Book value and insurance cost: Book value per share was essentially flat (including the $101 per common share dividend paid in 2011), mainly because of a record level of catastrophe claims, which cost Fairfax $1 billion, the largest catastrophe loss year ever. It cost 19.3 percentage points on our combined ratio versus six percentage points in an average year.
Out of adversity, opportunity arises: In addition to the benefits of a rising rate environment, we have made an important investment in the aforementioned Thai Re. Following the 2011 flood losses suffered by Thai Re, we have participated in a recapitalization, investing $70 million at 3 baht per share for a 25% stake in the company.
We are growing again! Net premiums written were up 23.4% – 10.9% excluding acquisitions.
Total investment return of only 6.4% (versus an average of 10.6% over the past five years and 9.6% over our 26-year history), because our common stock portfolios performed poorly – particularly at RIM (RIMM) (I am trying to help!), Resolute (the former AbitibiBowater), Bank of Ireland (IRE) and Level 3.
Three of the finest companies in the world: Wells Fargo (WFC), $19.36/share cost. Johnson & Johnson (JNJ), $61.37/share cost, US Bancorp (USB), $15.9/share cost.
Secret of 35 years of investing: average down when buying and average up when selling! Illustrated with the case of International Coal, we averaged down from our initial cost of $4.58 per share to an average cost of $3.37 per share. We sold half our position at $7.26 per share (a 115% gain) and only five months later, there was a takeover offer for the whole company at double that price. In spite of not buying only at the low and not selling only at the high, we earned $341.2 million by selling at over three times our cost.
Bank of Ireland (IRE) Investment: In spite of having hundreds of years of history and the strongest credit culture in the country, Bank of Ireland barely survived the real estate crisis in Ireland, where both house prices and commercial real estate prices dropped by approximately 50% from their highs. It is the only major Irish bank to survive that crisis – the rest of the Irish banking industry is now government owned. The rights issue plus other capital generated by Bank of Ireland has resulted in the Bank having capital to withstand an even further drop in Irish commercial real estate prices and Irish house prices. Bank of Ireland is very strongly capitalized, led by an excellent banker, Ritchie Boucher, and its shares were available at a significant discount to book value. We look forward to being long term shareholders of Bank of Ireland and hope to make more investments in that country as it continues under strong leadership diligently remedying its economic problems. Fairfax’s share was $387 million, cost $10c a share.
Continue to be fully hedged: We continue to fully hedge our common stock portfolios as our concerns about the United States discussed in our 2010 Annual Report persist. All of this reminds us of the late 1980s in Japan. Given interest rates at close to absolute zero and no fiscal stimulus bullets available in the western world, we continue to maintain our 100% equity hedge. Ben Graham’s observation that “only 1 in 100 survived the 1929-1932 debacle if one was not bearish in 1925” continues to ring in our ears!
Hard landing in China? As for China, late in 2011 the Chinese bubble in real estate burst. Developers have reduced prices by 25%+ to sell apartments in Shanghai – causing riots by angry buyers who paid full price. Expect apartment prices in China to come down significantly in the next few years. This may result in a hard landing in China, again with major consequences for the world economy.
Mini-tech bubble in progress: optimism continues to prevail in the financial markets as corporate spreads are back to levels prior to the great contraction in 2008 and stock markets are rallying on hopes of repeating the increases from the 2008/2009 bottoms. Record high profit margins on the S&P 500 are being extrapolated into the future, but they may well regress to the mean. We have a mini-tech bubble in progress similar to the one we witnessed in 1999/2000.
The game is over for long treasuries (almost!). Even if the rates go to zero, long treasuries can provide a compound annual return of only 6% in the next ten years compared to twice that by stocks, if we assume no change in P/E multiples and historical earnings growth. We have already sold half our long treasury position at a yield to maturity of 3.0% (realizing a gain of $271 million) and we expect to sell the remaining soon.
When to remove our equity hedges? In time, we will remove our equity hedges as the risks that we see get discounted in common stock prices. The major risks we see are in the next three years, as we expect common stocks to do very well in the next decade. If P/E ratios revert back to their mean, shares of companies like Johnson & Johnson can provide compound growth rates of 20%+ in the next decade.
Read the complete shareholder letter.