Fairfax Financial Holdings - $FFH.TO
Is Fairfax really such a high margin of safety opportunity? Adding Exposure
DISCLAIMER: This article is not a recommendation to buy or sell any financial instrument. Please do your own research. My analysis could be totally wrong and the stocks could have negative returns.
DISCLOSURE: I own shares of Fairfax Financial
Fairfax Financial - Why is it still under book value?
I decided to almost double my Fairfax exposure despite it being at all time highs. With Event-Driven investing, the fact that a company is at all time highs is pretty much irrelevant, since the event (in this case, interest rates going up) has transformed the company in such a degree that past valuations do not matter at all. In Fairfax’s case, we can assume that interest and dividend income will be much higher than in the past, at least for the next three years.
The best Fairfax writeup I found out there is by Oliver Sung. It also includes a detailed excel model that you can download at the end. Below you can find my highlights of his model:
Underwriting profit should keep growing like it did in the past (assuming a 94.7% combined ratio)
Interest and dividend income will be much higher than in the past (~1.5B USD/yr) at least for the next three years. After that, I still expect interest rates to be much above 0% so it will surely be higher than before 2021.
With this inputs, book value per share should be around 1274 CAD in 2025. But this is according to Oliver’s model. I think book value will be even higher though! At the Q1-2023 report it was already 1091 CAD.
Assuming a 1.3x price to book, which I think Fairfax deserves with the higher earnings prospects it has, right now the fair price for Fairfax should be around 1418 CAD. In 2025 it should be higher than Oliver’s 1656 target in my opinion, since book value will be probably higher.
Right now Fairfax is trading at 0.9x price to book, and I think it should trade over book, while book value will also increase due to the high interest income and underwriting profit (and any investment gains that they can get).
The biggest risk is if Fairfax starts posting underwriting losses, but I think that their discipline is high and it will not happen, and even if it happens, I will be able to exit the position at a profit. Even if Fairfax had zero underwriting profit, book value would keep improving so I think that this is a situation with a high margin of safety. A long-time has passed since interest rated went up, and the market has not yet fully priced in the earnings power of Fairfax, it really shows the power of Event-Driven investing. Most market participants are not looking at this company through an Event-Driven lense.