Fairfax Financial: Deserving of a Discount?

Derek DeCloet of the The Globe and Mail opines that regardless of the merits of its legal action against short sellers, Fairfax Financial (FFH) deserves to have its stock trading at a discount:

If a fraction of the claims are true (they have not been proven in court), then Fairfax is dealing with a very sleazy bunch here. But the heart of the lawsuit is Mr. Watsa's view that the conspiracy brought about "massive declines in Fairfax's stock price.

The implication, of course, is that the company is undervalued -- that the stock would be worth more than its current price, $120 (Canadian), if not for the nasty tricks campaign of the short sellers. Could that be true?

Maybe the shorts are nasty people, but that isn't why Fairfax's stock is down according to DeCloet:

What kind of return would you need to compensate you for the risk in a highly leveraged insurance holding company? It's a lot higher than 6.3 per cent. But the only way to get it is (a) if Fairfax starts generating a much higher profit and return on equity, or (b) if you pay much less than book value.

Since the investor can't control Fairfax's profitability, he chooses (b). If we had to guess, we'd say the "correct" price for a stock with an ROE this low is probably two-thirds of book value -- or about $120 in Fairfax's case.

Fairfax seems undervalued to me -- and I remain optimistic its true value will be realized over time.

But you have to read as much stuff as possible when managing your own money, and not only columns cheering your point of view.

Comments

[NO DooDahs:]

"Deserve's got nothin' to do with it." - Clint Eastwood as Will Munny in "Unforgiven."

What YOU see as undervalued is what some other folks see as a leveraged company with complicated, opaque financials, low ROE, and a egotistic management that's more concerned with the stock price than with the books. Everyone votes with their money, and the stock is priced according to sentiment, not the fundamentals. Sentiment = the money-weighted average opinion about the facts.

Now, maybe you've got your facts right and they don't. Maybe they've got the facts right and you don't. I dunno.

However, it IS a sharp stick in the eye to see that, the day after they file suit about shortsellers being critical of their accounting, they announce a restatement due to accounting errors. Does the phrase "stupid company tricks" ring a bell?

This company (FFH) looked like it might have been a halfway decent value opportunity to me late last year. When I wrote about it, what kept me from buying was the reliance on financing cash and the inscrutable books and corporate relationships that made it hard to value. I WORK for an insurer and have some small amount of actuarial talent, and FFH defied me figuring out what it was worth. YMMV (your mileage may vary).

Do you have a good idea of a piecemeal value for FFH and its holdings? Do you understand its bookkeeping? I don't. Warren Buffett said you shouldn't buy something you didn't understand. Since we're talking about valuation here, I guess those are appropriate questions.

2006 Aug 04 02:38 PM