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Buy Fairfax Financial Holdings Ltd. and its Preferred Shares if You’re a Bear

There’s a growing sentiment that this incredible bull market is going to run out of steam like it always does. We can all agree that it’s not a matter of if it happens, but when it happens. There is a lot of actual cash to be made for investors who can accurately predict when it will happen, and for investors who can survive long enough while losing money betting against the bull market.

One company that has bet a lot of its money on the end of this bull market is Fairfax Financial Holdings Ltd. (TSX:FFH). Prem Watsa, the CEO of the company, is often times compared with Warren Buffett because they both run large insurance companies that use the float to make large investments. However, while Buffett likes to buy businesses outright, Watsa likes to make macro-investments. The big one Watsa is betting on is a significant drop in the S&P 500.

However, because he made that bet, his returns have not been all that great due to how amazing the bull market has been. But when the market turns—and many agree that it will—Watsa is poised to make a considerable amount of money.

The primary problem with Fairfax is that it’s priced at 2 times its book. That’s a pretty expensive premium to pay for a company like this. That doesn’t mean you won’t make money if/when Watsa is proven correct, but the returns might not be so incredible.

The preferred shares are a great choice

Another option that I am quite fond of is to buy the preferred shares of Fairfax. Before the share reset, these shares were an income juggernaut, generating investors close to 8% in dividends each year. However, in March, Fairfax announced that the dividend would be cut to an annual rate of 2.91% based on the $25 price.

But if you look past the dividend, you can see that the shares are enormously undervalued, presenting a 30% upside in capital gains when Fairfax takes the shares back. The reason for this is simple … Fairfax originally issued the debt at $25/share. When it pays it back, it will have to pay that $25. Based on the price of around $17, you can easily see that you’re sitting on $8 of potential gains.

And while the dividend is not as lucrative as it once was, since you’re getting the shares at a discount, the dividend still does factor out to around 3.80%. It’s not nearly as high as what Fairfax investors were getting before the reset, but it does still present a much nicer dividend in comparison to the parent company.

Between the potential capital gains and the dividend, new holders of this stock could definitely see some significant returns on investment.

If it were a riskier company, I would suggest against making these kinds of bets. However, because the company is so powerful and has so much money coming in, I’m comfortable suggesting you buy the preferred shares.

This article has been corrected. An earlier version misstated the yield. We apologize for the error.

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This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Jacob Donnelly has no position in any stocks mentioned.

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