Pod Insights The Investor's Podcast (We Study Billionaires) - The Investor’s Podcast Network TIP832: Fairfax Financial (FFO.TO): The Berkshire Of The North w/ Kyle Grieve & Shawn O'Malley About this episode In today's episode, Kyle Grieve and Shawn O’Malley analyze Fairfax Financial, the insurance conglomerate that Prem Watsa built from a near-bankrupt trucking insurer into a compounding machine often compared to Berkshire Hathaway. They break down Fairfax's insurance and non-insurance segments, its use of float, and the capital allocation moves, from acquisitions to buybacks, that have driven decades of growth. The conversation also covers Fairfax's competitive advantages, key risks such as catastrophe exposure and succession, and whether the business remains an attractive opportunity today.
IN THIS EPISODE YOU’LL LEARN:
(00:00:00) Intro
(00:05:30) Why Fairfax's history shorting backfired for years
(00:08:41) How Fairfax structures its insurance and non-insurance businesses
(00:15:10) How Fairfax treats its winning investments
(00:19:03) What the combined ratio reveals about Fairfax’s underwriting abilities
(00:28:52) Why Fairfax's culture keeps talented operators for decades
(00:30:56) How Fairfax uses debt to fund acquisitions
(00:37:54) Why Fairfax's buyback timing shows disciplined capital allocation
(00:41:11) How Prem Watsa's pay stays modest despite success
(00:46:56) What risks Fairfax has as it continues to scale
(00:53:52) Valuation discussion of Fairfax
(00:55:36) Intrinsic value of Fairfax
(01:00:04) Whether Kyle and Shawn will add Fairfax to the Intrinsic Value Portfolio
Disclaimer: Slight discrepancies in the timestamps may occur due to podcast platform differences.
BOOKS AND RESOURCES
Join the exclusive The Intrinsic Value Mastermind Community.
Track The Intrinsic Value Portfolio.
Learn more about how to join us in NYC for our Intrinsic Value Conference.
Read The Fairfax Way by David Thomas here.
Listen to Kyle's episode, where he covers the history of Fairfax Financial here.
Follow Kyle on Twitter and LinkedIn.
Related books mentioned in the podcast.
Ad-free episodes on our Premium Feed.
NEW TO THE SHOW?
Get smarter about valuing businesses through The Intrinsic Value Newsletter.
Check out The Investor’s Podcast Starter Packs.
Follow our official social media accounts: X | LinkedIn | Facebook.
Try our tool for picking stock winners and managing our portfolios: TIP Finance.
Enjoy exclusive perks from our favorite Apps and Services.
Learn how to better start, manage, and grow your business with the best business podcasts.
SPONSORS
Support our free podcast by supporting our sponsors:
Plus500
Netsuite
Shopify
Vanta
References to any third-party products, services, or advertisers do not constitute endorsements, and The Investor’s Podcast Network is not responsible for any claims made by them.
Support our show by becoming a premium member! https://theinvestorspodcastnetwork.supportingcast.fm
Transcript 13,324 words · 4 speakers
0:00 Speaker 00 You're listening to TIP.
0:03 Speaker 01 The fact that they compounded at 18% a year for over 40 years now, that's just unbelievable. I mean, it has to be one of the most under the radar, long-term success stories that we've ever come across. Right. And to think it all started with acquiring a nearly bankrupt Canadian trucking insurance business with just, you know, $13 million in float and has now grown that to nearly $41 billion. And the bet they put on the housing bubble during the GFC was like absolutely incredible trade, right? And I think they netted over $4.5 billion. And so really the big short should have been about them, not Michael Burry.
0:41 Speaker 00 Since 2014, with more than 200 million downloads, we have interviewed the world's best investors, studied deeply the principles of value investing and uncovered many compelling investment opportunities. We focus on understanding businesses and intrinsic value, investing accordingly and sharing everything we learn with you. This show is not investment advice. It's intended for informational and entertainment purposes only. All opinions expressed by hosts and guests are solely their own and they may have investments in the securities discussed. Now for your hosts, Sean O'Malley and Kyle Grieve.
1:27 Speaker 01 Daniel and I researched the gold standard of value investments when we looked at Berkshire Hathaway last year. And fittingly, we added it as a position to the intrinsic value portfolio that we run. And so we have some experience looking at insurance-based holding companies. And Berkshire Hathaway is one of the best, simply because they have the world's best capital allocator, leading the business. And Warren Buffett, and he led it for many, many decades. But I'm excited to look at another insurance business that tends to run much more under the radar than Berkshire, simply because its CEO, Prim Watzah, doesn't quite have the same cult-like following as Buffett and lives in Canada too, not the US.
2:10 Speaker 01 So maybe that's a factor. And, you know, for a lot of diehard investors though, going to this company's annual shareholder meeting is just as important as going to Berkshire's.
2:21 Speaker 02 That's right. And this business is Fairfax Financial and it's compounded its book value at over 18% per year since 1985. Now, interestingly, one of the biggest tenants in value investing is that price follows intrinsic value over the long term. And Fairfax has done just that, compounding its share price at 18% as well. And since 1986, when Fairfax had positive earnings per share, it has compounded its earnings per share at about 15% and just insanely high rate for any business over a 40-year time period.
2:49 Speaker 01 And speaking of Berkshire Hathaway, they've compounded book value at just a touch under 20% a year since inception. So Fairfax is really not too far behind. And Fairfax is interesting because it really has so many parallels to Berkshire from having an incredibly well-aligned CEO who prioritizes shareholders, to running a decentralized organization, to taking advantage of float from insurance. There's just a lot of parallels that stand out between the two businesses.
3:17 Speaker 02 Yeah, they really do. You know, Prem Watsa has often been called the Canadian Warren Buffett, and I doubt Prem would ever say that himself, as he seems to be a very humble person. But I think he's taken a lot of inspiration from Warren Buffett and Berkshire Hathaway. If you just look up, you know, the annual reports, there's a very striking similarity between the two, and I don't think that's really a coincidence. But of all the managers I've really analyzed closely, I think I might have a hot take here in some circles, but I'd actually say Prem is a manager that is definitely most similar to Warren Buffett that I think I've ever come across. In business, you seem to see many managers, you know, spelt the lessons from Buffett and Munger. But when you dig into what they really do, I think they are more or less just paying lip service to them rather than actually implementing their principles
4:00 Speaker 02 into how they conduct themselves in business and in life. And when you look at Prem Watsa, he aligns just so closely to Buffett, and he's been such an exceptional steward of shareholders' capital for over four decades now.
4:11 Speaker 01 We'll be going over many more similarities between Fairfax and Berkshire today, but let's begin here by looking at exactly where Fairfax Financial came from. How did this company come about to even be mentioned in the same breath as Berkshire?
4:25 Speaker 02 Yeah, so Fairfax began with a very simple idea. So Prem learned that if you run an insurance company, you get access to a float. And the great thing about that float is that you're basically collecting premiums upfront. So you can then invest that money for a time before the claims are paid out at a later time. Now Prem worked very hard to get to Canada from India. And when he arrived, he started working as an investor. And in 1985, he took control of a near bankrupt Canadian trucking insurer owned by Markel. So he renamed it Fairfax. Now, the reason that he chose Fairfax was simple. He wanted to treat people fairly, hence fair. The F is for friendly deals. He doesn't take part in any hostile takeovers. And then the AX part is for acquisitions, which is obviously very, very integral to Fairfax's business model. But his blueprint wasn't only based on Warren Buffett.
5:10 Speaker 02 He also studied Henry Singleton of Teledyne to help him better understand how to properly allocate capital. Not just in mergers and acquisitions, but also in the intelligent use of buybacks. When Fairfax was young, his goal was to maintain a 20% ROE. And the business model, you know, it was quite simple. Just leave the managers alone to run their insurance businesses, then invest the float.
5:30 Speaker 01 But from my understanding, Fairfax had this interesting chapter in its history that occurred after the great financial crisis. And it was sort of a black mark on an otherwise incredibly successful history. And similar to Michael Burry, Fairfax made a fortune betting against the housing bubble. But that win had some pretty hefty implications for multiple years after the great financial crisis.
