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You're listening to Te IP. Hey, how's everyone doing out there on today's show? We bring back our friend Jake Taylor from Farnam Street Investments and the author of The Rebel Allocator. Jake takes us on a deep dive intrinsic value assessment of the company Fairfax Financial Holdings. The purpose of these episodes is to give the audience a thorough discussion and analysis of company so they can pick up on the key considerations and questions for other companies and a similar sector, or even for just general analysis of a stock.


Jake is a superb thought leader and someone that demonstrates exemplary critical thinking skills, and you'll see all that throughout this episode. So without further delay, here's our chat with Jake Taylor.


You are listening to the investor's podcast where we study the financial markets and read the books that influenced self-made billionaires the most. We keep you informed and prepared for the unexpected. Hey, guys, welcome to the Investors podcast. I'm your host, they brought us in and as always, I'm accompanied by my co-host, Preston Peche.


We are here today with Jay Taylor, CEO of Farnam Street Investments. Jake, thank you so much for joining us here today. Thanks for having me back on the program.


You know, Jake, we are excited to have you back here on the show. And our listeners probably remember you from the outstanding analysis you did of Berkshire Hathaway back on Episode two hundred eighty nine. We'll be talking about a different company today, namely Fairfax Financial Holdings. So simply called Fairfax. And later, we'll be transitioning into talking about Fairfax Africa. But please do not be fooled, guys.


Even though we're talking about different companies, BUCSHON, Fairfax might have a few similarities to.


So Jake kicking this episode off, perhaps you could start by providing an overview of Fairfax. Sure, it was founded in nineteen eighty five by this Canadian immigrant named Preme Latza, and it's primarily a PNC property and casualty insurance company and it has a lot of decentralized insurance companies around the globe that are part of its company. And, well, it's kind of nice is also that they profess to have a value investing approach to the money that they manage. Their stated goal is to compound book value at 15 percent per annum.


And since nineteen eighty five, they've done it at eighteen point five percent. So they've been achieving their goals for a long time, which you can't say about too many companies. The other thing I like is that, you know, the culture is what they call fair and friendly. There's never any hostile takeovers or anything like that. And they do draw a lot of comparisons to Berkshire, but they are definitely a little bit different. I already mentioned there that there are a few similarities between Berkshire and Fairfax.


I mean, you even mentioned a few of them yourself. You know, the very friendly I would imagine Warren Buffett would call it differently. But, you know, he's not a big fan of hostile takeovers either. Very decentralized organization. But what are some of the other similarities and perhaps differences that you see to.


The biggest difference is really in the size of the operations, I mean, Berkshire is an elephant and Fairfax is an aunt, and to give you an idea or shares float is six times the size of Fairfax. They have similar underwriting profits last year, kind of surprisingly, but book value is 30 times X for Berkshire. Their cash flow from operations is 30 times their price to book also is to X, right? So it's more expensive and enterprise value is actually seventy five times X, so they're quite a bit different in the size of the company.


And I'd say in general that auction has a lot more operating businesses between the railroad and the energy and probably a higher quality business than what Fairfax has amassed so far. But in general, they're underwriting their cultures. Their investment approaches are relatively close together.


So, Jake, just as you can't say Berkshire Hathaway without saying Warren Buffett, you can't say Fairfax without saying Prem Watsa. Prem Watsa is a legendary investor for us insiders of the value investing community, but he's not much known outside of that community. And could you please just provide an introduction to our audience to about Prem Watsa?


Prem is known as the Canadian Warren Buffett. One of the differences is that he's actually 20 years younger than Buffett, so he's only 70. But his background is he grew up in India, got a degree in chemical engineering from Madras, and then he immigrated to Canada with eight rupees in his pocket. And he worked and put himself through the MBA program at Ivy Business School, which is in western Ontario. And now after founding Fairfax, he owns about 10 percent of the company.


