Sunday, January 27, 2008

Whitney Tilson likes Fairfax Financial and Berkshire Hathaway

here's the link

Interestingly Whitney Tilson says he believes the stockmarket represents the best value he has seen since late 2002 and early 2003.

Monday, January 21, 2008

What a legendary investor did during a stockmarket crash

With European markets falling over 6% during Monday’s trade(marking a 20%+ drop since last June) and Wall Street set to fall sharply on Tuesday, its easy to feel a sense of panic right now. Are we in for 1987 all over again?

Let me tell you what Shelby Cullom Davis did on that infamous day “Black Monday” in 1987. Davis , one of the greatest investors of all time, achieved 20% plus compounded share returns over multiple decades and put himself on the Forbes rich list.

On Black Monday, Shelby Davis picked up the phone & placed millions in buy orders to his broker’s trading desk. His office manager thought he had gone mad and tried to hang up Davis’s phone. But Davis grabbed the receiver back and kept on dialing(The Davis Dynasty – Rothchild)*

After the market had closed, Davis had lost $125 million* on paper. But as far as Davis was concerned, he hadn’t lost anything. He had bought many stocks at big discounts to what he knew was their real value. Why did other investors sell to Davis? Because they panicked. Over time Davis was proven right as Wall Street rallied following its Black Monday correction.

There’s a well known saying that when panics occur in the stockmarket, wealth flows from weak hands to strong hands.

So whatever happens on Tuesday or beyond, remember what Shelby Cullom Davis did. The worst thing you can do during a panic is to sell. And if you have the nerve and conviction, its probably smarter to buy stocks on discount.

*(The Davis Dynasty by John Rothchild is an excellent book I highly recommend).

Disclaimer: The above comments represent the authors own opinions and are not intended as investment advice and should not be relied upon as investment advice.

Saturday, January 19, 2008

Title insurers could be on the menu

"[Stock market investing] is the one sphere of life and activity where victory, security and success is always to the minority and never to the majority. When you find anyone agreeing with you, change your mind. When I can persuade the Board of my Insurance Company (National Mutual) to buy a share, that, I am learning from experience,is the right moment for selling it."
John Maynard Keynes quote (Sep 1937) p154 The Keynes Mutiny Justin Walsh

With the depressed housing market, housing related stocks are very unpopular at the moment. The housing industry in the US will remain in recession for at least 2008 and probably 2009 and the general economic outlook is negative. Unsurprisingly, housing related stocks such as homebuilders, mortgage insurers, banks etc have been on Wall Street's sell lists. Title insurers have also been swept up in the large wave of selling of housing related stocks.

When will these stocks bottom? Who knows. But the storm will eventually pass , it always has in the past. Nevertheless, it will claim its victims, companies with weak balance sheets or banks and lenders who have written poor loans will suffer the consequences.

Title insurance is a very old business and is indispensible in all real estate transactions. When you buy a property you want protection from anyone else laying claim the property, you want a clean title. Title insurance provides this protection. In fact it is required by law.

Title insurance is a very profitable business because defects or problems with title are generally very low. Its required every time a property is sold or refinanced, residential or commercial.

Over the foreseeable future, title insurers will face headwinds from lower transaction volume and value, as vendors become reluctant sellers, but this is normal in the title insurance business during a down period.

I recently read an excellent presentation from the value investing conference by Zeke Ashton of Centaur Capital on two title insurers, Fidelity National Financial(FNF) and LandAmerica Financial(LFG). The stock prices of both these companies are currently trading close to 52 week lows. What is interesting also is that insurer Markel Corporation(MKL), know for its value investing prowess, recently disclosed a new position in LandAmerica and is seeking permission to push its ownership to over 10%. Markel also owns stock in Fidelity National Financial.

So could title insurers now be on the menu for patient long term investors?

Here is the presentation link (remember also that reading intelligent analysis is no substitute for your own research. A good place to start but not to end)

Disclaimer: The above opinions represent the authors own views and are not intended as investment advice and should not be relied upon as investment advice.

Disclosure: I own shares in Markel Corporation(MKL) but no other securities discussed.