5:53 Speaker 02 Exactly. So what they ended up doing was using these collateralized debt swaps or CDSs on major insurance related businesses like AIG, Swiss Re and Munich Re. Now, this was definitely a macro bet since they had a very good understanding of the assets that were inside of these businesses' specific portfolios. So basically what happened, they just didn't like what they saw inside of their portfolios. You know, these CDSs could be seen as Fairfax's own form of insurance in the event that these businesses suffered catastrophic losses. But the bets didn't really work out well at the beginning. It took nearly five years and $500 million for the bet to eventually pay off, which netted Fairfax $4.6 billion during the GFC once it finally hit, which was about four times what Michael Burry made from his great financial crisis bet.
6:37 Speaker 02 That was obviously documented in the movie The Big Short that we just discussed. But the problem, unfortunately, was that Prem kept thinking that there was just another catastrophe right around the corner after the GFC had already happened. So he kept hedging by shorting the S and P 500 and the Russell 2000. And those hedges unfortunately wiped out nearly all of operating income between 2010 and 2016. And on top of that, book value also slowed to a crawl at just 2% growth per annum. Watsa, however, is luckily very, very open, I think with his shareholders. And he eventually admitted that he made a mistake and he swore off shorting for good.
7:11 Speaker 01 Shorting is tough. I mean, it takes an unbelievable amount of skill to do right over a long period of time. And you basically have capped upside and unlimited downside. And I think once you gain a reputation for crying wolf and actually be right, then you tend to overweight the likelihood of another crisis. And so just recently, Burry actually closed down his fund. And he's made a lot of calls since 2008 that didn't work out nearly as well. And in many ways, I think we're all emotional byproducts of the era that we invest in. And so a lot of people today, including myself, haven't really seen a true financial crisis while investing. So I feel like I almost certainly underestimate the risk of another crisis because it's hard for me to imagine it.
7:55 Speaker 01 And every time the markets have dipped in what the last 16 years, they've pretty promptly rallied back. So I can totally see how when managing billions of dollars and living through something like the great financial crisis, you carry some of these scars that affect how you invest for a long time afterward.
8:13 Speaker 02 Yeah, I think that's actually completely correct. And if you even look back in time at the difference between Warren Buffett and even Benjamin Graham, Benjamin Graham, part of his entire system was built on the fact that he lived through the Great Depression. So he always thought that another depression was right around the corner. And luckily for Buffett, he was very, very young. And I don't even think he remembered anything that happened during the Great Depression. So I think you're 100% correct. Depending on when you're brought into the market, I think fully, fully affects how you invest into the future. But I want to look here at exactly what Fairfax does. So Fairfax, you can think of is basically a holding company with multiple segments. So they have kind of these three primary segments. The first one is the property and casualty insurance and reinsurance business. So this segment covers their insurance and reinsurance businesses that are all over the world, not just in North America.
8:58 Speaker 02 And when I say around the world, I really mean all sorts of interesting places. You've got Barbados, South Africa, Greece, Kuwait, Hong Kong, Bangkok, Luxembourg, Warsaw, Brazil and Argentina, among many other places as well. Then you have the life insurance and runoff section, and then you have the non-insurance business. So this includes restaurants and retail segments and Fairfax India, Thomas Cook India, and a bunch of other fully owned private businesses. Now, I really like the non-insurance part of this business. So I actually own a restaurant franchisor that exited to Recipe, which is a restaurant business with about $3.5 billion in system sales. So I followed that segment a little closer than the others. And the other assets in the non-insurance businesses that I find really interesting are Fairfax India
9:41 Speaker 02 and then Hamblin Watsa Investment Council or HWIC. So Fairfax India is actually a TSX listed company. It's kind of like a mini Fairfax, only its holdings are only in India. And Fairfax owns about 43% of the business. So that business invests in both public and private businesses as well, and they also invest in debt, too.
10:01 Speaker 01 I don't think we've really covered any franchise businesses. So it's not a model I'm super familiar with, but just to comment on Fairfax India. I remember listening to a stock pitch about Fairfax India about a year or two ago, since it does trade separately on the Toronto Stock Exchange. And it was really compelling. It sounds like they own some really unique monopoly type assets like. Airports, or maybe it was like the land around the airports. I don't remember exactly, but I want to discuss the Hamblin Watts Investment Council a little more. And so it seems kind of like the Buffett-Munger setup where they made a lot of the investments together along with other superstar capital allocators like Ted Weschler and Todd Combs, who were a part of the team at Berkshire.
10:47 Speaker 02 That's right, Sean. So HWIC is the investing arm of Fairfax, like I mentioned. But really, interestingly, Fairfax was actually born out of HWIC and not the other way around. So HWIC today is a wholly owned subsidiary of Fairfax, which basically acts as the investment arm of multiple parts of Fairfax's operations. So they invest funds for the Fairfax Holding Co.'s, the property and casualty insurance and reinsurance businesses, the insurance and runoff companies, as well as for Fairfax India. So if you look at Fairfax Investments, you can get a pretty good idea that they are deeply, deeply rooted in value investing. The businesses just tend to be quite cheap. So one of their positions, Metlin Energy, trades for a P of .2X. You heard that correctly. .2 times earnings. So when I was looking at it, I actually had to double check
11:32 Speaker 02 to see if it was an error. So, you know, they follow traditional value and principles, whether that's the preservation of capital above returns, using a margin of safety, focusing on thorough business analysis, buying out of favor businesses when they're obviously pretty cheap. And then, you know, just holding cash when the market isn't offering opportunities, which is something that a lot of businesses tend to have a hard time doing.
11:53 Speaker 01 I tend to be pretty wary of businesses that have an investment arm because they can sometimes charge pretty exorbitant fees and there can be actually conflicts of interest that make these relationships not exactly shareholder friendly. But given what you've said so far about Prim Watts and how aligned he is with shareholders, I assume he's found a way to make the arrangement work.
12:15 Speaker 02 Yeah, he has, I think. So HWIC does earn fees from the entities whose money that it manages. So in 2025 and 2024, those fees were about 233 million and 186 million. So this business is generating revenue, but the important caveat is that HWIC is fully owned by Fairfax. So while one subsidiary is paying a fee to the other business, Fairfax, the parent company, is getting the fees at that parent level, which means that no money is really moving. It just kind of nets out. So HWIC is basically just a vehicle for investing money at better returns than its insurance companies could generate by themselves. That's kind of how I look at it. HWIC makes money by earning returns for Fairfax subsidiaries, not by, you know, charging these exorbitant fees.
12:57 Speaker 02 The exception to this is in Fairfax India, where Fairfax does charge them a fee. The fee is paid in cash or in Fairfax India shares based on a management fee and a performance fee that's tied to a target for increasing the book value of Fairfax India.
13:11 Speaker 01 If it's not already clear, Fairfax is not going to be the simplest business conglomerate for us to break down, but neither is Berkshire. And when you talk about this internal independent asset management arm, it sort of reminds me of capital G at Alphabet, and that's a $7 billion fund that Alphabet runs. And they've had 16 of their portfolio companies actually IPO, which I think is pretty impressive. They'll definitely recognize a few of them. One of their early investments was actually in Lyft.
13:39 Speaker 02 Yeah, so I think you're completely correct about about Fairfax being kind of a difficult business to to look at. I mean, it's not a simple business that just has one product or one service that it sells. It has, obviously, it's based around insurance, which is great. But yes, there's a lot of moving parts here. So hopefully I can make it simple for everyone to really understand well.
14:00 Speaker 01 And so Hamblin Watson Investment Council is just one of many non-insurance businesses that Fairfax owns. But I think it's worth looking at some more of these assets as the non-insurance businesses have a market value of more than $4 billion. And so you've spoken about recipe in Fairfax India. But how are the how are the economics of this segment overall? I mean, are these good businesses to be in?
