Sunday, February 27, 2011

Fairfax Financial – 4th Quarter Review

I did manage to read the Fairfax Finacial 4th quarter earnings release and listen to the conference call twice as soon as I got home.  I hope I will be able to make it to the annual meeing, but Iw ill have to pull a few strings to make it happen.  To summarize they lost something like $18/shr in the 4th quarter and increased book value a modest 5% for the full year.  Fairfax currently has hedged 90% of their equity exposure with puts on the Russell 2000.  The Russell index is too high in my opinion, as I believe it is selling for close to 30 times earnings.  Many of the small cap names are selling for far too much and the large high quality companies in the DOW are quite cheap in comparison. 

Fairfax did also take a hit on its municipal bond portfolio on a mark to market basis.  These losses are nothing but temporary.  Meredith Whitney and friends have created fear in the muni bond area and investors ran for the exits in Q4.  Prem Watsa noted in the conference call that these bonds are selling for ridiculous prices.  They are currently yielding around 6.5% and are worth around 8.8%-9% on a pretax equivalent basis.  I do find it paradoxical that he also said it is very hard to purchase any bonds at this time.  Perhaps the selloff is based on low volume. 

Fairfax’s muni bond portfolio is 65% guaranteed by Berkshire Hathaway, Warren Buffett’s company. 

While on the topic of Warren Buffett, I found it interesting that he now isn’t a firm mark to market proponent as he once was.  He made the comments in a taped 2-hour interview with the FCIC on the cause(s) of the financial crisis.  Click here to access.  (If you want the coles notes version of the interview Click Here.) 

While I disagreed with Warren when he was a stanch mark to market proponent, his stance now is much better (as briefly mentioned in the interview).  There are times when mark to market doesn’t work, and we found that out during the financial crisis.  Mark to market does not work when the market is not function properly.  Just because no-one would purchase residential mortgage back securities during the crisis didn’t mean their value was zero. 

As yourself this question… If you put your house for sale and for one year you don’t get any offers on it does it mean your house is worth zero?  That is what mark to market accounting would say it’s worth.  There could be numerous reasons why you didn't recieve an offer in any particular year. 

Illiquid assets, and markets that are not functioning properly cannot be fairly valued by mark to market accounting.  Now the securtized mortgage market was not functioning properly during the financial crisis.  Isn’t it ironic that the stock market turned the corner is March 2009 after mark to market accounting was thrown out?  (Hmmm, something to seriously consider)

Warren should know this as all value investors look for mispricing in the market.  People are motivated all the time to buy or sell for reasons other than price.  This mispricing is what allows value investors to pick up dollar bills for fifty cents. Now to be fair Warren prefers mark to market accounting because it doesn’t allow wiggle room for accounting fraud.  I agree with him on that but to allow no wiggle room on illiquid assets is ridiculous, especially when it was bankrupting our banking system. 

Back to FFH

Looking at the rest of FFH results, I have the utmost faith in Prem Watsa to run our company.  If you listen to the call you will hear that companies like Zenith are only writing half of the business they were doing compared to recent times.  In the future they feel they are capable of writing 3 times the current levels they are currently underwriting.  Zenith is focused mainly in California, specializing in workers' compensation insurance.  They feel that current current insurance climate doesn't meet the standards of the company and as a result they are passing on business that they don't feel make economic sense. 

Now to be clear,the biggest negative of the report was the combined ratio of the US insurance divisions.  It came in at 130.6%.  That clearly isn't sustainable.  Now because of the tough insurance environment in US, I don't have any problem with the conservative stance Fairfax has taken on both it's equity exposure to it's underwriting stance.  Being patient is the best way to ride out this phase in the insurance market.


Anyway, enough for now.  I will be back with some further comment's on Peyto's reserve report that was released a couple weeks ago.  If you are looking to invest in the natural gas sector, I wouldn't waste much time researching much further than Peyto. 

My only problem is finding time to write these blog posts.  I am seriously considering writing a book for my children to help them better understand life, human action, economics, business, investing, & why both Canada (& the USA) are the wealthest countries in the world.  I feel that their are some key concepts, principles, and values which if I had know when I was in high school would have changed my life.  Remarkable many of these concepts are interrelated.  I also have some thoughts on how globalization will change their lives.  Perhaps I will be right, perhaps I will be wrong, but at least they will have the tools to understand how our world works. 

