investing in Fairfax, which I’ve mentioned a couple times and featured as the “idea of the month” last month for the Irregulars, is as a hedge. Watsa profited from his big bets on the housing collapse, and over the past few years he’s been consistently betting on the US and most developed economies going into a deflationary crisis, and has been increasing his bearish bets on equities in general.
That positioning has worked against Fairfax’s investment returns to this point, most of the derivatives that Watsa has entered into are losing money and he has suffered from the short-heavy portfolio. But if he’s right and inflation falls well below 1%, or we have real deflation or a market crash, then those positions should be hugely profitable… and since that would mean most other investments have lousy performance, perhaps Fairfax shares could offer a bit of a “hedge” for a small investor’s portfolio. And it doesn’t hurt that it’s also a well-run insurance company, and that Watsa is an active value investor who might provide market-beating returns some of the time even if he’s wrong about the big picture (which is entirely possible, most people are wildly wrong about the big picture most of the time).
So that’s not a new and exciting name for you, but yes, it’s still being recommended by Inevitable Wealth Portfolio, and this happens to also be a stock I’ve been intending to buy (I haven’t actually bought shares yet).
What follows is a bit of an excerpt of my “idea of the month” writeup of Fairfax from last month, to keep you entertained while I toil away listening and taking notes at the Grant’s conference in New York (don’t worry, Irregulars, you’ll get something new just for you when I share my thoughts from that conference).
From Sept. 16, 2016 (this is about half of the article, the full thing is here):
I’ve noted many times that my favorite “real” insurer (Berkshire Hathaway doesn’t count) is Markel (MKL), because of its strong niche businesses, excellent incentive structure, and solid investing record… but also that it hasn’t been in what I’d consider a “buy” range for a long time. There’s no real provision for super-growth in book value or earnings for most insurers, including Markel, and it’s trading at a pretty high multiple of book value (over 1.5X book now). That’s justifiable, perhaps, but not cheap enough to get excited about… the big run in MKL stock has not been because the stock suddenly got 50% more profitable or grew the business that quickly, it has been because investors decided they were willing to pay more for those earnings.
And, of course, if the market crashes… Markel will crash with it. The impact will perhaps be more muted than for many stocks, since Markel has strong long-term operational metrics and a big bond portfolio to buttress the losses that they would take in their equity portfolios, but it would certainly fall… partly because it’s likely investors would be willing to pay less for Markel (one of the things Markel does better than most insurers is put more of their investment capital to work in equities, which generates better long-term returns, and they’ve also had very good investment management led by former investment manager and now CEO Tom Gayner).
There is, however, a good insurer that did quite well during the 2008 crash, has consistently gotten better on the operational side in recent years, and whose investment manager is positioned now for what he thinks will be an ugly and deflationary market… and, in what is probably not a big surprise in the incestuous world of investments, the company in question has common roots with Markel. So that’s our idea of the month for September: Buy Fairfax Financial (FF.TO, FRFHF).
Fairfax is an insurance conglomerate that’s not necessarily for the faint of heart, it has already had a good year and is trading at prices that are within shouting distance of all-time highs, and the valuation is not at peak levels but is on the high side compared to their recent history. I don’t own shares yet personally, but it’s my intention to buy some in the relatively near future (it will be at least three trading days before I do so, per Stock Gumshoe’s trading rules).
Fairfax’s CEO, Prem Watsa, who has run Fairfax since he came in as an investor and bought control of what was then called Markel Canada in 1985, has been called the “Warren Buffett of Canada” because of the phenomenal and Berkshire-like growth in book value Fairfax has enjoyed (growth was truly remarkable in the first 25 years, compounding at 25% a year,
But Watsa has not moderated his strategy as much as Buffett has had to — partly because Fairfax is still a relatively small operation that’s not as constrained as the mammoth Berkshire has become. Fairfax under Watsa is much more likely than Bekrshire to take substantial investment risks, actively hedge, or make large directional “macro” bets on the markets…. and that’s part of what’s appealing about investing in Fairfax right here for investors who are a bit worried about the market.