14:26 Speaker 02 Yeah, you know, the non-insurance segment definitely makes some money for Fairfax, but it's actually pretty low margin. So in 2025, it reported $397 million in operating profit, which is a nice improvement from 241 million in the prior year. But the segment has margins of just 4.6%, you know, pretty razor thin. The business model for the non-insurance seems to be based on, you know, taking these kind of controlling stakes in mispriced assets, then trying to improve them, finance them with nonrecourse debt, and then, you know, just take advantage of being decentralized, let management do its thing to help increase the value of that business. This can then add book value to Fairfax, or they can sell partial or full parts of these businesses at a profit or to fund other high returning areas of the business that we'll get into later on today.
15:10 Speaker 01 One of their biggest successes on the non-insurance side was with a business called Digit. And so Fairfax owns 49% of that business and has made an annual return on that of 41.5% a year since 2017, which is outstanding. And what I like to see is that Fairfax takes a concentrated approach with this position because it makes up over 50% of their investments in India. And so to me, this indicates that Fairfax is very willing to let its winners run. And you know, this is a key principle of how we're trying to run our intrinsic value portfolio. You know, Alphabet, for example, has doubled since we first invested in it. And Reddit has gone up by a similar amount. And we haven't really sold either of those positions because while the stock prices have gone up,
15:56 Speaker 01 they've dramatically increased their intrinsic value. The underlying business has kept up with the stock price. And so as long as we continue to think that they're great businesses to own, well, why would we want to sell and have to try and find equally good businesses to replace them? That's, that's not an easy thing to do. And so it's really tempting to lock in your profits when you've made gains. But if there's one thing we've learned from studying legend investors and covering so many companies on that show, it's that holding on to your winners really can be what differentiates a good investor from a great one.
16:29 Speaker 02 Yeah, and I think that, you know, Prem has probably shown that he is a great investor. And you can obviously see that right here with Digit, which was just a massive winner for them. So Digit is really interesting because it kind of intersects insurance with India and to some degree, technology. So Fairfax has invested about $140 million in that business and its carrying value now is a touch over $2 billion. So one area I think I should highlight is that Fairfax owns non-insurance businesses in kind of three different ways, which can be kind of confusing. So they list their investments as common stocks that are mark to market, common stocks that are equity accounted, and then common stocks that are consolidated. So just briefly, let me kind of try to break this down for you in a simple way.
17:11 Speaker 02 So the first group is stocks where Fairfax owns just a small piece, you know, just kind of too small to have any real say into what goes on in that business. So their earnings either go up or down along with the stock price, plus whatever dividends that they get paid from that business. The second group are larger stakes, so where Fairfax definitely has some influence, but it's not a majority shareholder. And the third group consists of companies that Fairfax actually controls and runs their day-to-day operations. For these, instead of just taking a slice of the profits, Fairfax actually combines that company's entire financial results with its own, and then it sets aside that portion that belongs to any other owner, so it doesn't get mixed with Fairfax's numbers.
17:48 Speaker 03 Let's take a quick break and hear from today's sponsors.
17:50 Speaker 01 Early in my career, I was shipping away at student loans and it felt like it would never end. I'd make a payment, check the balance, and it barely moved. What finally changed my mindset was seeing a real finish line, a date I could actually circle on the calendar. That's what Monarch's debt paydown simulator gives you. It uses your real balances and payments to show your exact debt-free date. Then you can run different scenarios side by side, like adding an extra $100 a month, and instantly see how much sooner you'd be done. Watching that timeline shrink is really motivating, and you're the one in control of the plan. Plus, a quick check-in on your phone or laptop tells you exactly where your money stands.
18:32 Speaker 01 It's so important to manage your finances, and I believe Monarch can help you in doing so. Write your own money story with Monarch. Use code WSB at monarch.com to get your first year of Monarch Core half off at just $50. That's 50% off your first year at monarch.com with code WSB. Interested in futures trading and looking for a place to get started? With Plus 500 Futures, you can explore some of the world's most active markets, all from one easy-to-use platform. Trade futures on popular assets like the S&P 500, Nasdaq, oil, gold, Bitcoin, Forex, and more. Whether markets are moving in crypto, commodities, or indices, there's always something to follow.
19:17 Speaker 01 500 Futures is designed to make trading straightforward with a platform you can access wherever you are, right from your phone. And you can get started with a minimum deposit of just $10. Not ready to trade with real funds? Try the free unlimited demo account first and explore the platform without putting real money at risk. Backed by nearly 20 years of experience and trust by millions of customers worldwide, Plus500 gives you the tools to stay connected to the futures markets. Visit us.plus500.com to learn more. Trading in futures involves risk of loss and is not suitable for everyone. Not all applicants will qualify. Plus500, it's trading with a plus. You don't need me to tell you that rent and mortgages are only getting
19:59 Speaker 01 more expensive. That's why Built created three credit cards designed to offer the richest rewards on rent, mortgage, and everything else you spend on. Whether you rent or own, you can earn up to 1.25X points on every housing payment without the transaction fee, no matter where you live. Points can be redeemed for flights, hotels, Lyft rides, a future housing payment, and much more. Turn one of the most unavoidable payments in your life into the most rewarding. Find the card that's right for you and apply at joinbuilt.com/tip. That's J-O-I-N-B-I-L-T.com/tip. Use our link
20:43 Speaker 01 so they know we sent you. Terms apply. Subject to approval and eligibility. Built cards are issued by Column NA, Member FDIC pursuant to license from Mastercard International, Inc. All right, back to the show. So this is something that that really surprised me when I first began to study accounting as an investor, which is that there are so many different ways to account for the value of a company's investments and the income that those investments produce in GAAP accounting. So if it's a publicly traded company and you own a small position in it, then the fluctuations in the stock price of that holding are treated as losses or gains that impact the income statement. Whereas if you own a significant minority stake or a majority stake, that
21:27 Speaker 01 Completely changes the accounting where you either record your share of the underlying company's earnings as your own earnings or claim all of it and deduct out the minority interest. And so point being, there's a huge difference in recording the changes in stock price of your holding company as income, even if you haven't sold and locked in any of the gains and recording a percentage of the underlying company's operating earnings. Right. Those are wildly different things. And the idea to some extent is to try and reflect the difference in business influence that you're truly a passive owner of and businesses where you can significantly influence the operations because you have so much more voting power or even have majority control of the business.
22:12 Speaker 02 So now I think we need to discuss the insurance business in more depth here because that segment is really what I consider to be the motor of Fairfax. So the underwriting profits from insurance for 2025 were $1.8 billion of Fairfax's operating profits. So we're about 32%. So it's generating a substantial profit for Fairfax and has risen from 18% in 2021. So I mentioned earlier that Fairfax started out as more of an investment company that utilized the float to grow. But in Fairfax's early years, the insurance businesses just weren't really that great in terms of the quality. So from 1986 until 2005, Fairfax's average combined ratio actually exceeded 100%.
22:50 Speaker 01 For those unfamiliar with the combined ratio, let me just break it down very quickly. You can think of it as a report card for how well an insurance company does its job of collecting premiums and paying out claims. And so let's say you collect $1 million from customers for their insurance. What matters are two things, the money you pay out in claims ultimately, and also the money that you spent running the business, the overhead costs. And if those two things add up to less than $1 million, well, congratulations, you made a profit just from writing insurance. But if they add up to more than $1 million, you lost money on the insurance underwriting part of things, which you generally try to then make
23:31 Speaker 01 up for with the income you receive from investing the float in the meantime. So you get to hold You get to keep, let's say, any interest that's earned on it. And that is what can make insurance businesses overall be profitable if the actual underwriting isn't. But if you can profitably underwrite insurance and earn income from float, well, those two things combined may for a very, very special business. And in insurance, this is captured by that combined ratio that we've mentioned. So if the combined ratio is under 100%, the company is making money from writing insurance. But if it's over 100%, that means the company is losing money.
24:13 Speaker 01 So it's really as simple as under 100 good, over 100 bad, almost. And over the last decade or so, Fairfax's combined ratio about 97%. And so what that technically means is that for, let's say, every dollar that they collect as premiums, they're making three cents in profit. So they collected a dollar premiums, but they only had to pay out 97 cents.