If I could put in a book plug here, it would be for Poor Charlie's Almanack.  This is a book of the wit and wisdom of Charlie Munger.  It is a fabulous book.  It discusses mental models and more importantly synthesizing mental models.  As Charlie points out we have numerous divisions in our universities and very little interdepartmental cooperation.  Intergrating the "soft sciences" with the "hard sciences" rarely happens but they should.  If you think psychology doesn't have anything to do with business and investing you are grossly mistaken.  Now if the book doesn't get you interesting in psychology, nothing will.  I found it facinating... In fact, just writing this short review makes me want to re-read the book for a third time. 

Well it's seriously time to sign off.

Best Regards,

Kevin Graham

P.S. I applogize for my poor spelling and grammer.  Everytime I read one of these posts I find another error.  Remember, it's the thought that counts. 

Full Disclosure: Long FFH & PEY

Monday, February 21, 2011

Back in Canada - Book Reviews

We’ll I’m glad to be back in Canada, looks like I didn’t miss much other than cold weather.  When we left sunny Hawaii it was 27°C (80°F) and arrived back in Canada it was –30°C (-22°F), almost a 60°C temperature drop.  I was happy to read in the local paper that the Canadian Dollar hit a new high relative to the US dollar the day we checked out. 

I see not much has changed on the investment front other than the continued march forward.  The economy is doing better than what the double dip crowd has maintained, but I see many are still quite afraid of the US budget situation on all levels of government.  It really doesn’t concern me yet, as the US enjoys very low income taxes and consumption taxes relative to the rest of the west.  That said I don’t believe the budgetary problems should be corrected by raising revenue, costs can and should be slashed to correct the problem. 

I have seem many comments recently sounding the alarm bells as Illinois just jacked income tax rates from 3% to 5%.  While the percentage increase is huge and makes headlines the overall tax rate is still quite low.  Alberta has among lowest tax rates in Canada at a flat 10% of income, Ontario is 5.05% on the first $37,000 and then it jumps to over 9%.  I have looked at many graphs of total (state and federal) income tax rates for US citizens, and I personally would love to be a US taxpayer.  I know some who have transferred to the US (in a division of the company I work for) and they have commented on how dramatically lower the tax rates are. 

We’ll I did manage to read two and a half books while away, Bull by Maggie Maher, Blink by Malcolm Gladwell, and the half was The Revolt Of The Masses, by José Ortega y Gasset's. 

Bull was an interesting book the internet bubble, however I felt it dragged on for too long.  She really got into all the cast of characters behind the scenes on Wall Street. 

Blink, I felt, was not as good as Malcom Gladwells other books like Tipping Point.  However it did have some interesting insights into our subconscious and the whole Pepsi vs. Coke challenge in the 80’s.  I do love both Pepsi and Coke (Pepsi a little better), and I know I can tell them apart in a side-by-side challenge.  Gladwell presented a different way to perform the taste test which is much harder.   Have someone prepare three cups two of one drink and one of the other and have the participant to tell them apart.  I thought for sure I could do it but we tried last night and I failed miserably, in fact I got all three backward.  Both my brother and my wife got it correct, and neither are big soda fans. 

As for The Revolt Of The Masses, I am a little better than half way through it.  It is a tough read as it was written originally in Spanish in 1930.  Some of the terminology was hard to catch on to at first.  I will perhaps make further comments on my political views in the future.  Ortega is big on different social classes and mass culture and I would agree with many points in the book thus far.  His understanding of economics are a little fuzzy, but his characterization of society in some respects are bang on. 

In synthesizing this book with some other highly recommended books that I have read, (books like Victory of Reason - How Christianity led to Capitalism, Democracy, and Western Success by Rodney Stark & The Road to Serfdom – Friedrich Hayek) I would have say political and economic history are definitely some areas of interest to me.  I simply find it amazing how little the average person understands and appreciates of history. 

I believe the single largest problem facing North American society today is that people know absolutely nothing about how Capitalism works, believe Capitalism is a bad thing, and have a definite entitlement attitude.  We are most definitely on the road to serfdom.

I would encourage all readers to attempt to describe capitalism in their own words. 

I should perhaps sit down some day and write down my own political and economic views and views on life in general.  Ludwig von Mises is 100% correct to say economics is the study of human action, while the majority believe it has to do with business, money, and the like.  Those are simply bi-products not prime products. 