He's a billionaire. So it's really one of those rags to riches stories. The other thing that I've noticed from going to the shareholders meeting for a number of years now is that Prem is an incredible cheerleader of his teams. He speaks so highly of everybody. You can see why everyone shows up to work wanting to impress him. I mean, Warren is good about that. But like the energy that Prem conveys is even stronger. And the other differences between going to like a Berkshire meeting and Fairfax's I remember the first time I went to the Fairfax meeting within five minutes, I had already met Prem and got a picture taken with him and moved on and moved into the meeting.


And it's very small. And Berkshire, you can't get within one hundred feet of Buffett because there's security and there's just a million people crowding around him. So a very different experience. And that speaks back to the size of the companies. So, Jake, I think it's so important to really kind of understand the essence of the assets and liabilities on a company's balance sheet, what for Fairfax really stands out to you on their balance sheet? Well, I think that Fairfax should be analyzed just like any other insurance company, and so we think about that they take money now in premiums.


What do they end up doing with it? How do they transform those premiums into assets and then eventually use those to pay back claims? What's left over after that? So when I look at that, Fairfax's balance sheet, they have about ten billion dollars in cash, about 15 billion dollars in bonds and about five billion dollars in stocks. And then below that, you'll have to call it three billion in what I call joint ventures, which are just investments that they're making that that they have to recognize on their balance sheet as ownership.


About seven hundred million in derivatives and then two and a half billion dollars that's invested in Fairfax, India and Fairfax, Africa. And then you have about 12 billion in intangibles and other assets. Now, against that, you have seven billion dollars of debt and about 40 billion dollars of predicted insurance liabilities. So they have about 30 billion dollars. And what I would call liquid assets and then versus about forty seven billion in liabilities that are have to eventually be paid.


So obviously, those two numbers don't exactly match up and you're going to need some kind of asset growth to meet those future liabilities. What's a little bit funny is that preme and team have been maligned as bad stock pickers lately. But what's interesting is that only one in six dollars, I would say, of the liquid securities is actually in equities. It's a little bit ironic, actually. They've been actually been helped by these regulatory handcuffs of insurance and had to be weighted into a lot of bonds, and that's actually kind of helped their investment results.


So it's a little bit funny to see people who they have an incredibly long, good track record. But, you know, sort of like what have you done for me lately? Like, a lot of value, guys have struggled a little bit. And so they actually been bailed out a little bit by the fact that they have so many bonds based on their insurance operations. Fairfax has an impressive track record, like you also mentioned before, eighteen point five percent measured in US dollars, and that is since the press and management took over in nineteen eighty five.


Now, whenever you look at the print watch, this led us to shareholders. You can't help but see some similarities to Buffett's letters, to his shareholders, which is amazing. Read. And if you want to learn more about insurance, if you want to learn more about Fairfax.


But it's also quite clear then that if you look at the numbers of the track record, like where that eighteen point five percent came from, like it came from the very beginning, not so much recently. And you could also argue that one reason why this decline performance has happened is because Fairfax mocap is only 10 billion plus. So that obviously limits the universe of potential investments. But even if we count for that, it doesn't really explain why Fairfax has been trailing the S&P 500 since the financial crisis.


So I'm curious, Jake, what are your thoughts on why has Fairfax suddenly started to underperform? You're right about the book value growth over that time period, and just to provide a little context around that, when they took over, it was a dollar fifty two in book value in nineteen eighty five and now it's roughly four hundred and eighty six dollars. So over that same time period, the share price is compounded at sixteen point six. Branom What it's helpful to break up an insurance company.


There's really two key variables. The first one is their combined ratio, which is the premiums that they accept versus the losses that they have to pay out. Basically, how profitable are your insurance operations? And then the second thing is, what do you do with the money that you get? What is the return on the investment? So it's helpful to break up Fairfax into multiple time periods to trace the history. So if you look at nineteen eighty six to twenty five, their combined ratio was one hundred and five percent, which means they were losing money in their insurance operations, but their investment returns were around 10 percent per annum.


