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Fairfax Financial Remains Undervalued

- By


Fairfax Financial Holdings Ltd. (TSX:FFH) (FRFHF) is a financial services holding company based in Canada and headed by renowned value investor Prem Watsa (Trades, Portfolio). It owns Northbridge Insurance as well as several global property and casualty carriers, including Brit PLC, Allied World and Odyssey Group.


I started investing in Fairfax after it got hit by the Covid-19 meltdown last year. The company has regained some value, but still remains well below previous years highs, even though book value is strong and Fairfax's deep-value investment portfolio is starting to perform well. Profits have come back and now exceed 2019 levels. As such, the company's stock likely lags behind gains in the portfolio value.

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Insurance income is robust and has grown at a compound annual rate of 14% per annum since 2012. The combined ratio for 2020 was 98%, which is good given insurance losses due to Covid.




In contrast, investment income was a weak spot since Fairfax is a deep-value investment manager and, over the past several years, the value investing style has been out of favor. The value dynamic, however, has changed in recent months, so I expect Fairfax's portfolio to perform much better in the coming years.

In an appreciating market, reported value of investments lag behind the market value (of course, the reverse is true as well). Fairfax has a common stock investment portfolio of $9.77 billion (out of total portfolio of $42.1 billion).

Fairfax Financial Remains Undervalued
Fairfax Financial Remains Undervalued

I favor valuing insurance companies like Fairfax through book value rather than earnings or cash flow, as the latter can be very erratic from year to year. Insurance companies are also leveraging the strength of the balance sheet to underwrite. Growth of the book value over the years gives a good proxy of the growth rate.

Fairfax Financial Remains Undervalued
Fairfax Financial Remains Undervalued

The above chart shows that given historical median price-book ratio, Fairfax should be trading at around $700 versus the current$550 price.

Conclusion

Fairfax Financial has performed well in 2020 in spite of the pandemic. The insurance operation is profitable and growing well. The investment portfolio is coming back. The stock is at least 20% undervalued and selling below book value. In the recent past, it has consistently sold above book value. Therefore, the company is like a coiled spring that will expand substantially in the quarters ahead.


This article first appeared on GuruFocus.