Dividends , Portfolio


Today I wanted to talk about one of the stocks on my Christmas wish list . This investment is a good example of how some good detailed homework can find you some great investments. Lets jump right in.

What if I told you that right now you could invest in Berkshire Hathaway at a tenth of its size, run by a Buffet-like manager with a similar investment track record, and that pays a significant dividend that not many are aware of? Intrigued?

Let me introduce you to Fairfax Financial . Fairfax is a Canadian holding company whose holdings are comprised mainly of property & casualty insurance and reinsurance companies. The holding company manages the float generated by these companies and invests it for the long term. The stated mission of the company is ‘to build long term shareholder value by achieving a high rate of compound growth in book value per share over the long term.’ Its goal is 15% compounded growth. On the insurance side of the business its goal is to only underwrite business at a profit even if that means walking away from business in poor environments. Its balance sheet is conservative and rock solid. Sounding familiar? Fairfax is run by Prem Watsa, who since 1985 at the helm has put together an impressive enough track record to be called the Warren Buffet of Canada. Under his management Fairfax has compounded book value per share at 26% per year and the stock price has followed at 22% per year.

Today Fairfax is 1/10 th the size of Berkshire, by assets, and is priced at a compelling valuation which makes it a terrific investment in today’s environment. Fairfax trades at a slight discount to its Q310 ending book value of $401 per share. Since 1985, it has traded at P/B values from 0.97 to 4.58 with an average of 1.91. See chart below.

It is about as cheap today as any time in its history. On a P/E basis it trades at less than 7 times earnings. The low valuation can be attributed partially to the insurance business being at a low point in the cycle. But as the cycle turns this presents a compelling catalyst to Fairfax. Also, its investment portfolio is quite compelling. Of its $22.5B in portfolio investments 13% is in cash, 58% is in bonds, 23% is in stocks/equity investments (largest positions are WFC, JNJ, KFT, USB), and the remaining 6% is in derivatives. The derivative positions are primarily used to hedge risk. At the end of Q310, this portfolio represents approximately $1,098 in investments working for the long term benefit of the shareholder.

How is this possible? You buy one share for say $400 but you get $1,098 of investments working for you. That’s the power of the float (insurance premiums) and a modest amount of debt being invested for the long term. But wait, it gets better. All those bonds and many of those stocks in the investment portfolio pay interest and dividends. At the end of Q310, interest and dividend income was about $800M annualized or $39 per share. That is an investment yield of 9.7% on book value! The trick here is that this income accrues to the portfolio and Fairfax management usually reinvests it, instead of paying it all out to shareholders. Fairfax usually does payout a dividend to shareholders once a year but it is not nearly as big as the dividends being generated internally. This is why I call it a stealth dividend stock. Its generating significant dividend income but its not readily visible.

If you normally re-invest your dividends, which everyone should do in my opinion, then an investment in Fairfax has the same mechanics of any dividend stock. If you spend your dividend income then you can ‘generate’ dividends by selling a small portion of your Fairfax holdings once a year.

At the end of the day, the most compelling reason for an investment in Fairfax is solid business fundamentals, its long term investment track record, and its conservative and capable management. As is evident from Berkshire, Markel, or White Mountain, insurance businesses can be cash flow machines when run well. The value of float combined with good investing can lead to great returns. Fairfax is handily trashing its goal of compounding book value at 15% over the long term, but even at 15% it will generate substantial wealth for its shareholders. And management is strong, vigilant, and shareholder friendly. Even if you don’t invest in the stock go and read the annual letters from the CEO, Prem Watsa. Like the Buffet letters they are great investment education.

In summary, Fairfax is a great stealth dividend stock, trading at a compelling valuation, and with great potential for 15%+ long term returns to shareholders. That’s why it is on my Christmas wish list.

You can own the stock in two ways – buy buying it on the Toronto exchange, FFH.TO, or buying it on the OTC market, ‘pink sheets’, in the US, FRFHF.PK. Almost all brokers nowadays give you the capability to buy shares in Canada.

Disclosure: long FFH.TO

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8 thoughts on “ Fairfax Financial – possibly the best stealth dividend stock in the world

  1. pretty sweet set up on this particular one… added to my watchlist…

    a strategy on individual stocks that I use is to monitor about 40 stocks and when one report negative news (such as GERN selling additional shares this morning) i determine (in my mind) if the news is a threat or not… if not a threat I buy some (in this case 2000 GERN @ 5.05) knowing that bag holders will double and triple up… when it appreciates enough (sold @ 5.13) i get out for a nice daily profit…

  2. I’ve looked at FFH in the past. Not sure how you get your yield # as I show it yields just over 2% which is nothing amazing. The internal yield of 39$ should increase the stock price to fill your yield number but depending on when you buy and sell that may not be the case. It’s a fairly volatile stock with a very low volume too. Enjoying your financial and RV blogs!

    1. Steve, thanks for the comment. In the post I am taking about a ‘stealth yield’ or as you state an internal yield. I am looking at the yield of their investment portfolio, not what they pay out to investors. You are correct that what they pay out to investors is a yield of 2.5% or so. But the portfolio yield is much higher as I state. The management just chooses to re-invest most of this for future growth vs paying it out. Obviously, as an investor one needs to be OK with that. I’m OK with that. An the volatility and low volume presents enormous opportunities at times. As an alternative you can invest in the Canadian version of the shares, FFH.TO, which are much more liquid.

  3. Paul, I’m in Canada so I was looking at the TSX trade. The bid/ask size was pretty small when I looked at it earlier today. I prefer to trade in stocks that are very liquid. As a long term trade FFH shows good capital appreciation over 5 yrs although there have been some wild swings in there too. Be nice if there were option trades on it. Good read in your writeup on it, I’ll keep an eye for a reasonable entry point which I would like to be down around 380.

    Do you only trade stocks such as FFH and MLP’s or do you get into regular equities and options? Not looking to clutter up your blog with questions though so email if it’s better for you.

    1. Steve, hard to beat Fairfax’s record over the long term, a very Buffetesque 25% CAGR on book value. 380 would be a great entry point, right around last quarter’s book value. They’ll be announcing annual earnings and annual dividend payout soon so it would be worth waiting for that too.

      As far as my portfolio I get into all kinds of stuff. See my post on the investing for a living model if you’re interested. I have an longer term portfolio which is focused on dividend payers, which MLPs fall into and stocks like FFH. Then I have a trading portfolio which I classify as anything with an outlook of less than a year. In this part of my portfolio I trade a lot of options, almost exclusively selling premium and also trade stocks, mainly swing trading. I’ll prob be talking more about this part of my portfolio this year on the blog.


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