During their latest episode of the VALUE: After Hours Podcast, Taylor, Carlisle, and Weber discussed The Fairfax Stock Price Has Tripled in Three Years. Here’s an excerpt from the episode:
Tobias: JT, do you want to take a shot at your veggies?
Jake: I do, and I shall.
Jake: [laughs] I don’t remember why it popped up, but in late October 2020, I did an interview, an appearance on TIP with Preston and Stig. I don’t usually talk about individual names ever, but I made an exception that time, and I talked about Fairfax back then. I thought it might be interesting, now that we’re three years on, to do a little post mortem on that. What I saw at the time, what’s happened since– If you rewind the clock back to three years ago, we were smack dab in the middle of the pandemic. We still didn’t know what we were really doing from a policy standpoint. Not sure if we ever figured that out.
But you also had, like, the market had ripped 30% off of the March lows already by October. I felt a little bit like whistling past the graveyard sometimes. It’s easy to forget, but US Treasury, the 10-year was at zero point 79. Like, 0.79. We were talking about MMT at that time, we were talking about, can rates go negative in the US. I think there was something like $17 trillion worth of sovereign debt that was trading in negative rate territory already. Why wouldn’t the global reserve currency also potentially trade negative? The line from the last 40 years pretty much looked like this direct arrow that was going to go negative.
Tobias: It’s not over yet. It’s not over yet.
Jake: [laughs] You’re right. Don’t call it. Yeah. And of course, in that situation, banks and insurance companies like Fairfax, they’re going to have serious trouble earning on their assets. They have this big pile of cash that they have to do something with. If you’re getting 0.79 a 10-year, boy, your ROE is going to suffer. Fairfax was no exception at that point. They had really inconsistent operating results for the five years before 2020. Net income was roughly flat in 2015 and 2016. 2017 was a little better. I think it was around $1.7 billion. Then 2018, it was flat again. $2 billion in 2019, flat again in 2020. So, you’re just like up and down, can’t really get it in gear. The ROEs, of course, are following that same kind of earnings pattern. They were relatively anemic, especially compared to historical, if you looked back.
Prem[?] and team at that time were being much maligned for this, hedging into the face of a bull market at that point. The narrative was really that a lot of the pessimism basically was justified because they weren’t doing a great job in their investment portfolio. It was up and down. It just felt like, where is this going? But the market sentiment, actually, surprisingly, the price to book over that five-year period was actually like 1.2 times, which was higher, actually. Sorry, that was a high of one and a half times in 2015. And a low of 0.9 in 2019. And the five years before that, from 2010 to 2015, they were actually cheaper. They averaged about one time price to book during that phase.
So you had results, and yet it wasn’t really that cheap all along. I guess maybe people thought they were going to figure it out. I don’t know. Anyway, what’s happened in the three years since that setup? Of course, insurance rates have experienced a hardened market mostly through that time period. They’ve had pretty good results, as you would probably expect. Net income in the last four quarters alone has been almost $5 billion. That’s on today like $20 billion market cap. These rates going up, obviously, is really helping their ROEs quite a bit. And especially for Fairfax, they didn’t take a lot of duration risk. So, their bond portfolio didn’t really get pinched and hammered as much as other people who took more duration risk, more credit risk, and really reached for yield during that time period.
So as bond yields have been going up, they’ve been able to deploy into these higher yields. The average ROE for Fairfax since that podcast came out has been around the 20% range, which is, obviously, quite a bit healthier than zero that it was before. Naturally, then the math, book value has grown from $11 billion to $20 billion. So in late October 2020, the price per share was around $266. And today, it’s around $900. Now, lest you think I did anything too heroic here with that price movement, my cost basis is higher than that, $266, [Tobias laughs] but not a ton. But what’s been really interesting to watch, it’s been fairly easy to hold it this entire time, and that’s not always the case often when you have the price going up of something that you own.
It’s because I felt like Mr. Markets never really pressed my hand by giving me too tough of a decision, by pulling forward gains. So, the average price to book over this time period, the last three years, has been 0.9. So, you’ve still been like below book value this entire run. The high was earlier this year, and it didn’t even get above 1.2. So, it never really felt like, “Hey, man, this is getting expensive. You should probably punch out.” No, it’s just been business results growing, staying relatively cheap, and so you haven’t really been that tempted to sell.
When I contrast that with something like Markel, which I’ve also owned, on average, it’s traded at 1.4 times price to book. So, there’s a little bit of a difference between 1 and 1.4. 40%, by my math. [chuckles] But it briefly got down to 0.9 price to book in March of 2020 for like a week. I was a relatively happy buyer at that point as well. It’s not anything heroic there either. You follow these businesses, and they sell off occasionally, and when they get to that level, if you just hold your nose and buy, I think it tends to work out.
I think one of the interesting things I’ve observed is that sometimes the higher quality business is actually harder to make money on because it doesn’t trade at these extremes that some lower quality businesses do. And as long as you feel like, in general, that the trend is a little bit up and to the right for the business results, the fact that the valuation can move so far up and down away from that actually provides you the opportunity to be a clever buyer and seller along the way and boost your return over and above if you just bought and hold the entire way. So ironically, sometimes I feel like I could make more in a Fairfax situation than even a Berkshire, even though Berkshire objectively is a better business across almost any measurement that you would want to trot out. So, the difference between just purely business analysis, but also taking advantage of Mr. Market, I think you have to marry those both together if you want to get the best result that you can.
Tobias: Yeah. March 2020, what a great time for buying stuff.
Scott: Pretty much.
Jake: Who knew?
Jake: Yeah. Pretty much.
Scott: Unless you put it all on toilet paper that day, you made money.
Tobias: I posted a few things. I was tracking Berkshire’s price to book through that, and Berkshire got about as cheap as it got. Most of the comments underneath were how the book value was impaired at the same time, which was true, but slightly missing the vast forest for the trees.
Scott: Jake, it may not have been your intent, but one of the veggies I took from your discussion of Fairfax, there is the notion of standard deviation of a stock price, which is often conflated with risk from a mathematical sense in our business. It could actually be not necessarily just risk.
Jake: Yeah, absolutely. I think the standard deviation gives you the opportunity set to be able to do things that, when it moves to extremes, you can hopefully make some smart decisions around that, as long as you can get comfortable
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