24:33 Speaker 02 Exactly. And I think this really matters because the combined ratio affects the insurance float, obviously. When an insurance company collects premiums, it holds them until it eventually has to pay it out as insurance claims. But there is a gap in that time. It could be years until it needs to be paid out. In the meantime, that money is generally invested in low returning assets like bonds for most insurance companies. So the combined ratio tells you what the float costs the company. If it's below 100%, which it has been for Fairfax since 2006, you're essentially getting paid to hold other people's money, which is just a great situation and exactly what Buffett took advantage over his entire career with Richard Hathaway. For most other insurance companies, though, the float makes just single-digit returns.
25:15 Speaker 02 You know, a great example is Allied World, an insurance company that Fairfax bought in 2017 for about $5 billion. So the insurance company had been great with an average combined ratio of 91%, but its float had a track record of just about 4% returns.
25:30 Speaker 01 That's because most insurance companies are run by insurance operators. So investing in low-risk bonds ends up being a pretty simple, low-risk process. It doesn't require equity specialists to come in and manage the portfolio. And then you can contrast that with the approach that Buffett took as really being a stock investor first and taking that float and investing it into wonderful businesses.
25:53 Speaker 02 Exactly. But as we know, with Hamblin-Watt Investment Council, they clearly have the right people in place to earn very high returns on the float while keeping risk relatively low, which you have to do. So since Fairfax today now aims for an ROE of 15%, we can just see how they'd get that with a business like Allied. So if you can increase the returns on the float, you don't need to make any incremental returns on the underwriting profits and you'll actually still earn a really high return on equity on that investment. So according to the great book, The Fairfax Way, Fairfax believed it could earn a 20% ROE on Allied simply by just increasing the float's return from 4% to 7%.
26:30 Speaker 01 Float is like really effectively free leverage, right? That's what you're describing, especially if you have a profitable combined ratio, meaning that you're underwriting insurance profitably. And so you're enhancing your purchasing power with float, which means that you're buying more assets you'd otherwise be able to, and then getting to keep the rewards for doing so. That's free leverage. And you mentioned something there that I think we should chat a little bit more about. And that's how Fairfax's combined ratio has turned from something of a liability earlier into being really a major boost for the business today.
27:04 Speaker 02 That's right. So the turnaround really started many years before the numbers, I think, started showing up. So we have to actually rewind back to 1996. So Fairfax acquired Scandia America, which was a reinsurance business. They ended up renaming it Odyssey. But when they bought it, it had about $250 million of gross premiums and $290 million of equity. And by 2020, that number swelled to 4.3 billion in premiums and 4.8 billion in equity. So this was arguably the best acquisition that Fairfax had ever made. But during this time, Fairfax had to fix a number of issues with some of its other acquisitions. So TIG, Crum and Forst. Arrived carrying just these very, very large reserve deficiencies. They had to spend years fixing how they underwrote insurance just to bring their combined ratios
27:48 Speaker 02 down, which definitely made Fairfax's numbers look kind of uglier until they were able to fix those things. Another lever that they really pressed on was leveraging their decentralized business model and putting the right people in place to lead those insurance businesses. So Prem trusted the managers of the insurance businesses and gave them time to fix things. Fairfax has presidents who stayed on literally for, for decades. They show this in their shareholder letter, which helps insurance companies focus on the long term rather than chasing risky premiums just to boost kind of your short term performance numbers.
28:20 Speaker 01 If managers of insurance companies are only around for a good or bad cycle, it's actually really hard to evaluate them. You need managers in these businesses to stay for multiple cycles. So you can see how good they are at fixing things because repairing these businesses won't really show up until years down the road. If you're the parent company and you get impatient with your subsidiary presidents and subsidiary managers, you might fire them and later learn that they're actually doing a really good job.
28:51 Speaker 02 That's exactly right. And I think Buffett talks a lot about this, about being a disciplined insurance underwriter. And the reason being when insurance is sparse, when people aren't willing to go out and, and underwrite properly, what you can basically do is you can make business by selling for the wrong price. And unfortunately, what happens in the future is if you do that, well, then you're going to be hit with a number of large claims down the road and that can literally just break an entire insurance business. So I want to move on here a little bit and look at Fairfax's competitive advantages because I think on the face of it, it's not really a business that looks like it has any obvious modes. You know, insurance is most definitely a commodity business and it's also very, very competitive. So when you look at it that way, I mean, insurance doesn't really seem like the type
29:35 Speaker 02 of business that anyone would want to get into. And like I said, you know, if you aren't running an insurance business properly and you're not disciplined, you can literally implode and destroy the entire business. So besides that though, I would say there still are a number of advantages that Fairfax specifically has, but they're also available to competitors to some degree. I just don't think that they can take advantage of it. So the first advantage, like we already have been talking about here for the last few minutes, is the combined ratio, which has trended in the right direction due to very, very effective management. The fact that Prem has access to an ever larger float and can earn higher and higher returns on it than most insurance companies is also just a massive advantage. Just to give you an idea, the float has grown to about $40.8 billion, up from $13 million in 1985.
30:18 Speaker 02 The second advantage is the capital allocation track record, which spans over 40 years. So their long-term return on investments is about 7.7%. And even though that number has trended down somewhat since the early days, I think it's one that they can reasonably maintain for quite a long period of time. If the average insurance company earns a return of, let's say, 4%, which is closer to the longer-term return of bonds, then this is just a very, very big advantage because it means that an insurance company will just earn more money simply by being part of Fairfax rather than remaining as a single entity.
30:48 Speaker 01 I would say, though, that there are other companies out there that come to mind that probably do a better job of generating higher returns on float. It's obviously Berkshire Hathaway, but also Markel comes to mind, too. And so underwriting insurance profitably, if we haven't said it enough, is just so hard to do. And like you said, it's a commodity business. But then to expect to be able to do excellent investing on top of that is really just almost like an unreasonable thing to ask of most companies. And that's why most companies can't do it well. And that's why it's such a special thing to find companies like Fairfax and Berkshire and Markel, where they have this formula for writing insurance well and also simultaneously being great investors.
31:29 Speaker 02 That's right. And I think you just brought up the kind of key point there where in order for these businesses to really, really succeed, you need both of those. You need the talented operators of the insurance businesses and you need people who can invest really, really well. And it's very, very important, both of those kind of work in conjunction. And even if you do have really, really good investors, they're still handicapped to some degree because regulators basically won't allow you to invest 100% of a float, for instance, into just equities. I don't, I don't, I don't think there's any place that does that. Just different jurisdictions have different regulations, but you have to obviously be really, really, really careful with that money because if a whole bunch of claims come in, you have to pay that out and you can't just be gambling on the stock market. You have to be able to have that, that float available to be paid out. So.
32:13 Speaker 02 Best competitive advantage that I want to mention here isn't really a traditional one either. And that's just the culture, I think, that Prem Watts has built inside of Fairfax. So throughout the years, Prem has acquired some just incredible operators. Fairfax has an exhaustive list of presidents who have been with their company for literally multiple decades, both before and after being acquired by Fairfax. And you know, I think it's kind of easy to see why. Given Fairfax's decentralized nature, it often buys insurance companies that were already very well run. All Fairfax requires is that they really just keep running them well. And then Fairfax takes care of growing their float. And Fairfax also tends to internally promote their executives. So this is really good for culture because if you are inside of Fairfax and you're just great at what you do,
32:58 Speaker 02 if a promotion becomes available, you know that you're probably going to have a really, really good chance at getting it because Fairfax is unlikely to look for an outsider to fill that position. The best example of acquiring talent was actually from Odyssey. Fairfax got Andy Barnard and Brian Young. So as of today, Brian Young is the president of the Fairfax Insurance Group, a position that was previously held by Andy Barnard, who then moved to the role of chairman of the group. And you know, they've worked together for 35 years and 25 of them have been under Fairfax.
33:26 Speaker 01 So I probably have my own biases because TIP has sort of a decentralized structure. You know, the company that we work at here and we also hire from within. So like I said, I have my biases toward thinking that it's a, it's a pretty good model. But yeah, there is a lot of evidence that, you know, giving talented people the space and the discretion to just do their jobs well without being micromanaged and without multiple layers of middle management and, and all these other different forms of bureaucracy that you tend to get better business outcomes. So it is pretty cool to see that Fairfax has a similar structure to that.
