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 1/10th 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
Full Disclaimer - Nothing on this site should ever be considered advice, research or the invitation to buy or sell securities. These are my personal opinions only.