Tuesday, January 15, 2008

Post-Christmas sales

Everyone loves a post-christmas discount sale, investors should feel no different about the recent correction in equity markets. The fact is, its better to buy companies when they are cheap & negativity abounds than when everthing is positive.

Buy at the sound of canons, sell at the sound of trumpets. So goes the saying.

Now is a great time to start making a list of stocks with your preferred buy target price that you have always liked but may have been too expensive to consider in recent years. My only suggestion is to stick with companies with strong balance sheets & great managers that can weather tough credit and consumer conditions.

If you own mutual funds , now may be a good time to consider making contributions. Its always smarter to average down than try & pick a stockmarket bottom so consider staggering those contributions over each month.

Hopefully I will have a few interesting stock ideas to post in the next few weeks so stay tuned.

Disclosure: The above comments represent the opinions of the author and are not intended as investment advice and should not be relied upon as investment advice.

Friday, January 11, 2008

Why Fairfax Financial(FFH)remains one of my largest positions

Property and casualty insurers will face tough headwinds over the course of 2008. On the underwriting side, over-capacity is driving rates down and lowering premiums and we are likely to see worsening combined ratios. On the investing side, some insurers face losses on CDOs and riskier corporate bonds while insurers with large equities positions will see lower returns from capital gains as economic growth slows.

It all sounds a bit grim. There are opportunities out there for investors in insurance stocks, but now is the time to be extremely selective.

Canadian based insurer Fairfax Financial is one company I own and remains one of my top holdings. Here are my reasons

Fairfax will benefit from a large housing downturn and I think we still have ways to go. Fairfax owns a large credit default swap position ( with a notional value of over$18 billion at 30th September 2007) on 30 names exposed to a collapse in the housing market such as mortgage insurers, financial guarantors and mortgage lenders. Fairfax has enjoyed substantial unrealized gains on this CDS portfolio to date, in excess of $1 billion as of the 3Q 2007 conference call, and this CDS portfolio will likely have continued to appreciate in recent months.

Substantially all of Fairfax’s fixed income portfolio is in government bonds, they have no CDOs or other toxic securities . As treasury yields(and interest rates) fall, Fairfax will enjoy unrealized gains on the bonds they own, a 1% fall in interest rates will lead to a 10% increase in the value of their bond portfolio(2006 Annual report). This will boost shareholder equity and book value per share.

Fairfax has hedged 80% of its equity portfolio against a decline in the S&P. This is insurance for Fairfax, protecting its capital position against any unforeseen shock we might see to equities as the economic fundamentals and business conditions deteriorate.

Fairfax’s Asian operations will continue to grow rapidly with the economic expansion throughout the Far East. US is facing a recession but the prospects in Asia continue to look favourable. Fairfax’s net premiums written on its Asian subsidiaries are up 20% year over year.

Fairfax’s investment portfolio is worth more than its carrying cost. Their 26% interest in ICICI Lombard, India’s largest general insurer, is carried on the books at $60 million well below its fair value estimated at $147 million in Fairfax’s balance sheet disclosures. Commentators such as Whitney Tilson have placed even high fair value estimates. Also Fairfax owns private equity investment in Chou Associates Fund that would be in the books at cost.

Softer insurance pricing for reinsurance and general insurance will affect Fairfax’s US and Canadian operations. However, even as the top line shrinks, Fairfax enjoys an improved reserving position from that which existed a few years ago which means Fairfax can continue to improve its bottom line through a stronger combined ratio. In the first nine months to 30th September 2007, even though net premiums were down slightly, Fairfax’s had a big improvement in underwriting profit of $198million versus $62 million for the year earlier.

Prem Watsa, Fairfax's Chairman and CEO, is a fantastic value investor with a great track record. Investors in Fairfax should rejoice over declining equity values, as Prem Watsa will have the opportunity, the smarts and financial wherewithal to take full advantage.

Finally, with an estimated book value of around $220 as at December 2007. At around $280 per share Fairfax trades for a reasonable 1.3x book value. That’s cheap considering Fairfax has compounded book value at a 24%+ clip over 20 years . Looked at another way, Fairfax has around $1000 per share in cash and invested assets, if they can do conservative 5% after tax return that’s $50 a share on a $280 share price.

