Although I’m sure Prem Watsa doesn’t mind too much, I’m often flabbergasted at how the CEO, chairman, and chief investment officer of Fairfax Financial Holdings Limited (TSX:FFH) isn’t more well known among retail investors.
Sure, Watsa does have a decent-sized following in Canada, but south of the border, most U.S. investors have never heard of the man. Considering his long-term record, I think they should start paying more attention.
Since taking over Fairfax in 1985, Watsa has delivered amazing results. Book value of the company’s shares have grown by 20% per year, handily crushing every index in the world. A mere $10,000 invested in the company back in 1985 would be worth upwards of $2 million today.
That’s a result pretty similar to what Berkshire Hathaway had over its first 30 years, and yet Warren Buffett gets much more attention than Prem Watsa.
Of course, some of this is Watsa’s own doing. Unlike Buffett, who seems to relish the opportunity to be in the spotlight, Watsa prefers the confines of his Toronto office. Watsa leaves the PR stuff to his staff, content to have his nose buried deep in one of the volumes that makes up Fairfax’s spacious library.
He’s obviously reading the right stuff. The man called the crash of 1987, the implosion of the Japanese market in the early 1990s, the tech bubble later in that decade, and he even predicted the U.S. housing bubble and profited handsomely on it by using derivatives. Needless to say, if Watsa talks, we should all listen.
Like Buffett, Watsa writes an annual letter to shareholders that is filled with all sorts of good stuff. In the 2015 edition—which was released on March 6th—Watsa warns about the excessive valuations in the high-tech world, and also talks about his large exposure to derivatives, betting on two huge macro themes. Specifically, Watsa is betting that deflation will become a major issue over the next few years and that stock markets will tumble.
Watsa’s bet on deflation is particularly interesting. Essentially, Fairfax has paid approximately $234 million for exposure to $111 billion in CPI-linked derivatives. If the value of the Consumer Price Index in the U.S., European Union, France, and the United Kingdom declines by a few percentage points over the next decade, these contracts pay in full. The reason the premium is so low is because CPI tends to creep up, not down, over time.
To put the size of the bet in perspective, Fairfax has a current market cap of $16.1 billion. There’s some major potential upside if Watsa turns out to be right.
But is it enough?
Watsa’s bet on deflation isn’t the only reason for investors to take a look at Fairfax shares. Like Berkshire Hathaway, at the heart of Fairfax is an insurance company that constantly has premiums streaming into it, giving the company a form of ultra-cheap leverage. That’s a huge and often understated advantage.
But perhaps the market is starting to figure out Watsa’s advantage. Shares of Fairfax have soared since the beginning of 2014, rising nearly 75%. Fairfax shares typically trade at a level close to its book value, but they currently trade hands for nearly twice that much. It’s easy to make the argument that Watsa might be worth the premium, but remember, most of Fairfax’s value is in the underlying investments. Those are pretty easy to value.
Is Fairfax overvalued? Or is Watsa’s record so good that he deserves the premium? I’m not exactly sure, but if I were to guess, I’d say it’s unlikely Watsa would be buying his own shares at this point. That doesn’t necessarily make them a bad investment, but it’s obvious the company is on the expensive side. So, even though Watsa deserves all the credit I can give, I’d recommend waiting until the company is a little cheaper.