34:05 Speaker 02 That's right. So I like to switch gears here and look at Fairfax's debt situation. So through much of Fairfax's history, they haven't really feared debt and have used it to actually help fund a lot of their M and A. So as of today, they have about $14 billion of debt, and this is split among the holding company, insurance and reinsurance companies, and non-insurance companies. But with cash, their net debt position is about $11.6 billion. But this cash position doesn't actually include the insurance float, which is currently valued at $73 billion. So even though the cash available for investments for Fairfax is pretty low, they're actually still in a very, very good financial position. Fairfax has always carried debt to fuel its acquisitions, but when you have an ROE as high as they do, it makes sense
34:48 Speaker 02 to purchase businesses with a little leverage. I'm focused on a few key metrics to evaluate Fairfax's financial health. First is just their interest coverage ratio, and this is simply operating earnings divided by their interest expense. Right now, that sits at a very comfortable level at about 10x, but it's actually trended a little lower over the years from 14x in 2023. Now, total debt to capital has ranged from about 26% to 33% and currently sits right in between that number. And I think sticking within that range makes a lot of sense as they can continue to add new businesses, whether that's insurance or non-insurance, to their portfolio to help continue driving more and more growth, or they can buy out minority shares in the businesses that they already do own, once they know that it's a really, really good fit and that the business model has been validated.
35:33 Speaker 01 It does feel like it would be fair to call Fairfax a serial acquirer, and one of the hallmarks of serial acquirers is using debt consistently to finance further acquisitions. So where do you see debt going in the future? I mean, is it likely to just simply keep trending upward, or is there a chance that they actually deleverage in the future and increase their equity value relative to the debt holdings?
35:57 Speaker 02 I think that given they've had this kind of debt to capital number that stays in a pretty tight range around 30%, my assumption is that probably is going to stay that way into the future. So as long as they're continuing to generate profits and increase their shareholders' equity and capital base, I assume they'll continue to take on moderate amounts of debt. Now, the good thing about this for Fairfax is that they can raise debt quite easily and don't have to dilute shareholders in the name of growth. So since 2018, diluted shares outstanding have trended downward from about 28 million to about 23 million. And the businesses they bought over the decade have had various pricing tags, some as low as $103 million for Singapore Re. Then you have some larger kind of billion dollar plus acquisitions such as Allied World
36:40 Speaker 02 Insurance for 4.9 billion and Gulf Insurance for 1.4 billion. So, you know, they definitely do need access to leverage to buy some of these bigger deals.
36:49 Speaker 01 I can see how Fairfax would definitely need access to more capital to make more acquisitions since the pipeline for doing so does not seem to be slowing down anytime soon. And plus, as you mentioned, they can buy out minority stakes in businesses that they already partially own. And so they've already deployed some capital in these minority buy ups, if you want to call it that, at Allied World, Gulf Insurance, and Brit, and raising their ownership levels in all three effectively by deploying capital to buy more skin in the game with those businesses. And so they actually just closed a $1.65 billion deal for Kennedy Wilson Holdings as well, I believe.
37:29 Speaker 02 That's right. And speaking of acquisitions, I actually think this is probably a good time to assess the capital allocation of Fairfax because this is a very, very important part of the thesis. So I think there's just a lot of positives here. First is the 18.7% compounded annual gain in book value per share over 40 years. You know, I think this alone just shows you that they have deployed capital very effectively and have continued to grow profits at a very strong rate. So ROE, return on equity, is a primary metric that they use here to analyze the capital efficiency, and it's a very, very positive story with ROE at 19% for fiscal year 2025. Now, they have a stated goal of 15% ROE. So if they can do that, which, you know, they've been doing for well over 40 years here, I think you'll likely earn returns that track this ROE number.
38:14 Speaker 01 Those are definitely really strong and healthy numbers, especially post 2021, coming out of COVID. And they've maintained a range right around that 15% number, it seems like. But they clearly had some weakness leading up to the pandemic. So can you just explain what was going on there?
38:33 Speaker 02 Yeah, so ROE actually went negative because of something I mentioned earlier, which was the erroneous thinking that other, you know, GFC-type events were right around the corner that Fairfax could benefit from. So these investments into the CDSs were expensive and directly consumed much of Fairfax's operating earnings. Additionally, the market actually did really well during this time, so the opportunity cost of shorting the market was very, very high. So during that time, the book value decreased a couple of years in 2011, 2013, and 2016. But that wasn't the only reason for the depressed operating metrics. 2011 was a brutal year due to a multitude of catastrophic event like the Japanese earthquakes and tsunami. And this caused their combined ratio to go up significantly, up to about 114%.
39:13 Speaker 01 I want to harp on one of the things you mentioned earlier, and that's how much respect Prem Watsa has for both Buffett and Henry Singleton, who's lesser known, but still an incredible investor. And so I know Fairfax has done some really interesting things in terms of capital allocation to help increase shareholder value with Odyssey. That's the insurance business that we've discussed a few times today.
39:35 Speaker 02 Yeah, they did some really, really interesting financial engineering, which I think helps explain just how savvy they are with capital allocation. So with Odyssey, they actually ended up selling off just a 10% stake in the business at one time. So here's the nifty financial engineering, though. They sold the 10% stake in Odyssey at a book value of 1.7x. Now, that number might not mean anything to people who don't follow insurance, but that's actually a pretty high multiple for an insurance company. And once Prem realized that he could earn the premium by selling off a piece of Odyssey at a high valuation, he just jumped on it. But the real reason he did this was to increase Fairfax Financial's shareholders' ownership stakes. So the proceeds from this divestiture were used to buy more Fairfax shares, which at the time of the deal, were actually trading for only 0.9x book value.
40:20 Speaker 02 And this is just capital allocation at its finest. You see something expensive and then you buy something cheap. It sounds really easy, but it's very, very rare to see in reality.
40:29 Speaker 03 Let's take a quick break and hear from today's sponsors.
40:32 Speaker 01 You know that sinking feeling when a meeting ends, everyone's nodding along and two days later, you realize that nobody wrote down who was doing what. That's why I use Granola. Granola is an AI-powered notepad that makes your meeting notes useful. It captures what happens in your meetings and it turns it into clean, structured notes with decisions and action items pulled out and made easy to find. On days with back-to-back calls like guest prep and team check-ins, community calls, I used to spend the gaps cleaning up messy notes and trying to remember who owned what. Now I stay in the conversation and weeks later, everything is searchable in one place. Once you try it on a first meeting, it's hard to go without. You can try it totally free.
41:16 Speaker 01 Head to granola.ai/wsb. That's granola.ai/wsb to get your time back. Go to granola.ai/wsb and try it on your next call. Interested in futures trading and looking for a place to get started? With Plus 500 Futures, you can explore some of the world's most active markets, all from one easy-to-use platform. Trade futures on popular assets like the S&P 500, Nasdaq, oil, gold, Bitcoin, Forex, and more. Whether markets are moving in crypto, commodities, or indices, there's always something to follow. Plus 500 Futures is designed to make trading straightforward with a platform you can access wherever you are, right from your phone. And you can get started with a minimum deposit of just $10.
42:02 Speaker 01 Not ready to trade with real funds? Try the free unlimited demo account first and explore the platform without putting real money at risk. Backed by nearly 20 years of experience and trust by millions of customers worldwide, Plus 500 gives you the tools to stay connected to the futures markets. Visit us.plus500.com to learn more. Trading in futures involves risk of loss and is not suitable for everyone. Not all applicants will qualify. Plus 500, it's trading with a plus.
42:31 Speaker 02 This September, I was in New York for the Intrinsic Value Conference. The talks were great, but what I kept thinking about is what happened around them. On Friday night, about 20 of us crowded around a long table at a family-style Italian spot near Times Square. Saturday, we did it again. And Sunday morning, a group of us were still debating Socrates over breakfast before everyone headed home. Many of the people at those tables had only known each other from our calls in the Mastermind Community. That is the community I host with Kyle Greve and Daniel Manca. Each week, we get together on live calls to dig into markets and individual businesses. We bring in fund managers, operators, and authors as guest speakers.