In part due to poor equity market conditions, Fairfax’s shares are also likely discounted as a result of Fairfax’s troubles over the last few years. However, on the latter point, I remain confident, based on their improving reported financials, that Fairfax have now put these reserving issues behind them.

Disclosure: I own Fairfax Financial (FFH) shares

Disclaimer: The opinions expressed in this article represent those of the author and are not intended as investment advice and should not be relied upon as investment advice.

Thursday, January 10, 2008

A tough 2008 lies ahead for insurers

2008 will be a year in which over-capacity in the insurance industry takes its toll on insurers, in the form of weaker pricing and lower premiums. Maintaining record profitability will in turn become a tougher proposition.

Here is a link to an excellent article discussing what we can expect...

Greenberg drops plans to exert control over AIG

Joe Petrelli from Demotech responds re. Universal Insurance article

Joe Petrelli from Demotech Inc has provided his response to my article 8th January 2008 on Universal Insurance. Please click on Comments at the end of the article.

Tuesday, January 8, 2008

Small cap insurer Universal Insurance(UVE) plays a high stakes game in Florida

Universal Insurance’s website (at gives the appearance that this Florida insurer possesses sound financial strength. A red elephant stands proudly next to the company’s logo and the financial stability rating of “A Exceptional” appears further down the home page.

However, dig a little deeper and you may conclude that Universal’s financial condition is not as rosy as it appears.

Universal’s questionable rating

Firstly, the “A” rating does not come from a nationally recognized rating service such as S& P or Moodys but from a lesser known rating service used by smaller insurers known as Demotech.

Demotech’s definition of this rating follows:-
A - Exceptional financial stability
Regardless of the severity of a general economic downturn or a deterioration in the insurance cycle, insurers earning a Financial Stability Rating® of "A" possess exceptional financial stability related to withstanding a general economic downturn or deterioration of an underwriting cycle.

I believe this rating is misleading and in this article I will detail my reasons for this.

Insurers can minimize their underwriting risk by writing policies in different States, giving them geographic diversity, and by writing multiple product lines they lower their product risk exposure.

Universal Insurance carries greater risk because it is a one state and one product company. Operating in Florida through its subsidiary Universal Property and Casualty Insurance Company(UPCIC) it principally writes homeowners insurance which represents 85% of its premiums and a further 15% of premiums come from dwelling insurance.

Being based in Florida means UPCIC is exposed to substantial catastrophe risk from hurricanes. Further, because it is 100% exposed to property, its losses from hurricane damage will have a greater affect on its financial position than on other more diversified insurers operating in Florida.

Universal expands business rapidly by taking big risks

In the wake of the dislocation in the Florida insurance market after the strong hurricane season in 2005 that resulted in larger insurers reducing their policy coverage in Florida, UPCIC took the opportunity to grow its policy count and expand its premiums rapidly and as of June 2007 had captured a 3% share of the homeowners insurance market in Florida , with around 341,000 policies.

This rapid business growth is reflected in Universal’s financial results. Based on the September 2007 quarter, year over year comparison, Universal’s earnings growth is 237% and revenue growth 136%. Meanwhile it had an impressive return on equity of 131% and combined ratio in the 70s. Universal’s premiums written have grown from $41 mil in 2004 to $371 mil in 2006 and are $263 mil for the first half of 2007.

Shareholders equity has expanded almost three-fold from $22 million at December 2006 to $63 million at September 2007.

Yet all this has been achieved by Universal taking on enormous risk, a strategy of win big or lose massively.

At the Small cap equity conference in August 2007, Bradley Meier ,CEO of Universal ,detailed Universal's exposure to a major hurricane or catastrophe. He said that based on their models, Universal would take a $45 million dollar hit on the first storm, $9 million on the second event and $9 million on a third event. Translated, if the hurricane events of 2004 or 2005 repeated themselves in 2007, Universal would have been exposed to $63 million in losses before tax, over $40 million after tax. That would have taken a 67% chunk out of shareholders equity of just $63 million.

Universal relies on models due to its short operating history

Furthermore, these forecasts given by Meier are based on models and assume reinsurance coverage. Universal’s models are based on industry data rather than individual data, because Universal is a relatively new insurer. If problems emerge that Universal’s models are not correct or a reinsurer is not prepared to foot the bill, Universal would have very little shareholder’s equity to play with. There is simply little or no margin of error.

