Top quality insurance companies are among the best values in the market today. I’ve written about Fairfax Financial before as the best stealth dividend stock in the world and about their CEO, Prem Watsa, who is often called the Warren Buffett of Canada. As it turns out, Berkshire Hathaway is pretty darn cheap these days as well. So, I thought I’d compare these two stellar companies side by side to see which one is the better value today.

First, lets look at Berkshire. A recent valuation analysis from top value investor Whitney Tilson gave me the idea for this post. Most of the time price to book value is the most common metric to value insurance companies but Tilson takes a different approach with Berkshire. Based on the annual letters from Buffett he uses a valuation method that he thinks Buffet uses to value Berkshire. Since Berkshire is not just an insurance company anymore, the valuation method uses a valuation metric for the insurance portion of the business and a different metric for the operating companies that are part of Berkshire. Below is the slide that shows the method.

The method is pretty straightforward. It takes the per share book value of the investment portfolio of the insurance companies as the value of the insurance business and adds to that a valuation of the operating companies using a multiple of earnings. For 2010, the $94,730 of per share investments is added to the earnings of the operating companies, $7,200 at a P/E multiple of 10. Tilson arrives at an intrinsic value for Berkshire of $166,730 per A share or $111.15 per B share. With A shares trading at $113,000 and B shares at $75.62 that is a decent discount to intrinsic value. No question Berkshire is undervalued. The only slight quibble I have with Tilson is that contrary to Buffet he includes insurance earnings in his calculation of operating earnings. On the other hand he uses a conservative P/E multiple of 10 for the operating businesses. I’ll call that a wash.

Next I decided to apply the same valuation method to Fairfax. Well, in the case of Fairfax its pretty easy since they don’t have any operating companies. And I just assumed that insurance earnings are zero. Using the Tilson method Fairfax’s intrinsic value would be just the book value of their per share investments. As of the end of 2010, that number is $1,139 in investments per share. With Fairfax trading at $385 that would make the company a screaming value and a better one than Berkshire. Now, I’m not entirely convinced with Tilson’s valuation method so I also decided to value the companies using the traditional price to book. Here is a summary of the results of the two methods.

For both companies I used book values ad of the end of 2010. I also used historical average book values since 1985 for both. Also, for Berkshire, I used the B shares in the table. The table shows that on a P/B basis and using the Tilson method that Fairfax is a better value than Berkshire.

Lastly, besides being a better value today than Berkshire Fairfax is also an income investment. It pays an annual dividend, yielding about 3% at today’s prices and its investment portfolio is more geared towards income investments. This is more a matter of personal investment style but one I think is quite important for income investors in particular retirees.

In summary, both Berkshire and Fairfax are compelling values today. Both companies trade at significant discounts to history and to intrinsic value calculations. However, in a head to head comparison Fairfax Financial is a better value.

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4 thoughts on “ Is Fairfax Financial a better value than Berkshire?

  1. Paul,

    I think you have made a strong case for Fairfax.

    Could you explain the logic behind Buffett’s using the per share book value of the investment portfolio of the insurance companies as the value of the insurance business?

    1. Tony, I think Tilson is assuming that over the long run the cost of the insurance float is zero, i.e. the insurance underwriting business breaks even at the minimum. That means that the incoming premiums are enough to offset all losses over the cycle. If that is the case, then the insurance business could be valued as the book value of the investment portfolio. The only issue I have with this is that since most of the investment portfolio is marked to market, that book value of the investment portfolio could be over valued or under valued. So I think an investor also needs to judge if the book value of the investment portfolio is over valued or under valued. On this metric I also judge Fairfax to be a better value or at least to have more downside protection. Its portfolio is only 23% equities and 90% of it is fully hedged. For Berkshire about 60% of the investment portfolio is in equities and none of it is hedged.


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