Tuesday, March 11, 2008

We have moved to a new website

here's the link http://www.insurancestockinvestor.com

& check out my new book review on successful value investor Sir John Templeton

Friday, March 7, 2008

Prem Watsa -" Regression to the mean has begun - but only just begun!"

This quote is from Prem Watsa's annual letter to shareholders for 2007 released today. The performance for Canadian insurer Fairfax Financial(FFH) for 2007 was excellent and I have discussed this in earlier posts. I think there are only a handful of companies in the world that can boast of a 26% compounded return in book value over 22 years.

But I want to focus on Prem Watsa's outlook as he discusses in his annual letter.

"We have witnessed credit spreads widen dramatically for mortgage insurers, bond insurers and junk bonds, reflecting mainly the problems of the housing market. We remain vigilant for the spreading of these risks into all credit markets, because the same loose lending standards and asset backed structures have been applied to these markets"(Prem Watsa 2007 annual report)

This concern has certainly been reflected in the credit default swap index that has widened out to over 180 basis points as of yesterday according to Bloomberg up from 29 basis points a year earlier.

Prem Watsa is clearly concerned that defaults will spread to credit cards, auto loans & so on.

"BenGraham made the point that only 1 in 100 of the investors who were invested in the stockmarket in 1925 survived the crash of 1929 – 1932" (Prem Watsa annual report 2007)

Imagine going to a financial advisor to put some money into a mutual fund and him or her advising you that equities can be risky investments and ,by the way, only 1 out of 100 investors survived the 1929 - 1932 crash. This was a fascinating piece of historical perspective.

"In our 2005 Annual Report, we also discussed the Japanese experience from 1989 to 2004 when the Nikkei Dow dropped from 39,000 to 7,600 while yields on 10 year Japanese government bonds collapsed from 8.2% to 0.5%. With the Federal Reserve dropping the Fed Funds rate down to 3% from 5.25%, we might be witnessing a repeat in the U.S. of the Japanese experience. In spite of record lowinterest rates and record high fiscal deficits, Japanwent through years ofmild deflation. The feelings at the time in Japan were that they were different andwould not allow stock prices andland prices to fall – not dissimilar to the sentiment currently prevailing in the U.S.!!" (Prem Watsa 2007 annual report)

Could the US face the Japanese experience all over again. Deflation is definitely under way with falling asset values and rising commodity prices. Its a scary thought and would have global stockmarket implications.

"We continue to protect our shareholders froma 1 in 50 or 1 in 100 year financial storm by hedging over 80% of our equity exposure against the S&P 500 (mainly), by holding approximately 80% of our investment portfolio in treasury bills and government bonds, and by our $18 billion notional CDS position." (Prem Watsa 2007 annual report)

Prem Watsa has built the defences for Fairfax Financial to protect the company if we are in fact going into a 1 in 100 year storm. Even though the insurance industry and Fairfax are facing lower premiums from a softer insurance cycle , I still like the way Fairfax Financial is positioned and if credit markets continue to deteriorate Fairfax could end up making considerable investment gains on their credit default portfolio that will more than compensate for an inevitably softer underwriting performance.

Disclosure: I own shares of Fairfax Financial (FFH)

Sunday, March 2, 2008

Warren Buffett’s discussion on See’s Candy - Berkshire Hathaway Annual Report 2007

I felt this was a really interesting part of Warren’s annual shareholder letter this year.

Here are a few of my takeaways with quotes from Warren’s annual report…

1. The best businesses can be found in really slow growing industries (Classic Peter Lynch)

“The boxed-chocolates industry in which (See's) operates is unexciting: Per-capita consumption in the U.S. is extremely low and doesn’t grow”. Since 1972 See’s sales have grown at at “ only 2% annually.”(Warren Buffett – Berkshire Hathaway Annual letter 2007)

2. They have a moat or durable competitive advantage & great management…

“Yet (See’s) durable competitive advantage, built by the See’s family over a 50-year period, and strengthened subsequently by Chuck Huggins and Brad Kinstler, has produced extraordinary results for Berkshire.” (Warren Buffett – Berkshire Hathaway Annual letter 2007)

3. They throw off a lot of cash with little capital reinvestment required.

“We bought See’s for $25 million when its sales were $30 million and pre-tax earnings were less than $5 million. The capital then required to conduct the business was $8 million….

Last year See’s sales were $383 million, and pre-tax profits were $82 million. The capital now required to run the business is $40 million. This means we have had to reinvest only $32 million since 1972 to handle the modest physical growth – and somewhat immodest financial growth – of the business. In the meantime pre-tax earnings have totaled $1.35 billion” (Warren Buffett – Berkshire Hathaway Annual letter 2007)

4. And of course selling a great product & recognized brand that people love. Who doesn’t like chocolate!

Disclosure: I own shares of Berkshire Hathaway (BRK-B)

Friday, February 22, 2008

Value investors crowd around Sears

I just wanted to update a January article I wrote called "Media Hype" that included a discussion about Sears Holdings (SHLD) . (quick note - My normal focus for my blog is the insurance sector , you'll have to forgive me for digressing occasionally).

As you recall I compared the media attack on Eddie Lampert & Sears Holdings to what happened with insurer Fairfax Financial & Prem Watsa (& Berkshire Hathaway & Warren Buffett.)

