“Since we began paying dividends in 2001, we have paid cumulative dividends per share of $93. Hope you have used them wisely!” –Â Prem Watsa (Trades, Portfolio), in the 2016 Fairfax Financial Letter to Shareholders
Watsa, one of the investing gurus followed by GuruFocus, is known as the Canadian Warren Buffett (Trades, Portfolio). But this Canadian is in the financial news because he’s betting big on the new American administration headed by President Donald Trump.
He has pulled back on the defensive hedges his company, Fairfax Financial Holdings Ltd. (TSX:FFH, Financial), has had in place for several years and added equities. That includes the friendly acquisition of Allied World Assurance Co. Holdings AG (AWH, Financial) for nearly $5 billion, a deal that Watsa calls "transformative."
As Holly LaFon wrote in a GuruFocus article on Dec. 22, 2016, “Prem Watsa (Trades, Portfolio) embarked on his 'largest and best' acquisition in his company’s 31-year history this week, encouraged by what he views as a pro-business environment ushered in by the election of President-elect Donald Trump.”
Yet Watsa is much more than his latest trades. He also has a unique investing style, one that originated with Benjamin Graham, and although he’s lagged in recent years, he has matched Buffett in generating returns for his shareholders.
Because Fairfax trades only on the Toronto Stock Exchange, the regular company information and analysis provided to GuruFocus readers will be available only to those with Canadian and/or Global subscriptions. Also, in assessing Fairfax’s results keep in mind apples and oranges; Watsa says, in the 2016 Letter to Shareholders, “As our book value is reported in U.S. dollars and our stock trades in Canadian dollars, the weak Canadian dollar in the last four years has resulted in our stock price going up faster than our book value.”
Who is Prem Watsa?
The investing guru was bornin Hyderabad, India, in 1950. After earning a degree in chemical engineering from the Indian Institute of Technology, in Madras, he emigrated to Canada. Once in Canada, he earned enough as a salesperson to be able to afford the University of Western Ontario, where he earned an M.B.A.
After completing this degree, Watsa worked for a life insurance company, and then in 1984 started an investment firm with a former boss. The following year the firm took over a company called Markel Financial and renamed it Fairfax Financial Holdings. That insignificant little company now has a market cap of 14.22 billion Canadian dollars ($10.66 billion).
It’s no surprise he’s called the Canadian Warren Buffett. Like Buffett he runs a holding company with many insurance companies, and like Buffett he uses the "float" from insurance premiums to finance his investments (float involves several elements, but mainly the upfront payment of premiums by policyholders).
And while Watsa rarely talks publicly or to the media, he does write an annual Shareholder’s Letter, which has many parallels with those written by Buffett. That includes an easy-to-read style, folksy wisdom, acknowledgement of mistakes and occasional wisps of humor.
Perhaps the most controversial of Watsa’s investments has been his long and continuing involvement with BlackBerry Ltd. (BBRY, Financial), which was previously named Research in Motion. It is, of course, the smartphone pioneer that was later eclipsed by Apple’s (AAPL, Financial) iPhone and others. BlackBerry has now finalized its exit from the hardware and smartphone business through licensing arrangements (it will collect royalties from phone makers that use its name). Its promise lies in BlackBerry Radar (a player in the Internet of Things) and QNX, which has a solid foothold in the automotive market, including that of self-driving cars.
Ironically, one of the first gurus to see the potential of Trump’s economic policies has been a South Asian immigrant. We see many parallels with Buffett, including a communication style and a willingness to take a long-term perspective on a stock most market players wrote off long ago.
What is Fairfax Financial Holdings?
We’ve pointed out that Fairfax is a holding company with many insurance holdings. More specifically, it holds all types of insurance companies, including property/casualty and life. In addition, the company owns other holdings, including several restaurant chains.
However, the big revenue generator is insurance business (premiums, whether gross or net), as this excerpt from the 2016 Annual Report indicates:
To understand Fairfax, think in terms of cash flowing in from insurance policies, some of which can – and must –Â be invested, as well as the earnings of all the companies in its stable. Altogether it adds up to sizable sums that need to be deployed. It’s a happy problem Fairfax shares with Buffett’s Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial).
Fairfax Financial Holdings trades on the Toronto Stock Exchange. This Stockcharts chart shows the ups and downs of the share price over the past five years:
The recent, and significant, pullback began on Oct. 3, 2016. Rupert Hargeaves explained the 20% drop this way in a GuruFocus article: “There is one main reason for this poor performance, and that’s Fairfax’s investments. While the company has compounded book value by 20.4% CAGR and the stock price has followed it, achieving a CAGR of 19.4% over the same period, the company’s recent performance has been dented by a loss of $378 million on equity investments and a loss of $436 million on CPI linked to derivatives. These derivatives are a bearish bet on the world economy and have a notional value of around $109 billion.”
Hargreaves goes on to explain that Watsa began reducing his hedging commitment; as noted, Watsa became much more bullish about American markets and the American economy with Trump's election.
Watsa says, in the 2016 Letter to Shareholders:
"As the table shows, hedging our common equity exposures has been very costly for us over the last five years. Not only did the stock markets do well in the last five years but our stock selections, overall, did poorly. Not our finest hour!
"Of course, our bond returns have been outstanding!"
The loss in 2016 was only the fourth losing year in 31 years, and overall book value per share has compounded by 19.4% (20.2% including dividends) per year while the stock price has grown at 18.6% per year.
The Canadian equivalent of the SEC’s EDGAR is known as SEDAR. You can read the Fairfax filing with SEDAR here.