So, you know, you had bad underwriting but great investment results then. Twenty six to twenty ten combined ratio is ninety nine percent and investment returns were 11 percent. And a lot of that had to do actually with Prem made that same bet that a lot of guys got very famous for making, which was basically shorting housing the housing bubble he had the CDs is on housing. So you could almost say that this was sort of the golden age for Fairfax.


They had good underwriting and they had really good investment returns.


And it could also sort of point to the idea that Fairfax probably does better during downturns and maybe not so good during bull markets. So twenty eleven to twenty sixteen combined ratio of ninety six percent. Fantastic investment returns, two point three percent, very anemic. What happened? Well, Preme was concerned, especially in the later part of that period with where the market was and he had a lot of hedges on and that's a little bit equivalent to driving around with the parking brake on.


So what's interesting is they actually still have one hundred billion dollars of notional value in these deflation hedge bets, CPI linked that are carried on the books at only seven million dollars. So they've been written down almost to zero these hedges. But you could imagine an alternate universe where maybe the market crashes in twenty sixteen and it looks very much like that two thousand nine, twenty ten period again. And they look like geniuses and no one's questioning their track record at all.


So twenty seventeen to twenty nineteen combined ratio ninety nine percent and investment returns five point six percent. So not bad. That's sort of like middling, but that's still going forward. That's going to take a little while to get to that eighteen percent or to maintain that eighteen percent they've had. If you're only getting call it one percent on your operations and five percent on your investment book. So obviously it's going to take more to get back up to what they've been doing.


My understanding is that the in general, the insurance pricing market has hardened quite a bit lately and that's a good sign for the premiums that Fairfax will be accepting. So there's potential that there's probably good underwriting happening right now. The other thing to look at is that their bond book that they have is very short duration. Most of it is less than five years and it has this a blended rate of three point six percent. So if you have locked in three point six percent for the next five years, it will be tough to get to 15 percent.


But they run their operations very conservatively, and they're not the only ones who have been hurt by these low interest rate environment. I mean, every bank and every insurance company is suffering through this, but they're very conservative and they've tended to lately take more ownership, debt and preferred than pure equity. So they've limited their downside a little bit while also accepting some smaller upsides, which we actually seen Berkshire be doing more lately as well. So the other thing, too, it's important to note, is that over the last five years, it really hasn't been the S&P.


Five hundred, it's been the S&P five. And what I mean by that is Microsoft, Amazon, Google, Facebook and Apple have accounted for plus two hundred fifty percent over the last five years. The rest of the S&P, five hundred, those other for the S&P, four ninety five are up. Twenty five percent total over the last five years. So if you missed those five stocks, which Fairfax did, you're going to look bad against the S&P.


Five hundred because there just wasn't much else to be had. And especially they've been more internationally focused than a lot of other companies and also more resource focused natural resource focus, which I think I don't know if that's like a Canadian thing. It seems like everybody in Canada likes natural resource companies. So that explains a lot of why we would say they've underperformed the S&P. Five hundred. But I'm not even sure if the S&P five hundred is an appropriate benchmark for Fairfax's operations because they're so much more global.


I would probably pick more of a global index like maybe MSCI or something and maybe even more bond exposure as well, because, I mean, they just have a more full book. They're not ever going to be one hundred percent US equities. Right. And that's what S&P five hundred kind of represents as a benchmark. I really like how you phrase that there. I used to own stock in Fairfax quite a few years ago, but to me the role I had in my portfolio was very much protecting my downside risk.


That was very much how I saw it. And so I guess you could say the same thing about Berkshire. The upside is one should probably not be too blinded by the eighteen point five or the sixteen point six you mentioned before, depending on whether you look at book value growth or stock price growth. But the downside protection, especially whenever you go in and look at the balance sheet and the different types of investments Prem Watsa has made.