Well it seems that some of the very best value investors around are loading up on Sears stock based on the latest 13Fs.

Here is my list of long term, top value investor stakes. Holdings of Tisch & Perry are as reported in a Barron's article "A Storied Name on Sale?" (Oct07) & neither of these insiders have sold stock since.

Eddie Lampert & ESL 65.6 mil
Bill Ackman & Pershing 6.1 mil
Thomas Tisch & family 4.2 mil
Richard Perry 2.7 mil
Bill Miller - Legg Mason 12.7 mil
Bruce Berkowitz - Fairholme 6.2 mil
Mohnish Pabrai funds 516 thous
Chris Davis- NY Venture fund 1.2 million
Michael Price & Whitney Tilson NM

total 97 mil

Now the total share float is around 137 million but may have been reduced through more Lampert repurchases. I would regard the 97 million shares listed as in long term hands , generally loyal to Lampert. All of these investors are very unlikely to want to sell any shares at current levels.

As of January 25, around 26 million shares of Sears were held short, 20% `of the available float. Based on my rough calculations there are really only 40 million shares the shorts can cover with & this is shrinking with Lampert's repurchases. Further, with Sears hitting new lows down in the $80s it is very likely one or more of the above value investors have materially increased their stake in Sears. This would have further reduced this 40 million share difference.

So the upshot of all this is that individuals/hedge funds shorting Sears Holdings may soon find themselves unable to buy back or cover their short positions very easily. When this situation is combined with some good news or a sense that Lampert & Sears Holdings could see an improved outlook, then potentially there could be a dramatic short squeeze in Sears stock, assuming the amount of shorts stay at their current levels.

Disclosure: I own shares of Sears Holdings (SHLD)

Disclaimer: This article should not be relied upon as investment advice and is not intended as investment advice.

Thursday, February 21, 2008

Interview with fixed income guru Bill Gross

I will warn you that this interview is actually quite depressing, yet worth listening to. Bill Gross is consistently right on the mark and his views mirror Prem Watsa's interview comments from my last article post.

Below is a link to the interview on Bloomberg. But first a few take aways from the interview -

- We're facing an environment where assets such as houses,shares are experiencing deflation while commodities (oil & food) are rising rapidly and creating inflation. The net effect being a real erosion of wealth.

- Bill Gross (citing Peter Bernstein) says the unwinding of the global derivatives and massive debt leverage globally will be akin to "water torture" both slow & painful. (I immediately had a recall to Warren Buffett & Berkshire Hathaway's nightmare with Gen Re & the un-winding of Gen Re's derivative portfolio. It cost Berkshire hundreds of millions in losses and was nothing compared to the global derivative trade we now have)

- cheap credit is over , the ability to obtain credit & the cost of credit will be higher in spite of recent interest rate cuts .

-the total losses from subprime will be $400-$500 billion but when combined with other corporate loan losses, losses in mututal funds & hedge funds , the total losses could be over $700 billion.

- Bill Gross didn't suggest there wasn't value in banking stocks. He did say Pimco was investing in corporate bank loan bonds paying a nice 8% yield.

-Bill Gross did suggest eventually there will be value in mortgage loans but only after the great unwinding happens and we are still yet to see that completely play out.


Prem Watsa (CEO Fairfax Financial -FFH ) says credit losses are far from over

from Bloomberg today - some interesting quotes

-``It's still early days,'' Watsa said in an interview today from his Toronto office. ``This is a very extensive credit problem.''

-``We're just rolling through mortgages right now, but we haven't gone through all the other areas yet,'' such as credit- card debt, commercial real estate loans and automobile lending, Watsa said.


-``We have sold most of our monoline insurers,'' Watsa said. ``You figure out risk versus reward, and you might well decide to sell. We've done that with monolines, but the others we're continuing to review.''

here's the link


Disclosure: I own shares of FFH

Fairfax's blowout year

Canadian insurer Fairfax Financial (FFH) has just reported its year ending December 2007 results and they are extraordinary. Normally I don't get carried away with a quarter's numbers but what is significant here is that an investment strategy brilliantly conceived by Prem Watsa and his team over the past few years has paid off handsomely. The simple premise was this, risk had been undervalued by the credit markets for too long with little to no distinction made between a safe AAA treasury bond and a AAA rated CDO that included unsafe subprime loans. Fairfax made its bet that risk would be repriced at a higher level, by using credit default swaps. In the last year, Fairfax was proven right as credit was dramatically repriced.

Driven by huge gains on this credit default swap bet, Fairfax ended the year with $4.1 billion in shareholders or $230 in book value, a 49% increase year over year. This closing book value was more than my more conservative estimate of $220 (see my article from earlier in January).

Further, there is clear evidence that Fairfax is finally getting its reserves under control with a solid 93% combined ratio for the quarter & 94% for the year.

Fairfax's credit default swap gains continued during the first quarter of 2008. A total of $151 million in realised gains & $596 million in unrealised gains up to February 15 2008. That puts Fairfax's book value north of $270 so far this quarter. A truely great result.

Prem Watsa and Fairfax Financial have suffered under a torrent of press criticism and outspoken Fairfax shorts over the last few years. Surely justice has been dealt today and Fairfax shareholders have been vindicated.

Disclosure: I own shares in FFH