by Travis Johnson, Stock Gumshoe | September 5, 2017 11:32 am
Today we’ve got a quickie just to answer some reader questions — and, frankly, it’s a quickie mostly because we’ve covered this pitch several times before, in slightly different variations.
This time around, the tease is coming from Charles Mizrahi[1] in ads for “Charter Memberships” in his new Park Avenue Investment Club[2]… which sounds pretty similar to his past newsletters in offering a basic portfolio of “value investing” picks to choose from. The offer is at $99 a year
But Mizrahi for this new service is teasing the same stock he’s been using for years as bait to lure new subscribers — whether for his Insider Alert[3] or his Inevitable Wealth Portfolio[4].
So what’s the idea? Well, I won’t go to deep into the quotes from the ad or make you wait too long, since this is an idea that we’ve looked at so many times, but here’s a little taste of this “next Buffett” idea:
“In the ’70s, a then-unknown man immigrated to Canada[5] 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[6] of Canada….
“Since 1985, the “Next Buffett” has led his company on a profit run — growing it at a compound rate of 21.3% — that’s outperformed Berkshire hands down.
“And he’s done it by putting his money where his mouth is.
“Like the Oracle of Omaha, he draws a modest salary while roughly 95% of his net worth is in his company’s stock.”
Mizrahi also points out some of the big wins this “Buffett of Canada” has had in the past, including huge gains on the market crash in 2008 and “calling” the 1987 crash… though the ad also overstates his recent prescience in saying that the 2015 call he made on tech stocks being overvalued has worked out well (it hasn’t).
And also notes that he’s currently “pounding the table” on pending deflation[7]…
“Right now, he’s pounding the table on the fact that China[8] is massively overvalued, and he also has active moves to hedge against pending deflation in Canada, the U.S., and Europe.”
Finally, the ad notes that this stock, unlike Berkshire, pays a (modest) dividend, with a yield of about 2%, and benefits from the same “free leverage[9]” that Berkshire (and other insurance companies) enjoy by using the insurance float to boost their investment portfolio.
So who is it? It is, of course, still Prem Watsa[10]’s Fairfax Financial (FFH in Toronto, FRFHF OTC in the US) that Mizrahi is teasing for his new Park Avenue Investment Club.
And this latest revamp caught my eye not just because several readers have asked about it, but because I also like the stock and have been building my position in it since last last year, while the stock has been pretty weak — including a buy a little less than two weeks ago.
Nothing has changed materially for the company since I last purchased shares, other than that Hurricane Harvey has hit and Hurricane Irma is on its tail and headed for Puerto Rico, Hispaniola, Cuba and maybe Florida (and the stock price is now about C$633, or US$512), so I’ll just share what I wrote to the Irregulars in their Friday File[11] on August 25 about Fairfax:
“I noted last week that Fairfax Financial (FFH.TO, FRFHF) was the most appealing stock to me at the time, though I didn’t buy last week, and it became a bit more appealing this week… so I did take some of that AIG money and boost my Fairfax position by about 20%. Fairfax was trading at very close to my cost basis anyway, so there’s no real change to that — just a bigger allocation now.
“What happened? Well, Fairfax is not as cheap as it was a week ago — but that’s for good reason, they made a Insurance[12]--Enter-into-Strategic-Alliance-and-Sale-of-First-Capital/default.aspx">deal with Mitsui Sumitomo this week that looks really appealing to me, and it also should immediately boost Fairfax’s book value per share. This, combined with the transformational nature of their large Allied World acquisition that’s not yet reflected in the share price, makes Fairfax a more compelling buy. The Allied World deal closed in early July, after the most recent quarter ended, and the incremental positive change in Fairfax’s balance sheet and increase in size of their investment portfolio on a per-share basis from the acquisition will take some time to have an impact, but the small book value boost should hit right away.
“In terms of specifics, you can check the presentation here[13] for more detail but Mitsui Sumitomo is buying Fairfax’s controlling interest in First Capital for $1.6 billion, which creates a $900 million after-tax profit for Fairfax on that position and will, they say, boost book value per share by $33 when the deal closes (late this year or early next year). Add that to the estimated $8 per share that the Allied World deal will immediately bring (conservatively calculated, I think), and you get a boost from the recently reported $378 per share to $419. That assumes there are no substantial negative book value events over the next six months, my basic assumption is that book value is likely to grow in at least the high single digits on an annual basis (it has increased at close to 20% a year for a long period of time.
That makes the current price, just above $500, pretty reasonable at roughly 1.2X book value. Particularly when we reflect on the huge growth potential of Fairfax’s many international operations — note for example, that this sale of First Capital, which Fairfax first capitalized back in 2002 with just $35 million, is going through at a massive premium to its book value (the presentation notes that First Capital had a book value of $485 million at the beginning of the year, and is being sold for $1.6 billion in cash).
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just click here...“As I mentioned last week, that definitely doesn’t guarantee that 1.2X book is a bargain basement price for Fairfax, which has sometimes traded all the way down to book value or a bit lower in the past… but it’s a very fair price, and it looks like a bargain given the valuations of other high-quality insurance conglomerates. Fairfax doesn’t really get enough credit for the fact that their insurance operations have gone from “ho hum” to excellent over the past decade, the stock is still traded largely based on Prem Watsa’s investment acumen… and after a very weak investment performance over the past five years because Watsa so aggressively hedged against loss of capital in the crisis he thought would come, confidence is fairly low.