On basic valuation metrics the stock is, like Markel, pretty richly valued (especially compared to historical valuations, at least using the price/book metric that I favor for insurance stocks)… but the company’s investment portfolio is aggressively hedged to protect against a down market or a weakening global economy, and that has the possibility of giving some “hedge” protection to a portfolio by helping to keep Fairfax’s book value per share relatively healthy even if the broad market goes south.
That’s not a guarantee, of course — this is active management, which means both that it will be different than a more formulaic investment approach (like index funds and short-duration bonds that lots of institutions favor now), and that “different” could mean “much worse” if Prem Watsa is wrong or bets too heavily based on his pessimistic sentiment.
That’s been the case for several years now, as Fairfax’s investment returns have paid a fairly high price for Watsa’s hedging strategy… but many investors also have warm feelings in their bellies as they remember Fairfax’s excellent positioning during the 2008 financial crisis, so they give Watsa the benefit of the doubt and haven’t let the stock get too cheap for very long even though the investment performance has lagged a bit in some periods.
This chart, really, sums up what makes Fairfax stand out for investors:
That shows the performance of Fairfax Financial shares from 2007 through 2009 (in US$), a period when most financial stocks hit real distress (as well all remember too well) and some of Fairfax’s very strong and high-quality competitors showed really mediocre returns, losing money for investors over a few years. Fairfax shares rose 98% during those years, compared to losses of almost 30% for Markel and WR Berkley (WRB), and 16% losses for Chubb (CB)… and even a 10% decline for Berkshire Hathaway.
Why did Fairfax do unusually well back then? Mostly because they were ready for the housing bust. Prem Watsa was expecting both the collapse of the housing market and the stock market downturn over the 2007-2008 period, and Fairfax ended up making profits of more than $4.5 billion on the hedges and directional bets that they entered over those years. That was a huge profit, and unusually large in scale for an insurance company (most insurers do not make big macro bets). Fairfax at the time had a market cap of only about $3 or 4 billion (it has grown since then, both organically and through acquisitions, so the market cap is around $13 billion now).
And it’s not just that Fairfax did really well during that terrible time period — the stock has done well over a longer period as well… here’s what that chart looks like from 2000 to the present:
If you can’t read those little numbers, Farifax over that time falls short of Markel’s phenomenal performance, but is right up there with Berkshire Hathaway and Chubb… which is fine company.
And in the meantime, of course, they are an insurance company with good operations, and they are consistently acquisitive, make interesting equity investments that can keep you entertained, and continue to have access to relatively inexpensive capital through their large number of preferred shares that the market seems to continually want more of (one risk factor is that demand for Fairfax preferreds could dry up, but that would hobble expansion more than it would harm the current balance sheet). They often underperform more “normal” insurance companies over long periods of time, and in the past they’ve sometimes had terrible operational performance from some subsidiaries (huge underwriting losses, inefficient operations at acquired companies that have had to be turned around, etc.), but the stock has still held up well.
On the insurance side, Fairfax recently took an underwriting hit with the Fort McMurray wildfires this year… but still managed to report an underwriting profit last quarter — the combined ratio came in at 95.7, including 3.2% from the Fort McMurray claims, so if you subtract that particular disaster the performance was very similar to last year’s 91.9 combined ratio, pretty on track with how insurers have generally been doing for a few years.
Prem Watsa writes an annual letter to shareholders, in the style of a somewhat less folksy Warren Buffett (Watsa intentionally emulates Buffett in many ways, which seems wise to me), and those are worth reading if you’d like to spend a little time getting used to his world view and investment and management strategies — they’re all collected here. Their latest quarterly press release is here. The letters and earnings releases have a consistent format, so you can get a good flavor and understanding of their comparable performance numbers over the years from reading back through their releases.
The main risk that concerns me with Fairfax, beyond the risks that apply to all insurers (they could screw up underwriting or we could have cataclysmic catastrophes that hurt all insurers, or investors could revalue the whole sector), is that they may well languish for a while, particularly if Watsa continues to be wrong about equity valuations and deflation. The stock has done very well over a very long period of time… but it has also had extended periods when the basic value of the company has not really grown. In the six or seven years leading up to the 2008 financial crisis, the book value per share did not really grow at all — partly because underwriting performance was bad during much of that time, partly because of some investments that didn’t work out, partly, particularly in the later years, because Watsa was betting on the 2008 housing crash well before it happened, and those bets did not look good until they looked really good.