43:13 Speaker 02 And a few times a year, like New York this fall and Omaha every spring, we meet in person. If you want to think in decades alongside people who do the same, apply for free at theinvestorspodcast.com/mastermind. If your application stands out, I'll be the one to reach out to you personally. All right, back to the show.
43:34 Speaker 01 So that's the key point there that you mentioned, Kyle. It sounds simple, but you don't see it happen. And it's a nuanced conversation, why? But I think one of the reasons you don't see it happen is that when a business is trading cheaply, it also just becomes harder for that business to sell pieces of itself at a premium price. But since Fairfax, in some ways, is really a sum of the parts play, even if Fairfax as a consolidated conglomerate doesn't have the best numbers, it doesn't mean one of its subsidiaries is not just absolutely blowing it out of the park.
44:08 Speaker 02 That's right. And another really interesting strategy Fairfax took to raise even more money for buybacks was their use of these things called total return swaps, or TRS. So you can think of a TRS as kind of a derivative, kind of like an option, but with a few differences. And the main one being that you take part in the gains of the upside and you take part in the potential losses if the value of the TRS goes down. But you don't actually have to own the stock. You just kind of put down a deposit. So what Fairfax did was during COVID-19, they bought these total return swaps in Fairfax's stock. Now, they knew at that time that Fairfax was undervalued, having just gone down about 50% in price. And from that time, Fairfax recovered very, very well over the years, netting Fairfax about $2 billion in cash from these total return swaps.
44:52 Speaker 02 And much of that cash was then used to repurchase even more shares of Fairfax.
44:57 Speaker 01 That's very, very cool. I think that's super interesting, the way they approached it. And one of the underappreciated aspects of buybacks is the timing of when they're done. Doing buybacks when your stock is at an all time high is actually not the right time to do it, even though a lot of companies do it then, because chances are that your shares are overvalued. And so really, if you're going to be very precise and tactical about your buybacks, you want to do them when pessimism for your business is at an absolute bottom.
45:27 Speaker 02 You are completely correct, Sean. Fairfax shows a great chart showing just how their share account has meaningfully shrunk over time. And the most meaningful number is just how many shares they bought at prices that are a fraction of today's price of about $2,340. They bought back shares in 2019 at an average price of just $473. In 2020, they bought back shares valued at about $500. I think this just kind of goes to show you that they're very good at buying back shares and understanding Fairfax's value and kind of pulling the trigger when Fairfax is at a depressed price level.
45:58 Speaker 01 So one other thing that caught my eye when looking at Fairfax was they do pay a dividend. And Kyle, I know you're not the biggest fan of dividends, nor would I say that I am in most circumstances, especially when that business can deploy capital at high rates of return, meaning that ultimately they would create more value by reinvesting and paying out dividends. But I digress. The upside is that Fairfax's dividend is a very small percentage of earnings that they pay out and the dividend yield is only 1%.
46:29 Speaker 02 You know me very well, Sean. So obviously, I'm not crazy about dividends either. Over the past 12 months, though, they paid about $350 million in dividends. And so like you just said, that's money that could have been used to fuel the M&A engine. But it's also a small enough number that I think I'm okay with it, provided that the yield doesn't continue to rise. And the number of support that the yield is actually continuing to trend down. So I'm not super concerned here about the dividend. The dividends have actually decreased over the past three years while profits have increased. So the fact that they pay a dividend is definitely not a deal breaker for me when it comes to Fairfax Financial.
47:04 Speaker 01 Dividends can be seen in different ways. For instance, when insiders hold large amounts of shares, dividends actually can be seen as an alternative form of taking a salary. And so if a business has a reasonable dividend and management can take lower compensation, correspondingly, that is maybe not necessarily a bad thing for all shareholders.
47:25 Speaker 02 Yeah, and that's exactly the case, I would say, with Fairfax. So Prem Watsa had a salary of about $600,000 since the year 2000, and it hasn't changed at all since then. And he also receives no bonuses, no profit participation, nor does he participate in any equity or pension plans. So, you know, I think this is a very reasonable deal for a leader who has compounded his business at high rates for over four decades. But I also think it shows that Prem understands how to create alignment between himself and the shareholders. So Prem Watsa, through a holding company, as well as his personal ownership, has 43.3% voting rights of Fairfax Financial. Fairfax has been through a period where it was attacked by shorters. So this large voting stake helps kind of the business stay protected from potential short attacks in the future.
48:07 Speaker 02 But Prem's economic stake is somewhere around 10% of the total shares. And with his current holdings, he makes somewhere around $19 million per year in dividends. So I would say that this is definitely part of the reason that Fairfax pays a dividend as it helps compensate the CEO, who you can argue is very, very underpaid relative to how much value he's created at Fairfax.
48:29 Speaker 01 Yeah, I mostly like it. I would say that with one caveat, Prem doesn't have a performance incentive. And I like managers to have a performance incentive aligned with creating shareholder value. And so I think we can assume that the incentive here is sort of implied that with the majority of Prem's net worth being in Fairfax's shares, he is naturally incentivized to continue increasing Fairfax's value. And since he doesn't hold any options, he takes part in both the upside and, more importantly, the downside of any declines in Fairfax's share price, which will, of course, mirror its intrinsic value over time. But how about the rest of the management team? I assume they have different compensation packages, but maybe we can go over that in some more detail here.
49:14 Speaker 02 Yeah, so it's probably not a huge surprise, but the remaining executives are making a very reasonable base salary, kind of in that 600K to $1.5 million per year range. There's nothing obvious to me here that would raise any red flags, but you know, most businesses have red flags in their kind of short and longer term incentive plans. So let's look there in a little more detail. So I could already see your eyes rolling here, Sean, you know, as Fairfax does have an options based award, but this system reminds me a lot of Lyftco's options plan in that the options that Fairfax grants are actually non-dilutive, a characteristic that's incredibly rare in most corporations. So Fairfax's equity based awards are based on subordinate shares that have already actually been issued. So you can kind of think of it as Fairfax buying these shares on the open market, then
49:58 Speaker 02 granting them to their employees. So once they grant, no dilution is actually taking place. And the vesting schedule is quite long with 50% vesting in five years and the other 50% vesting in 10 years. Fairfax has no pension plan, so these options kind of serve as its replacement. So, you know, I think I like the long-term nature of the options, along with the non-dilutive effects, but they still are to some extent time-based awards. Now, I will commend them for having these expiration dates for executives that go out past 2040. I mean, I think that's, that's quite impressive and something that I don't think I've ever seen before.
50:30 Speaker 01 Now, I really do admire it. If more of our portfolio companies took this approach to non-dilutive stock awards, where you actually have to buy real shares using cash rather than just printing shares magically, I think we'd see compensation expenses dramatically grained in and it would put more of a pinch on cash flows. But I also think boards would be much more careful about the comp packages that they structure and that is really the true benefit.
50:57 Speaker 02 That's right. And so just to briefly go over the other short-term incentive plan, it pays out about double of base salary and it's discretionary in nature. It's made up of both cash and options and these bonuses consider the performance of the executive in light of Fairfax's guiding principles. So for 2025, they gave about a 250% bonus as they had record results across the entire board. So the circular mentions a couple of things. It mentions underwriting profits, interest and dividend income, as well as a high rate of achievement in compounding the book value per share. So my assumptions are that's kind of what they're being paid off of. Now, normally I don't like incentive plans that are really so vague. Because I kind of like to be clear about what management needs to do in order to get their
51:42 Speaker 02 bonus. But I think when you look at Fairfax's guiding principles, it's pretty hard to argue that following them to a T won't produce stellar results and won't increase the intrinsic value of the company. They mentioned things like compounding book value at 15% annually, focusing on the long term over quarterly results, being open with communications with shareholders, and then just having a lot of honesty and integrity, and really just a lot more characteristics that you'd be thrilled to have when you're investing in a business.