A substantial hit to shareholders equity would threaten Universal’s risk based capital position under the Florida insurance Code and could force Universal into a substantial dilutive share offering to protect its capital position. It may in turn be required to reduce its premium levels to reflect its revised capital position.

Fortunately for Universal insurance , both 2006 and 2007 were benign years for hurricanes. However, there are no guarantees for 2008. Universal has indicated it is preparing to apply to other States to expand its geographic reach, one would suggest this should be a priority.

A further look at Universal’s reserve for unpaid losses and LAE estimates may give investors some more cause for concern. As at 31st December 2006, LAE estimates given by Universal’s actuaries were between $37 million to $60 million. Universal booked its actual reserves at $49 million. As well as the fact it is relying on industry data (due to its short claims history) , Universal’s reserves don’t provide much scope for error. If Universal had used the higher actuarial estimate of $60 million, this would have reduced its shareholder equity by 50% from $22 million to $11 million as at December 30, 2006.

Universal’s share price doesn’t account for risks

Universal’s share price takes no account of the high levels of catastrophe risk faced by its operations. It sports a market cap of around $280 million or 4.4x its book value of $63 million. This is well above its peer average of 1.7x.
Insiders have cashed in on the high share price selling 3.1 million shares over the last 6 months according to yahoo finance. There have been no insider buys during this time.

Concluding remarks

Universal has succeeded in growing rapidly in Florida however it has only achieved this by effectively “betting the house”. This Company does not deserve an A rating and its high share price masks the high level of catastrophe exposure its business faces.

Disclosure: no position in any securities discussed

Friday, January 4, 2008

Australian insurer QBE buys North Pointe

Looks like QBE have paid a decent premium of 1.6x North Pointe's book value. Given other foreign acquisitions of US insurers such as Midland, this could be an ongoing trend on the M&A front.


Thursday, January 3, 2008

Media hype

As investors we’re surrounded by media “noise”. Financial tabloids, television broadcasters and internet news services publish their daily opinions on their latest favourites and villains. Most of the time these opinions reflect a popular held belief that is the prevailing sentiment at the time whether it is factual or not. Share price movements in particular stocks can further reinforce these biases. Its easy to feel this pressure as an investor. When you see a stock you own being vilified in the press and trading down each day, its easy to start second guessing your own judgement and believing that you should join everyone else and dump the stock. After all it feels better and safer to do what everyone else is doing.

Lets explore three companies whose leaders and stocks have been subjected to a media storm, they include two insurance focused investment companies whose prospects and shares prices are now back on a favoured footing and one holding company with a retailing focus which is still down but certainly not out. In each case, the CEO or Chairman and Company has been the target of attacks by the press.

Prem Watsa and Fairfax Financial(FFH)

Smart people don’t suddenly become stupid, the story of Prem Watsa and Canadian insurer Fairfax Financial is a case in point. From 1986 to 2000, Fairfax Financial and Prem Watsa achieved phenomenal business results growing book value per share by 37% and Fairfax's share price by 33% (measuring from 1985 to 2006, compound book value grew a more moderate but still excellent 24% ) . Much of that success was attributable to Prem Watsa and his team achieving strong investment results using the float from the insurance businesses.

But by 2001, Fairfax Financial’s golden run was in trouble after making a series of takeovers , including TIG & Crum and Forster. Fairfax was forced to massively raise its reserves for these new subsidiaries and this substantially reduced its book value and placed pressure on its ratings and caused successive years of writedowns and losses. Things looked bleak , Fairfax Financial’s Canadian listed shares(FFH.TO) went from $600 in 1999 down to $85 in 2003 and were $175 as recently as January 2006.

Fairfax a one time darling of the financial community became a villain in the press . Fairfax’s record prior to 1999 was forgotten amid the media hail storm, in a Value Investor Insight article Jim Chanos a short seller of Fairfax described Fairfax as massively under-reserved and even implied it was a bankruptcy candidate or a “zero” . However, Prem’s closest friends and supporters all great investors themselves backed their man, they included Steve and Tony Markel at Markel Corporation, Mason Hawkins at Southeastern Management and John Templeton at Templeton Funds.

