Fairfax Financial (FFH.TO or FRFHF.PK) reported results for 2010 a week or so ago. Before commenting on the results, I had been waiting for the annual letter from Chairman Prem Watsa and over the weekend it was posted to the site. I’ve posted on Fairfax before ( here and here ) and I called them a great stealth dividend stock. Well, despite posting ‘weak’ results for 2010 Fairfax continues to be undervalued, a great long term investment, and still a great stealth dividend stock.

First, I highly recommend reading Prem Watsa’s annual letter for yourself. He’s not called the Warren Buffet of Canada for nothing. And, of course, read Buffet’s annual letter as well. There’s a ton of valuable and free investment advice in both letters.

Fairfax had a mediocre year in 2010. Book value increased only 5% in 2010 after the 3 previous years where book value increased by 146%. Results reflected the weak insurance market and mark to market losses on their investment portfolio. The weak insurance market resulted in a combined ratio of over 100% for 2010. The increase in the combined ratio was mainly due to their unwillingness to write new business at a loss to pad earnings – a long term positive. The mark to market losses in their investment portfolio were mainly due to losses on the muni bond portfolio (of which 65% is insured by Berkshire Hathaway) and their decision in the middle of 2010 to hedge 100% of their equity holdings. While these losses cause short term pain, and mark to market losses that show up in the income statement, they say nothing about the long term value of the portfolio. Fairfax builds their portfolio for the long term and not short term earnings.

During this period of weak insurance markets Fairfax is taking the opportunity to pick up more high quality insurance businesses. In 2010 they acquired 5 companies and still had $1.5B in cash on the books at the end of the year. This cash combined with their operating cash flow has them sitting pretty and looking for more acquisitions to build long term value. When the insurance markets turn around these new business plus the capacity to start writing profitable business in their current lines of business will generate substantial profits.

On the valuation front Fairfax trades below book value. As of today US shares trade at about $377 versus year ending book value of $379 per share. Due to the soft insurance cycle many insurance companies are trading near or below book. Talk about the baby being thrown out with the bath water. But lets take a look forward at prospective returns for Fairfax. Historically, Fairfax has grown book value at 25% per year over the last 25 years and has a stated goal of growing book value at 15% per year going forward. How realistic is that range given the current value and their investment portfolio? Here is where the true power of the insurance business shows, i.e. the power of the float. Here is break down of Fairfax’s total investment portfolio in per share numbers:

  • Book Value – $379
  • Debt – $119
  • Insurance Float – $641
  • Total – $1,139

When you buy a share for say $379, you get $1,139 in investments per share working in your favor. In order to generate 15% to 25% returns on book value the investment portfolio return needs to be approximately 10% to 15% per year. I used conservative estimates to arrive at these numbers. I assumed the cost of float averages a negative 1% per year, an average tax rate of 30%, and long term average expense ratios and interest costs. The float acts like leverage to investment returns. Over the last 25 years, the investment team at Fairfax has done better than this (see page 14 of the CEO letter). Even over the lat 5 years, returns have been 14% for equity investments and 13% for bond investments. So it looks like at the minimum that 15% growth on book value target is conservative.

Now what about that stealth dividend I mentioned? Looking at the financials, 2010 dividend and interest income from Fairfax’s investment portfolio was $41.31 per share. That’s $41.31 on a book value of $379 or an 11% income yield on book value. That goes quite a long way to meeting that book value growth of 15% per year and one reason I think it is conservative. That’s what I call a great stealth dividend! And management has a great track record of reinvesting those dividends and bond coupons for the long term. The market may take a while to realize this, probably until the insurance market turns, but eventually the stock price closely follows book value.

In short, Fairfax continues to build shareholder value for the long term. The stock is cheap due to insurance market weakness and I think it represents a compelling long term value consistent with my dividend theme.

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17 thoughts on “ Fairfax reports 2010 results – still a screaming buy

  1. Hi!

    Im a shareholder from Sweden. I have a question regarding your numbers “total $1,139”.
    I dont understand what your maths. Assets minus debt is the book value or in other words the shareholder equity. Can you explain what you mean? Are you counting the assets twice in your formula? When I look at the balance sheet

    I see that FFH has $ 22,000 in investment working, nearly 3 times the market cap. Maybe that number corresponds with your $1,139?

    My second question is about the dividend income and interest income. Is realized and unrealized gains included in this numbers of $40 per share?

    1. Hi Erik, thanks for the comment. Great questions. The numbers I showed are right from the CEO letter. On the last paragraph of page 10 of the letter it states “At the end of 2010, we had approximately $641 per share in insurance and reinsurance float. Together with our book value of $379 per share and $119 per share in net debt, you have approximately $1,139 in investments per share working for your long term benefit – about 7% higher than at the end of 2009.”