52:11 Speaker 01 I'm probably being a stickler, but I always have mixed feelings when you can earn back your entire salary and more just on short-term targets. And on one hand, I mean, that could mean that the salary is very modest, which would be a good thing for shareholders, or it could mean that it's just way too easy to get paid off of short-term targets, or maybe that the payout on short-term targets is so generous that it's a distraction from, or sort of a detriment to these longer-term targets that matter more for shareholders. But for the most part, I think it's a very good incentive structure overall. And part of the guiding principles is based on risk and minimizing risk as much as possible, which I think is a very intelligent approach, of course, because many companies engineer
52:54 Speaker 01 really effectively their own demise by taking large risks to boost short-term results to meet quarterly earnings targets from Wall Street, but actually really positioning business to be more vulnerable longer term.
53:09 Speaker 02 Yeah, I like the focus on risk mitigation here, too. And I think that having it as a guiding principle is very admirable. And since the business has been around for so long, I think it's quite clear that they follow these principles very, very closely. But I think we should get into the real risks to Fairfax because they most definitely exist. So I mentioned earlier that insurance isn't really a Modi business. I don't think that's a hot take by any means. And even the non-insurance businesses aren't exactly wide moat businesses either, as they range from mattress stores to restaurants to retail. So let's get started with the largest risk that I see for Fairfax, which is shocks to the investment portfolio. During the year when Fairfax struggled, From 2010 to 2016, the reason wasn't that they were underwriting bad insurance. It was actually that their portfolio suffered drastically due to the equity hedges.
53:55 Speaker 02 But on top of that, if global equity markets were to experience large drawdowns, say in the 10% area, Fairfax estimates a $1 billion decrease in net earnings. A 20% drop would decrease net earnings by nearly $2 billion.
54:08 Speaker 01 This reminds me a bit of a business that you pitched earlier this year in Wise. And I know they've recently taken a hit to their investment income growth, and that was due to global interest rates dropping from effectively 3.9% to call it 3%. So for businesses that are connected to global equity markets or interest rates and are really tied to those, I mean, this can provide a major boost, but it also can be a significant detractor from future returns. Interest rates giveth and they taketh. And so I also think if the business is safe, though, during these times and has the right capital base and liquidity, then it tends to sort of even out to the upside over a long enough time horizon. And since Fairfax does have the cash and liquidity on hand,
54:53 Speaker 01 as well as the ability to generate profits from other areas of the business outside of just income from investments and float, then, you know, they should be able to withstand a hit to global markets.
55:04 Speaker 02 And that's the key right there. You know, if you have a long-term time horizon for these businesses, the best time to pick them up is actually when their share prices are weak due to cyclical market exposure. So the thing I like about a business like Fairfax is that the market corrections tend to be quite short-lived. So if you buy near the bottom, you won't have to wait around for years for the cycle to turn as it usually turns within 12 months and often much quicker. Now, the next risk that I'd focus on here is one that you can probably assume, and that's key man risk. So it's very similar to businesses that I've covered recently in SpaceX with Elon Musk or QXO with Brad Jacobs. I think Prem Watsa is a pretty big part of the thesis here with a pretty big caveat. So with QXO and SpaceX, those aren't businesses that I think are anywhere close to as decentralized
55:49 Speaker 02 as how Prem has made Fairfax. So this makes me think the better example might be more like Constellation Software and Mark Leonard. I think Constellation would never have made it to where it is today without Leonard. But the decentralized nature of the business that he built also means that the engine is going to keep humming along even after he's gone, which he now is, you know, not a big part of the business. And Prem also controls 43% of the votes. So for some businesses, you might run the risk that the CEO steps down to, let's say, become the chairman, and then a new CEO comes in who's really just a figurehead while the chairman now runs the show. So Coca-Cola in the 1980s was like this before the power struggle finished in favor of Roberto Goizetta. But I think that he had, he's done a really, really good job of making it so he's still
56:31 Speaker 02 important, but I think because of how decentralized it is, I think that the business is going to continue to run very, very well, even after he's gone.
56:39 Speaker 01 Prem Watsa is now 75 years old. So if Prem Watsa wants to leave or needs to leave, where would they turn to find a suitable replacement?
56:49 Speaker 02 So the board reviews this annually. So I don't think it's going to really come as much of a surprise for shareholders once Prem decides to step down. You know, Fairfax has said that they already have someone in place that would be more than suitable to take over many of his responsibilities. Now, there's no definitive answer to who would take over, but given that Fairfax has nearly always promoted from within, it would likely be someone a little younger than Prem, who has been with the business for a long period of time. Now, Peter Clark, who is the company's president and chief operating officer, appears to be at the top of that list. So as a president, all company officers report directly to him, and he's been with Fairfax for nearly 30 years. But even more importantly, he's had roles in Fairfax, such as the vice president, the chief operating officer, the chief risk
57:33 Speaker 02 officer, the chief actuary, and he's been a member of Fairfax's executive and investment committees. So, you know, he's one of these executives who's adept in both insurance and investing, which I think make him a great choice to lead the business once Prem decides to step down. It's worth noting that Watsa has actually stepped back as a vice chairman of Hamblin Watson Investment Council in 2019. So the investments have actually been running smoothly without participation from Watsa.
57:56 Speaker 01 It would be great to see Prim leading the company into his 90s like Buffett and Munger, but that's probably not a realistic standard to grade people on. So anyways, now with Fairfax being an insurance company, there must be some risk embedded inside of that. From the research I've done on Berkshire Hathaway previously, of course, the biggest risks were around the insurance side of things and specifically insurance reserving for losses and catastrophe risk. And so do you see Fairfax having a similar risk with its insurance companies? How do you think about that?
58:30 Speaker 02 Yeah, totally. You know, if you screw up the underwriting part of insurance and end up having to pay a larger amount of claims relative to the premiums that you charged, like I've already mentioned, you can break the business. So you need to have insurance reserves stocked up to pay out any claims from any major catastrophes. And if you're under-reserved, that can spell an insurance company's doom. So in the early 2000s, due to a couple of insurance acquisitions, they brought in books that were pretty much poorly under-reserved. In 2001, Fairfax actually lost money for the first time due to the losses from the World Trade Center and reserve deficiencies amid a very poor insurance market. But since COVID, Fairfax has done a really good job with its KPI, prior year development, or PYD.
59:13 Speaker 02 So PYD refers to how an insurance reserves for claims from past accident years change as those claims actually settle over time. So when an insurer writes a policy, it has to estimate and set aside money, which are reserves, for claims that it expects to pay, many of which won't be paid out for many, many years. And those estimates are never exactly right, so the insurer has to revise them in later years. And as a result, you get a redundancy or a deficiency. Now, you want a redundancy, as this means that the original reserves were more than enough. And once the claims are settled, you can actually release the reserves which go straight to earnings. In a deficiency, you're under-reserved and the insurer has to add more money to cover the shortfall. This raises the combined ratio and obviously negatively affects profits.
59:56 Speaker 02 But since 2020, Fairfax's PYD has been favorable, adding back hundreds of millions of dollars each year, which helps increase profits and makes sure the company is underwriting properly.
1:00:05 Speaker 01 Okay. All right. Well, we've covered a lot of the ground. I think it's that time of the show where we try and talk about the intrinsic value of Fairfax Financial. How do you value this business?
1:00:16 Speaker 02 Yeah. So Fairfax is a very, very interesting business to me. When I released my episode on a great book covering the business called The Fairfax Way on TIP 783, which I'll link to in the show notes, I often wondered to myself, why exactly I don't own Fairfax? Because I can honestly say, I don't think I've ever written a book that made me want to buy a business more than that book did. You know, when I think about Fairfax, it checks off pretty much every single box that I look for. High capital efficiency, check. High insider ownership, check. Aligned incentives, check. Long history of creating shareholder value, check. Large runway for growth, check. And since I've released that episode, you know, I keep asking myself, why don't I personally own it? And I think the reasons that I give are becoming harder and harder to justify. The one area of the business that I'm not craziest about
1:01:00 Speaker 02 is the exposure to catastrophes. While I think Fairfax is a very well-run business, this is one of the reasons that I tend to stay away from insurance companies. I really find it hard to own businesses that are facing these really, really massive headwinds that are completely out of their control.