So the battle lines were drawn, a small collection of some of the smartest investors of our time backing Prem Watsa and Fairfax versus numerous short-sellers and many financial publications. Given the central argument of the media and short sellers that Fairfax was massively under-reserved to the tune of billions of dollars that would potentially destroy all of shareholder capital, their argument was simply that management were either careless in setting reserves or were not being forthcoming about their exposure (translated - not of good character). But what was interesting is that the Markels and Templeton, people who knew Prem on a personal level, had worked with him and who were experienced with the insurance business and were in a better position than anyone else (media and short sellers included) to judge Prem Watsa’s character continued to back Prem and Fairfax. If you are a betting man, it pays to back the people in the know!

In 2006 and 2007 the tables began to turn. The reserve writedowns started to end, Fairfax’s Canadian, US and Asian insurance subsidiaries began firing and huge bet by Hablim Watsa Investment Council (owned by Fairfax Financial) against the bubble in the US housing market and inadequate yield spreads in the corporate bond market began to pay off in a very big way. Fairfax sued a group of short sellers who they said were spreading malicious rumours about Prem Watsa and the Company in the press in order to manipulate their share price. And over the last 12months Fairfax’s shares have bounced to new highs, up 48% from $187 to $277 today (4 Jan-07 to 4 Jan-08)

All of a sudden Prem Watsa and Fairfax were back. From favourite to villain to favourite again.

Warren Buffett and Berkshire Hathaway (BRKA & BRKB)

Everyone knows the legendary story of Warren Buffett and Berkshire Hathaway. Yet Buffett has received his fair share of media attacks. What really struck me as downright ridiculous was a series of media articles in 2005 by Peter Eavis for After it was reported that General Re was caught doing finite reinsurance deals with AIG, Peter Eavis in a March 2005 article bluntly titled “Show Buffett the door” said that “There has been no indication so far that Buffett was personally involved in the deal… But it would be absolutely no surprise if Buffett had played a part in this transaction or others like it.” And then Peter Eavis gave his view on why Warren Buffett should depart from Berkshire “Even if Buffett never ends up getting specifically tied to any particular deal that comes under the regulators' scrutiny, it is time for the Oracle of Omaha to go. His handling of the 1998 General Re acquisition is reason enough.”

Anyone who has listed to Warren Buffett or read his annual reports or any “informed” press on Berkshire Hathaway would know how irresponsible and unfair these comments were.

In 1999 commentators suggested that Berkshire was out of touch and missing the internet stock bonanza. Well in hindsight they certainly didn’t miss much. Then in more recent times the media concern became that Berkshire was sitting on too much cash because Buffett wasn’t spending it quickly enough. In a Forbes piece, released in October 2004 titled “Berkshire weighed down by cash” it was reported “…the biggest uncertainty for Berkshire Hathaway (according to Morgan Stanley) remains allocating its cash balance”. Berkshire Hathaway made some acquisitions but did avoid much of the private equity frenzy and buyouts over the 2004-2006 period.

Well fast forward to 2007. Berkshire Hathaway is now riding high . Its conservative balance sheet and big cash reserves are now being viewed favourably, its share price has jumped and its excellent business performance has stood out amid the storm that has engulfed numerous financial concerns over the last year due to the subprime loan crisis and credit market freeze. Many private equity funds are seeking to undo deals made at the peak of cheap credit in 2006 and early 2007 meanwhile Berkshire is taking advantage of all the distress and has become the acquirer , adding Marmon holdings to its collection of outstanding businesses just recently.

Warren just like Prem was always smart and honest, even if he was portrayed in a different light in some areas of the news media.

Eddie Lampert and Sears Holdings (SHLD)

Eddie Lampert and Sears Holdings are the latest company to feel the wrath of the mainstream press.

A few years ago, after Eddie Lampert made a vulture like move on Kmart in bankruptcy and later merged it together with Sears , he became the poster guy for the hedge fund community. Eddie Lampert was described as the next Warren Buffett and there have been press reports comparing Sears Holdings to an early day Berkshire Hathaway.

But this year , Sears performance has been ugly and Lampert’s star has faded. Sears has suffered from the housing downturn and like its competitors has seen a big drop in profitability. Sears shares in 2007 hit over $190 a share , but are now down nearly 45% and trading at $105.

