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Analysis of Guru Companies - Prem Watsa, Fairfax Financial

Chris Mydlo

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Of the investing gurus we follow at GuruFocus.com, six have publicly traded companies that are directly affected by their investments. So far I discussed Warren Buffett (Trades, Portfolio)’s Berkshire Hathaway (BRK.A)(BRK.B), Carl Icahn (Trades, Portfolio)’s Icahn Enterprises (IEP), and Ian Cumming (Trades, Portfolio)’s Leucadia National (LUK). The next stock I am discussing is Prem Watsa (Trades, Portfolio)’s Fairfax Financial (FFH:TSX, FRFHF).

The Guru

Prem Watsa is the chairman of the board and CEO of Fairfax Financial and has held the positions since 1985. He was born in Hyderabad, India in 1950. Watsa studied chemical engineering at the Indian Institute of Technology and earned his MBA at the University of Western Ontario in Canada. His professional career started at Confederation Life in 1974. The director of research handed him Benjamin Graham’s book, “Security Analysis.” From there he has been following the Benjamin Graham style of value investing with one addition. Watsa also hedges against market risk. In his latest letter to shareholders he stated that his equity portfolio is fully hedged. He gave the following response about hedging in his 2011 interview with GuruFocus:

“We are hedging not for 5-10% declines, we are hedging big market risk. We're worried about the markets coming down significantly. It might not happen, but we are just very downside protection oriented. We look at downside protection, we worry about that, and we have to live within our means. I keep telling our team, we don't have the Federal Reserve or the Bank of Canada to help us.”

Watsa also stated that he is hedged because he is in the insurance business:

“If the insurance business one of these days will turn, and we don't want to be restricted in the ability of our insurance businesses to write more business because the capital's gone down, because of mark-to-market hits. Mark-to-market declines this time may last for some time, as opposed to 2008-2009 when it lasted it seemed for a few months.”

The Company

Fairfax Financial Holdings Limited (FFH:TSX)(FRFHF), through its subsidiaries, is engaged in the provision of property and casualty insurance and reinsurance, and the associated investment management in the U.S., Canada and internationally. It uses its insurance float as the fuel for its investments in the same way Berkshire Hathaway does. The company started with the following timeline:

1985: met Francis Chou, then worked as a telephone technician at Bell Canada. One day, Francis asked Prem almost casually, "Do you know how Warren Buffett (Trades, Portfolio) made his money?" Prem thought he knew the answer, but Francis pointed to something he hadn't noticed: insurance float.

Met Steve Markel and set down the terms to buy Markel Financial for $5 million.

1986: Markel Financial was renamed Fairfax Financial. It means "fair, friendly acquisitions."

Fairfax is very conservative in its underwriting practices. They are willing to have large drops in revenue if the environment does not allow for profitable underwriting.

Fairfax also believes in strong corporate responsibility. Watsa stated the company’s philosophy as:

“Our philosophy is very simple: to do well for our shareholders, over the long term, by treating our customers and our employees well. And in our case, we have this principle of donating, or investing, in communities we do business in.”

Watsa also said that they do not lay off employees when the insurance business slows down.

Top 5 Holdings

Company

Market Value ($Thousands)

Resolute Forest Products (RFP)

$464,955

BlackBerry (BBRY)

$385,666

SandRidge Energy (SD)

$196,727

Overstock.com (OSTK)

$98,056

EXCO Resources (XCO)

$57,413

Conclusion

Fairfax Financial is a good way to have a hedge in your portfolio to protect against a large drop in the markets. In 2008 Fairfax was up 9.5 percent while the S&P 500 was down 38.47 percent. While Watsa’s goal is to increase book value per share by 15 percent annually, the book value has actually increased at a compounding rate of 21.3 percent per year since 1985.

Fairfax is another way to get exposure to Canada. Its two largest holdings, Resolute Forest Products and BlackBerry, are Canadian companies. He recently invested in CARA, one of Canada’s largest restaurant companies, that includes Swiss Chalet, Harvey’s, Kelsey’s and Montana’s. I recommend the burgers at Harvey’s and the fish and chips at Kelsey’s. As far as the stock, I recommend adding it to your portfolio as a hedge at this time. The stock is fairly valued on a relative basis of price-to-book (P/B) at 1.28. Similar companies, such as Markel and Berkshire Hathaway, are trading at P/B ratios of 1.26 and 1.37. It will likely underperform the S&P 500 until there is a large drop in the overall markets. If you are looking for growth at this time, I would not recommend Fairfax Financial. In the long run, Watsa plans on getting back on track with an annual increase of 15 percent in book value per share.

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