1:01:14 Speaker 01 And if Berkshire didn't have the absolute fortress balance sheet that they have, I would probably feel differently about it. But we have seen how utility liabilities and wildfires have weighed on Berkshire for sure. And but I'm not sure that admittedly, I mean, do you think this is a risk that they're able to hedge much by selling to reinsurers? Or does the buck really stop with them and they have the most exposure?
1:01:39 Speaker 02 Yeah, I mean, they do have some of the reinsurance businesses. So they clearly understand that part of the business and can deploy capital in some parts in that way to help reduce risk. But I don't want to digress too much. I want to go over my base case here for Fairfax. So the thing about Fairfax that's interesting is that the business of Fairfax is quite complex, but the actual evaluation, I think, is like, is kind of simple, which is kind of surprising to me. So basically, what you do with an insurance business is you tend to use book value to evaluate them. So a natural capital efficiency number that directly impacts book value isn't return on invested capital, but it's actually return on equity. That's why we discussed ROE here today. And then you basically apply a price to book ratio to that terminal value and there's
1:02:21 Speaker 02 your terminal value and you're good to go. So I assume that Fairfax stays true to its long-term goal of achieving about a 15% return on equity. And this is, this is a number that provides additional margin of safety, given that the five-year average ROE is nearly 21%. I assume that their ability to allocate capital remains top-notch and that the insurance and non-insurance businesses continue to turn a profit and are run very, very well, which they seem to be doing here. So with these assumptions, it gives me two numbers, the book value and the business's net earnings. From there, it's a pretty simple path to calculate the ending book value, which I'm using at the end of 2030. I get a book value of about $2,424. Then I assume the terminal multiple remains at the same number that it has today at around 1.3 times book. And
1:03:06 Speaker 02 this is a number somewhere around the midpoint of the last decade's multiple, but that was also severely dragged down by COVID. So I think the business continues to grow at about a 15% ROE. And this is a pretty reasonable multiple to put on it. So applying that, I get a terminal value, including dividends of about $4,600 Canadian, which offers about a 14.7 annual per return.
1:03:26 Speaker 01 Just for context for listeners, as you think about Kyle's assumptions here, Berkshire trades at one and a half times book value. So actually, the multiple you're using comparatively is pretty reasonable and cheaper than Berkshire's. And already I can tell you that if they can achieve that 15% ROE target, I'm pretty confident this stock is attractively priced. But how about we hear the bear case before we make any decisions about wanting to add the business to our portfolio?
1:03:52 Speaker 02 That's right, Sean. And for the bear case, it's equally quite simple. So I assume that they just have a couple of weaknesses in the returns of their portfolio, which drops their ROE to about 11%. Now, ROE has gotten to this point, historically speaking, leading up to COVID. So it's definitely not out of the realm of possibilities. Perhaps they maybe decide to chase profits in some other segments that drag down profits for a time. Now with the reduction in ROE, I apply a lower price to book ratio of just one times. And with these assumptions, I get a value, including dividends of about $3,000 Canadian, and this is still an annual return of 5.3%. So I think this shows that this business does have really, really Good downside production. Another thing to keep in mind is that this book value means that the business is trading somewhere around liquidation value. You can argue that some of
1:04:37 Speaker 02 the assets would be marked down further, reducing the liquidation value. But even this is probably wrong. So Fairfax actually holds some of its investments that are not mark to market, and they believe are heavily, heavily undervalued. So I think the business is pretty cheap in this scenario, and you still will make a positive return.
1:04:53 Speaker 01 Point being there, there's a double whammy. If returns disappoint, the company is also going to be punished with a lower multiple. That's something you want to account for whenever you're modeling a bear case, and that's going to crush your returns.
1:05:06 Speaker 02 So I apply a 55% probability to my base case, a 25% probability to my bear case, and about a 20% probability to my bull case. With all that, I get a business that's worth about $2,400 at a 20% margin of safety. Now, this is a touch above the current price of $2,300, but if you'd like to take a closer look at how I arrived at these numbers, please subscribe to the Intrinsic Value Portfolio newsletter, which will give you direct links to the model, so you can play around with it yourself a little bit and see if you have a different view on the value based on your own assumptions. So, I mean, really, I mentioned that this business is one that I've thought a lot about owning, and am I making a mistake in not owning it? Probably, but I think to the point that I made earlier about the insurance cyclicality,
1:05:49 Speaker 02 that kind of scares me off. And then the other thing that kind of gives me pause is simply just the complexity of the business. I mean, there's just so many different areas of the business that you have to understand. It's one of these businesses where you essentially have to place a lot of trust in Premwassa to do what's right. And I mean, that's probably a good place to put trust. He's been doing this now for four decades, but I just kind of can't get over the hump of the difficulty of kind of understanding all the different moving parts of this business. So for me, I think I'm okay with passing on this business for now. I will definitely be paying very, very close attention to it, though, because based on what's happened with this business and based on what can happen with catastrophes, the profits of the business can get hit pretty,
1:06:32 Speaker 02 pretty hard. And in that sense, if this business were to come down significantly, which it could, like, you know, if this business came down to, say, 1,500 bucks, I don't know if I could pass up not adding it, but that's just my opinion. Sean, what do you think?
1:06:45 Speaker 01 You could do a whole lot worse than investing in Fairfax. And if I was in maybe a more conservative stage of my financial life, perhaps closer to retirement, I would probably see Fairfax as a great way to have some equity exposure with probably more limited downside than let's just say the median stock out there on the major stock exchanges. But at the same time, I don't see any reason to get fantastically excited about the return prospects. I mean, with pretty high confidence, I can guess they'll be decent, but it's not likely to be a home run. And that's why we've been trimming our Berkshire position today to to fund investments in companies like Uber, where we feel much more strongly that the business is severely undervalued and the
1:07:29 Speaker 01 company has tremendous untapped earnings potential. So boring investing is good investing. But when you have some truly enviable software companies selling at steep discounts to their 52 week highs and objectively some of the lowest valuations that they've traded at in many years, companies like Adobe, Intuit, and Salesforce, and so on, I find that to be more compelling to turn over those rocks and then look at them, which is what I've been doing. And I sort of feel like Fairfax and Berkshire are always there to fall back on, but they're probably not my first choice at the moment of being the most interesting things to put capital in.
1:08:06 Speaker 02 Well, folks, that's it for today. But I'd like to leave you with a quote here by Prem Watsa. "Our earnings are lumpy. We have never had guidance in 23 years because we have ups and downs and take a long term view. In 22 years, we have lost money just twice, but our book value and equity has grown dramatically. Now, it's pretty rare for a CEO to discuss his business with such transparency, but I think that you will find that Prem is basically an open book when it comes to Fairfax. And this is a characteristic we look for in all businesses we want to own for the long term. And with that, I'll see you next time.
1:08:37 Speaker 00 Thanks for listening to TIP. Follow the Investors Podcast on your favorite podcast app and visit theinvestorspodcast.com for show notes and educational resources. This podcast is for informational and entertainment purposes only and does not provide financial, investment, tax or legal advice. The content is impersonal and does not consider your objectives, financial situation or needs. Investing involves risk, including possible loss of principal, and past performance is not a guarantee of future results. Listeners should do their own research and consult a qualified professional before making any financial decisions. Nothing on this show is a recommendation or solicitation to buy or sell any security or other financial product. Hosts, guests and the Investors Podcast Network may hold positions in securities discussed and may change those positions at any time without notice.
1:09:21 Speaker 00 References to any third-party products, services or advertisers do not constitute endorsements and the Investors Podcast Network is not responsible for any claims made by them. Copyright by the Investors Podcast Network. All rights reserved.
Previous TIP831: Pinduoduo (PDD): Is PDD the Best Buy in China? w/ Daniel Mahncke and Shawn O'Malley Next TIP833: Perimeter Solutions (PRM): A Niche Monopoly, One Acquisition at a Time w/ Kyle Grieve & Shawn O’Malley Page updated November 6, 2026 · transcript and summary are machine-generated