The last five years have been relatively difficult ones for Fairfax, but the company continues to earn outstanding returns for shareholders prepared to take the long view. Notably in the past five years fixed income has outperformed equities.
Watsa’s investing philosophy
In its profile page on Watsa, GuruFocus quotes him as saying,
“Warren Buffett attributes his success to Ben Graham's work, and in a smaller way, it is the same for me and hundreds of people who've made it as investors. You read that book and either you get what it's saying in a snap or you never get it. For me it was so simple and made so much sense, I thought I had died and gone to heaven. It was my 'road to Damascus' moment.”
The writer Simple Digressions at Seeking Alpha points to Watsa’s contrarian positions as a source of success, and “The great investment results recorded by Fairfax originate from clever hedge management.” As we now know, Watsa sharply reduced his hedge positions and made a heavy bet on equities when Trump was elected president and promised a more business-friendly environment.
On the contrarian side, observers can point to Watsa’s continuing position in BlackBerry. Once $140 per share, the company now trades for less than $10, but he continues to hold it. GuruFocus quotes him as saying, “Our long-term view has also meant that we have a commitment not to sell our core companies, no matter how attractive the price.” And, perhaps, also, no matter how dismal the price.
On the Prem Watsa Page at ValueWalk, Jacob Wolinsky wrote in 2011, “Watsa focuses on once-in-a-lifetime events –Â i.e., black swans. He had carefully positioned Fairfax for the financial storm before the crisis erupted in 2007-2009. Watsa made money for Fairfax by buying very cheap Credit Default Swaps CDSes on bonds, which rose tremendously in value as the subprime crisis erupted. Watsa does not invest in commodities; he invests in American and Canadian bonds and CDSes. Watsa also buys stocks and hedges them against the Standard & Poor's 500.”
Watsa and Fairfax are also acquisition fanatics. Reading the 2016 Letter to Shareholders demonstrates: comments on a long list of companies acquired and their successes.
In what it calls its Guiding Principles, Fairfax lays out four key objectives:
- Compound mark-to-market value per share by 15% annually over the long term.
- Focus on long-term growth in book value per share and not quarterly earnings. To do that it lists both internal means and friendly acquisitions.
- Always be soundly financed.
- Provide complete disclosure to shareholders every year.
There is little doubt that Graham has had a profound effect on Watsa’s approach to investing as he did with Buffett. Within the context of Graham and value investing, Watsa has plotted his own path, adding discount-priced assets and liberally applying portfolio insurance at times.
What are the results?
This GuruFocus table summarizes the Fairfax annual returns for the past decade:
And beyond the 10-year cumulative lie some other solid numbers, and especially the 30-year cumulative:
- 15-year: 130.6% (3.5% per year).
- 20-year: 931.2% (6% per year).
- 25-year: 2,668.7% (5.7% per year).
- 30-year: 34,117% (11.3% per year).
While the annual results bump up and down, Watsa has the kinds of results that value investing advocates like to see: strong returns over the long term. Not coincidentally, the Guiding Principles state several times the need to look past quarterly or short-term results.
What's in the Fairfax portfolio now?
The following chart and table from GuruFocus show us the American equity holdings of Fairfax Financial. This caution is appended by GuruFocus: “*Holdings do not include bonds, notes, debts, shorts, etc. Foreign holdings may not be included.”
For example, in the 2016 Letter to Shareholders, Watsa discusses the company’s position in Cara Operations Ltd. (TSX:CARA, Financial), which, with the help of Fairfax capital, has grown into the third-largest restaurant operator in Canada. Cara is not listed on American exchanges.
With these caveats in mind, here is a snapshot of the Fairfax sectoral profile at the end of 2016:
And this GuruFocus table shows the top 10 American listings over the past two reportable quarters:
Those companies are:
- BlackBerry Ltd.
- Kennedy-Wilson Holdings Inc. (KW, Financial).
- International Business Machines Corp. (IBM, Financial).
- Resolute Forest Products Inc. (RFP).
- Overstock.com Inc. (OSTK).
- Helmerich & Payne Inc. (HP).
- EXCO Resources Inc. (XCO).
- US Bancorp (USB).
- Johnson & Johnson (JNJ).
- USG Corp. (USG).
With some of these companies, Fairfax is a partner as well as an investor. The BlackBerry connection has already been discussed. Another example is Kennedy-Wilson Holdings, which is referenced in the 2016 Letter to Shareholders:Â “We have invested $692 million in real estate investments with Kennedy Wilson over the last seven years.”
Incidentally, while it doesn’t show up on the top 10 list, Watsa has taken a large position in Buffett’s Berkshire Hathaway: 16,000 shares of BRK.B and six shares of BRK.A.
What we have here is only a partial portrait, but it does suggest that beyond the insurance companies, Watsa has eclectic tastes. Presumably, the companies in the list were picked up when they were value stocks, although that is not specified. Not visible here are Watsa’s interests in fixed-income securities and derivatives.
Conclusion
Watsa might be newsworthy because of his recent moves to de-hedge and to move aggressively into stocks.
But the bigger story has to be his history, of the gains he’s generated over three decades of investing on behalf of one company. As reported above, he’s compounded the average book value of Fairfax Financial Holdings by more than 20% a year and the stock price by more than 18% per year – for 30 years.
The secondary story might be how he has used both equities and bonds to grow the company, while protecting them on the downside with hedging strategies. Granted, hedging has hurt him over the last five years, but in the longer term has given his portfolio longevity and stability.
There are no doubt other stories, but by any measure Watsa has more than earned his place on the guru list at GuruFocus.
Disclosure: I do not own shares in any of the companies listed in this article, nor do I expect to buy any in the next 72 hours.
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