In rereading Prem Watsa’s annual letter from March[14] this week, looking at the last two major deals (Allied World and Mitsui Sumitomo), and thinking about the growth potential as Fairfax aggressively grows its operations in India[15], East Asia[16], Eastern Europe, and Latin America (often, coincidentally enough, because of their partnership with AIG and purchase of AIG assets in recent years), I think this will be a powerful part of my portfolio for a long time.
“And yes, in case you’re wondering, there is some risk to buying an insurance stock just as a major insured event is about to take place — it used to be that a major hurricane would bring down the insurance company valuations considerably, and that is still possible if one of them happens to have an unusually high exposure to this particular region or industry (like a big customer base among gulf-coast oil[17] refiners, for example), but in these days of well-managed reinsurance that spreads the risk it’s more often the case, I find, that big insured events actually make the insurance companies more profitable in the long run, providing them with more pricing power and “hardening” the market over the subsequent renewal periods.
“Wall Street is aware of that as well, so the stocks don’t necessarily all have knee-jerk reactions to big hurricanes anymore. I don’t know of any particular outsize risk exposure to the Houston area by any of the insurance companies I’m invested in, though such is certainly possible — more likely Markel has more exposure than either Berkshire or Fairfax, given their decent-sized business in marine/energy insurance, but I’m not particularly worried.
“That said, Hurricane Harvey is likely to be the worst hurricane hit in the US in more than a decade and perhaps the biggest insured loss event since Tropical Storm Sandy, so there may be more risk than I’m appreciating even if the expectations of wind insurance losses are not that high just yet[18] (flood insurance is likely to be a much bigger deal, but that’s not insurance company risk because it’s underwritten by the federal flood insurance program). If the losses are larger or are feared to be larger, and if prices of insurers that I like come down significantly next week in a ‘investor panic’ reaction, I expect to be more inclined to buy than to sell.”
Fairfax is still in the penalty box with investors to some degree, largely because Watsa has spent the past several years betting big on a market decline and has lost millions and missed out on huge gains during that time because of that bearish positioning… but he liquidated essentially all of those short positions after the election last year when the markets clearly telegraphed a return of “animal spirits”, so those losses have been taken and the short bets are few now.
He does still have a substantial ‘deflation’ bet on the books, though it doesn’t take up much capital, and he has also positioned the portfolio with a huge amount of cash and an extremely short-term bond portfolio, so Prem Watsa has a lot of options[19] for where to take Fairfax in the future. I don’t know whether he’ll be right or not, but given his fantastic long-term track record and the excellent insurance operations at Fairfax to back him up, I’m happy to have him working in my portfolio. I would say that the current price is very fair, and I think it underestimates the gains that Fairfax will make following their last two deals (particularly the Allied World merger), but I wouldn’t say that this is your “last chance” or that it’s urgent to bet big on Fairfax today. There will probably be ample opportunity to build a position on “dip” days if that’s your intention.
Unless they announce another big deal that gets attention or have some other unexpected catalyst, the next bit of news will be their third quarter earnings report, which is expected in the first week of November.
So that’s what I think — Fairfax has become a top five position for me, along with similarly insurance-based conglomerates Berkshire Hathaway (BRK-B)[20] and Markel (MKL)[21] that are both arguably overpriced by comparison, and it is the most recent stock I’ve made material additions to in my portfolio. Your mileage may vary, of course — have any opinions about Fairfax or Watsa? Let ’em fly with a comment below. Thanks for reading!
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Hey, when you talk about buying Fairfax, are you talking long – term? How would a stock like this perform in a bear market? Thanks
Depends on how they’re positioned — it was fantastic in 2008/9 because Watsa foresaw the real estate collapse, but he was positioned poorly on a macro level for much of the past 5+ years. I would expect it to outperform in most bear market scenarios I can envision, but not necessarily to go up.
Ideally, I’ll be holding these shares 20 years from now — but minds can change.
Is there any chance that Mr. Mizrahi is a closet Irregular, and that he is getting his ideas from you?
Ha! He picked Fairfax way back in 2013 (maybe earier) when I didn’t really like it, I didn’t become convinced of the appeal until last year, and more avidly so with their Allied World acquisition this year.
Travis, it seems to me that you own quite a few stocks! Can you provide some advice on just how many stocks you think an average small investor, with total portfolio of less than $150,000 can manage effectively? This would be for a retiree who can spend about an hour a day on the computer.
Or for a retiree with under $50K and about 40+/- small positions?
It’s different for everyone — one rule of thumb is not to invest in a company unless you can spend an average of an hour a week monitoring and re-researching it, though obviously some stocks require more time than others.
More importantly, is that how you want to spend your time? Investing in individual stocks is a hobby that probably won’t turn out much better (often worse) than a diversified portfolio in either passive ETFs or quality active mutual funds, so it’s only worth the time and attention if you enjoy researching stocks and like the challenge.
Hi Travis:
Now that you have mentioned it, would you mind sharing in an article or two about your diversified portfolio of either passive ETFs or quality active mutual funds? This can help to temper the enthusiasm of small investors who come across your excellent analysis and tempted to dabble solely in stocks.
thank you,
Raja
I too, would love to read those articles
My portfolio is in a ROTH IRA and I avoid investments that have tax withheld from dividend payments by the country where the investment is based. Does Canada do that?
According to current tax treaties, I believe Canada shouldn’t withhold taxes for investments that are in retirement accounts, though I don’t know if that’s necessarily always true or if it’s implemented all the time.
So alls he’s pitching is fairfax financial?