In a recent CNBC broadcast, Lampert was nominated as one of the worst 3 CEOs of 2007. After being called a modern day Warren Buffett , he’s suddenly become one of the worst CEOs , besides the fact he is actually Chairman and not CEO but lets not get technical.

First lets look at the facts and start with Lampert’s hedge fund, ESL investments. Eddie Lampert achieved 30% a year for his investors from 1988 to 2006. An accident, I don’t think so! Richard Rainwater, a former business colleague of Eddie’s, has described Eddie Lampert as “…the greatest investor of his generation,"(Fortune Feb 6 2006). Unlike the financial tabloids, that is the kind of recommendation that I take note of as an investor. Like Eddie, Richard Rainwater has a great track record and performance and ,having known Eddie on a personal level, he is in a sound position to judge Eddie’s character as well as his business acumen.

When Eddie Lampert started buying up Kmart’s senior bonds at 40 cents in the dollar, it was no accident that he saw enormous potential unlocked value in Kmart’s real estate. He was betting big time and could not afford to be wrong. As it turned out he was right. During liquidation all of Kmart’s real estate had been valued at just $800 million, yet soon after taking control Lampert sold a small portion of Kmart’s real estate for $900 million to Sears and Home Depot.

Lampert later merged Kmart with Sears knowing that there was enormous value in Sear’s real estate along with its retail operation and other assets. Currently Sears shares are suffering under the weight of criticism in the press and the housing downturn. Certainly things look bleak. But taking a longer term view, Sears Holdings looks cheap. Its market cap is $14 billion and sells for less than the value of its real estate,estimated at between $15-$20 billion. Throw in its brands, $2 billion in Sears Canada stock and other assets , and its net asset value works out between $24-$26 billion and that’s not including an option play on its retail operations that may or may not be turned around.

Eddie Lampert sees value in the shares at current price also. He has spent billions in cash buying back shares, and in the September 2007 quarter spent around $1 billion.

Investors backing Eddie Lampert have to be brave. And there are smart investors backing Eddie Lampert like Bruce Berkowitz and Michael Price. Certainly Sears Holdings could be a 2 to 3 year work out. The press will continue to argue Eddie Lampert is out of touch, doesn’t know how to run a retailer. But I believe Eddie Lampert’s record speaks for itself. Sure smart investors make mistakes and Sears retail turnaround may be too hard a task even for Eddie, but given that the shares of Sears trade for less than the value of its real estate and you’re getting one of the smartest investors around without paying a “hedge fund like” surcharge, its hard to see much downside on Sears Holdings.

Just a final note, Eddie’s decision to be patient in selling real estate and unlocking value has upset many investors in Sears. But I have two points to make on this. Eddie has not been selling real estate to upgrade Sears stores and in so doing I believe he’s protecting his downside or his “out” option if the retail turnaround does not work, I think that’s smart. My second comment is that Eddie knows the real estate potential better than anyone, his current strategy is to maximize its use for its retailing concerns, if this doesn’t work out I’m sure he knows the potential for this real estate to be used or developed for other uses. Either way I trust Eddie Lampert’s judgement more than the popular press.

Wrapping it up

Media negativity surrounding Sears and Lampert at the moment is a good example of media journalists pushing a popular but ill-informed opinion like they have with Fairfax Financial and Berkshire Hathaway. My own view is that Lampert is smart and that hasn't changed. I am not betting that Sear's retail business will succeed but simply that Sears will not trade substantially less than its net asset value indefinitely.

Disclaimer: The opinions expressed represent the authors own point of view and should not be regarded as investment advice or relied upon as such.

Disclosure: I own shares in Fairfax Financial (FFH), Berkshire Hathaway (BRK_B) and Sears Holdings (SHLD)

Note: This blog post was updated and re-edited 4th January 2008.

Wednesday, January 2, 2008

Prem Watsa presentation

This speech by Prem Watsa , superinvestor & CEO of Fairfax Financial, was recorded earlier this year. His comments on structured finance and debt risk spreads are particularly interesting in light of the credit crisis that has developed through the second half of 2007. Here is the link...