I do want to go on the record saying that I am not a follower of Austrian economics nor narrow-minded Libertarian views which appear hand in hand over at the Mises Institute (  I would definitely place myself somewhere in the middle, and would definitely want to distance myself from Keynesian economic theory as well.  I am strongly against stimulus however in some instances it may be beneficial, however it’s effects are however overstated.

Anyway enough for now…  I will be back shortly with comments on Fairfax's 4th Quarter and Peyto's 2010 Reserve report. 

All the best! 

Kevin Graham

Saturday, February 5, 2011

Current Market Commentary

I haven't written much over the past little while mainly because there isn't anything meaningful to talk about.  The market is fairly valued, although some sectors should outperform the overall market doesn't interest me at this time.  Small and midcap stocks are definitely fairly valued, while a number of very large, high quality,  represent decent value.  Now for some doing nothing and allowing the dividends to accumulate is a very tough thing to do.  Sometimes you can add a lot of value by doing nothing. 

I should note that you could always do some valuable reading of annual reports.  How many annual reports do you read per year?  If you are desperate for some value plays I would recommend reading up on the following stocks; Axis Capital, PNC Financial Services, and Calloway Golf.  My Canadian recommendation would be Home Capital Group.  I have been reading the Home Capital annual reports for at least 5 years and finally the stock is trading at P/B and P/E levels that represent decent value.  Being patient does pay off.  The only problem is I feel the other stocks I own are cheaper.  All of those stocks are selling at or below book value and can earn decent returns on equity over the long term.  If you are looking for short-term gratification, you're reading the wrong blog.

It also appears that OPTI Canada, an oilsands company, is going broke as they are drowning in debt.  This may present an interesting distressed debt scenario over the next few weeks if you are into those types of plays.  I love Buffett's (or maybe Charlie Munger's) quote on debt, "If your smart you don't need it, and if your dumb you have no place using it."  Now, put yourself into either the smart or dumb category and re-read the previous quote. 

Since were on the topic of being smart and dumb, I have been constantly telling my son that the difference between a smart and a dumb person is a smart person doesn't pretend to know something when they don't.  Dumb people have opinions on all sorts of things when, if the truth be know, they lack the knowledge and background to make such comments.  Being able to recognizing what you know and what you don't know will take you a long way in both life and investing.  Some people will be able to relate with what I am talking about.  Let's get back on topic.

Recommendations Look-back

It's about 4 months since I started this blog and it's interesting that the first stock I wrote about, Hardwoods Distribution Income Fund, was the best performer.  It is a very small cap that has appreciated approximately 50% over that time.  Most of the financial companies recommended are up 20-30% including GE, MFC, WFC, BAC warrants, etc.  The worst performers, and perhaps still the best opportunities are JNJ, FFH, and KFT.  They have been flat to down. 

Looking Forward

It appears that the green shoots from last year are continuing to flourish and grow thanks to the easy money policy of the Federal Reserve.  For those who follow the economic data, the overall economy is doing quite well.  Headline US GDP was up something like 3.2%, but excluding inventories it was up around 7%.  Exports and consumer spending led the way, which are two huge positives and their importance can't be emphasized enough.  Auto sales are on the rebound, and housing will follow shortly.  Both the ISM Manufacturing & Non-Manufacturing (services) indexes reported very strong levels this past week. 

The US jobs report that came out on Friday was definitely interesting to say the least.  The total jobs number was poor, however the unemployment rate fell sharply to 9.0%.  This was mainly due to civilian employment and weather related adjustments.  More than that, the low headline number seemed to be at odds with the ADP employment report and the Canadian employment report, both of which were very strong. 

For those who do follow the numbers closer than what the media reports... the last several reports have included upward revisions.  The media reported the headline number of 36,000 jobs in January, but didn't mention revisions to November & December that added another 40,000 for total net additions of 76,000 jobs.  Also of note, normal weather related adjustments for jobs are typically around 400,000 for January, however the report had weather related adjustments of over 800,000.  To make a long story short the next few months should have some explosive jobs growth.


This will be my last post for a while as I will be on vacation for the next couple of weeks.  I am leaving my laptop and blackberry at home (not my choice).  I am taking three books to read, one on investing, one on social phenomenon, and one on political science. 

See you in a couple weeks,

Disclosure: Long GE, BAC warrants, WFC, MFC, HWD.un, KFT, JNJ, FFH (Personally or in accounts I manage)