      The $1,139 comes from taking the total portfolio investments and adding to it the cash at the holding company about $1,500M. So yes, $22,432 in total portfolio investments plus $1,500 in holding company cash divided by total number of shares outstanding gives you about $1,139 per share. The leverage over book equity comes from the insurance float and the debt.

      The dividend and income is a separate line item. On page 7 of the CEO letter it states :Interest and dividend income in 2010, with muni bond interest on a pre-tax equivalent basis, was $868.8 million or $42.31 per share. On the income statement for the end of year there is a line item for interest and dividends that says $762.4M, which is about $37.2 per share but a portion of the interest income in the portfolio is from tax free municipal bonds. So, that is why in the letter he says that on a pre-tax equivalent basis the dividend and interest income was $868.8M or $42.31 per share.

      Hope that helps.


  2. I agree that FFH is a great buy at these levels and thanks for a great blog!

    Best regards

    1. Thanks. Any good Swedish dividend stocks I should keep my eye on?

      By the way, my wife is from Denmark and over the years, while visiting family, we have made it over to Sweden many times and have enjoyed ourselves a bunch.


  3. Thanks for the answers Paul, it helped. I just wanted to know if I am thinking right.

    In Sweden and Scandinavia we have a lot och great companies. I own stocks in alla Nordic countries.

    Maybe Gjensidige (GJF) in Norway could be something for you? It is an insurancecompany operating in Scandinavia. It has a great capital buffert and a big dividend yield of 7 percent. Excess capital of 20 percent of the market cap. Big valuefunds like Skagenfonder has bought the stock due to it great financials and strong business.

    Best regards

    1. I’ll check GJF out, thanks. I wish more Scandinavian stocks traded as ADRs on the US exchanges. It would make them so much easier to own and cheaper to buy/sell.
      We only have one Norwegian ADR, Statoil, two Swedish ones, Ericsson and Autoliv, and two Danish ones, Novo Nordisk and Torm.


  4. it seems that Fairfax is at some of the lowest levels I have ever seen it. Why do you think that is if you agree with my assessment. Also, I invest in an IRA so at least some of the dividend gets lost by Canadian Govt. withholding. Thanks and hope your trip if safe and healthy. Jim

    1. Jim I think its the weak environment for insurance stocks across the board. Many insurers are trading at or below book value.

      I think if you own the us listed shares frfhf.pk instead of ffh.to on the canadian exchange I don’t think there is any tax witholding. I will check to make sure.


  5. Paul, GJF and FFH bring up something that has bugged me for a couple years. With my on-line discount broker, directly accessing foreign exchanges is not possible; you must conduct business by phone and the commissions and other fees are quite high. From ads and some research, ETrade and Fidelity allow limited internet access to foreign exchanges, and Interactive Brokers (IB)allows internet access to a large number of exchanges. I am tempted to open an IB account to see if it is as easy and potentially profitable as the ads would lead one to believe. Do you have any experience or thoughts on this niche of the investing world? Thank you.

    1. I have the same issue with td ameritrade. I have an IB account to trade bonds. I like their software platform a lot. As far as fees they are very cheap for small trades but more than other brokers for 50k trades and up.

      Haven’t bought any stocks on foreign exchanges through them yet. Something I am also looking to do more of.

      Ill do some digging and pls share what you find out.


    1. Hadn’t seen it. Wonderful. Thanks.

      From an undisclosed boondocking location in Texas.

  6. J Carroll

    I dont know who it works with on-line discount brokers in US or Canada but in Sweden I can buy stocks worldwide with low fees. As an example I buy US stocks for 15 USD and Canadian for around 30 USD. Swedish Stocks I buy for around 15 USD. I bet you got good brokers in US and Canada so that you can buy European stocks for decent fees.

    If you want to buy Scandinavian stocks visit avanza.se or nordnet.se. Great brokers with affordable fees.


  7. Here is a recent presentation of Prem Watsa. Quite interesting.


    I have followed FFH for a while. Watsa is definately an investment guru. What I find interesting is that he continues to beleive that the developed world could still go through a deflation (like what Japan went through from 1990). If he were wrong, his equity investment may not produce much return due to the 100% equity hedge. However, the insurance businesses should continue to grow.

    1. Tony, thanks for the link. I own Fairfax and have for a while. I have posted a couple of times on them on the blog. They just had their annual shareholders meeting as well. I’m waiting for them to post the presentation from the meeting so I can post on the highlights. They also announce Q1 earnings this Friday.


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