Why Fairfax Financial Is a Buy: Undervalued With Strong Management

Feb.20.11 | About: Fairfax Financial (FRFHF)

Fairfax Financial Holdings (OTCPK:FRFHF or FFH.TO) is a Canadian insurance company that is often likened to Berkshire Hathaway (NYSE:BRK.A). Both have strong records of increasing book value and are very shareholder friendly. As many readers may recall, Warren Buffett has called insurance one of the best businesses in the world because the float can be invested until it becomes a liability for insurance claims.


The primary reason to own Fairfax Financial is its management. The CEO, Prem Watsa, and his management team have compounded book value at a rate of 26% per year since 1985. Over the last decade this has slowed, but its ~10% per year book value growth over this time period is still very strong.

Hamblin Watsa Investment Counsel, a Fairfax Financial subsidiary that provides asset management for other Fairfax Financial subsidiaries, has a strong investing record. Its stock and bond portfolios have outperformed benchmark indices over the last 15 years as shown in the table below. Moreover, they correctly bet against the housing market using credit default swaps.

Performance 15 Year
Common stocks (with equity hedging) 18.3%
S&P 500 8.0%
Bonds 10.6%
Merrill Lynch U.S. corporate (1-10 year) index 6.8%
Click to enlarge

The company, of course, is a lot larger now than it was in the past, which means that consistent 26% per year growth is unlikely. However, it has a stated objective to increase book value by 15% per year, a goal that I think is very possible to achieve given the managements strong performance in the past.

One fact that makes Fairfax Financial stand out by itself is its conservative underwriting standards. Management is willing to lose market share if the underwriting market is soft rather than take a loss.


Management owns a considerable part of the company, aligning their interests with shareholders. Prem Watsa alone owns roughly 10% of the company, representing almost all of his net worth. With such a large share of the company, management will clearly do what is in the best interests of shareholders.


Currently, Fairfax Financial is trading at 1.05x book value. The average price to book value in the insurance sector is 0.9, but given the quality of Fairfax Financial's management, I think it deserves a higher premium, maybe closer to 1.3 or 1.6 time book value. A multiple of 1.3x book value would place shares around $475, or nearly 25% higher than shares are currently trading.

In conclusion, Fairfax Financial, has management with a great track record that is likely able to compound book value at its stated objective of 15% per year. Fairfax Financial is only trading at 1.05 times book value, a price that will prove to be cheap if its target growth rates are achieved.

Disclosure: I am long OTCPK:FRFHF.