When people talk about Fairfax Financial and its chairman Prem Watsa, the description used most often is the ‘ Warren Buffett/Berkshire of Canada’. This is fitting in many ways as the companies are in similar lines of business, insurance, and have impressive investment track records. But how do they compare in term of returns to shareholders and their prospects for the future? This is kind of like picking between two stellar athletes. Your odds with either are much better than average but there are some important differences that I think give one the edge.
First, we turn to historical comparisons. Both companies use change in book value as the key measure of company performance. Over the long run the stock price tracks the change in book value very closely. Starting in 1985, the first year Fairfax was public $1 invested in Berkshire in 1986 would be worth $69.60 at the end of 2012 for a compound annual return of 17%. A $1 invested in Fairfax in 1985 would be worth $245 at the end of 2012 for a compound annual return of 23%. All numbers are from the companies’ annual reports. Both easily trouncing any index. Now this is somewhat unfair to Berkshire since in 1985 they were already around for 20 years. Berkshires returns in the period from 1965 to 2012 are 19% per year, so pre-1985 they did better than the 17% post 1985. What about more recent returns? The chart below compares returns and the growth of a $10K portfolio in both companies over the last 10 years.
Over the last 10 years, Berkshire has slightly beaten the S&P500 (8.68% vs 7.98%) while Fairfax has handily beaten it with a return of 18.13% per year. Here is where we start to see some subtle differences between the companies. Look at the composition of returns between the two companies. Fairfax returns are ‘lumpier’, some amazing years – some not so good years, while Berkshire tends to track the S&P500 more closely. Also, note the difference in returns during the financial crisis. In 2008 Berkshire lost 32% while Fairfax was up 11%. Again, both great investments with Fairfax having the edge. Now, the most important question. What does this imply for future returns?
Going forward Fairfax still has the edge over Berkshire for two simple reasons; size and leverage. Berkshire is a $300B market cap company while Fairfax is about $18B. Its easier for smaller cap companies to grow vs large ones. This is why small cap tends to outperform large cap in general as I’ve discussed before. Even Buffett himself has said the Berkshire going forward will slightly outperform the index. Second, an equity investor has more leverage in Fairfax than Berkshire. When I say leverage for an insurance business I’m talking about float, the insurance premiums insurance companies get to invest up front. Fairfax is still primarily an insurance business while Berkshire is much more of an operating company than it used to be. That means Berkshire has less float per dollar of book value than Fairfax. That it means its quite reasonable to expect forward returns of 8-9% a year for Berkshire and 15% per year for Fairfax (the company’s own stated goal). A final few points for Fairfax are that an investor gets paid to wait with a decent dividend (about 2.5%), and that its returns are more uncorrelated to the index than Berkshire thus making it a good portfolio diversifier.
In summary, an investor has a great chance of beating the market indexes with an investment in either Berkshire or Fairfax but Fairfax has the cards stacked more in its favor simply due to size and the leverage present in the insurance business.