Moving on here with the episode, Jake, we've been emailing back and forth here before the interview. And you originally wanted to talk about Fairfax Africa because that was where he saw the most value higher. Now that we are talking about Fairfax, the parent company. Do you see any value there? And perhaps could you provide a range of the intrinsic value if we want to put the stock on a watch list? As maligned as price to book is as a factor these days by investment professionals, I still think it's a very appropriate place to start for valuing banks and insurance companies.


So the current price to book of Fairfax is point six nine. So call it 70 cents on the dollar. Now, if you go back and look over the last 15 years, the average price to book that Fairfax has traded at is one point one six. And the standard deviation of the price to book over that 15 years is point one three three. So I thought, let's just take a base case being what's the long run average that Fairfax has historically traded at?


And we'll multiply by that price to book. And what would that tell us that we should expect for the share price? So one point one six gives us a four hundred eighty five dollars share price, which is plus sixty eight percent roughly from where we are today. That's actually not that bad. Like Fairfax is cheap right now. Now, just for fun and I don't typically do this because I recognize that the investment world has much fatter tales than what a standard deviation doesn't conform to standard deviations.


But this is a starting point. But one standard deviation to the upside, I would say, gets you to one point three price to book, which implies a five hundred forty dollars price, which is eighty eight percent from where we are today. And then let's say one standard deviation downward gets us to basically like one times price to book, and that's four hundred thirty dollars price, which is about 50 percent up from where we are. So it's definitely cheap.


And if you think that pram and company have any talent still, I think you're getting a pretty good bet and you're paying a reasonable price for that bet. Let's take a quick break and hear from his sponsor.


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Talk to us a little bit about this company. Let me start with I think last time that I was on the story about talking to Charlie Munger and how he told me that I should be fishing where the fish are and not fighting all the other cod fishermen for where the where everyone else is looking. So, you know, I sat down and I'm staring at a globe and I'm spinning it. And what do I see? I notice Africa and it's staring me right in the face.


So I started doing some research and I'm going to share some numbers with you about Africa that I think are quite interesting. And really a bet on Africa is a bet on three things demographics, geography and infrastructure. So there's a saying that demographics are destiny. The UN projects that there will be one point three billion people added to Africa by 20, 50, and they will have a one billion person middle class that's six times the size of the US middle class.


So that's an incredibly big population to be servicing goods and services. There's going to be a lot of people living very reasonable lives in Africa by 20, 50, is what I would guess. The other thing is that Africa is very young. So the median age right now in the US is thirty five. China thirty seven, Europe, forty to Japan, forty six. The African median age is twenty and seventy percent of Africa's population is under 30 years old.


So they are incredibly young and they're young and they're hungry. And I think those are two good recipes for eventually making large economic strides. So the other thing is it's reason that there will be 90 cities in Africa of one million plus population by 20 30. There's this interesting book by Geoffrey West called Scale, where he talks about how the doubling of the size of a city more than doubles the output of both wages and patent output. It's due to density and network geometries.


Now you also get more than a doubling of crime and illness and other things. You could sort of say that cities make a doubling of everything that's human, but it's a one point one five times multiplier. So imagine 90 cities with more than a million people working, solving problems. It's actually a very exciting time, I think, for Africa. Now, let's talk about geography of Africa. If you look at a map, the Mercator projection greatly distorts reality.


Africa is huge. It's a further flight from Cairo to Johannesburg than it is from the US to Europe. It's over an eight hour flight. Africa has three times the landmass size of Europe. It's 11 million square miles. And I think a lot of us think about Africa. We say like, oh, it's all desert, right? That's actually wrong. It has 60 percent of the world's arable land. So it's not hard to imagine that eventually they figure out how to being geographically located between the east and the West.


That could be a very advantageous place to be, sort of the world's breadbasket. Now, there are one hundred and eighty trillion cubic feet of natural gas off of Mozambique alone, which is 20 years worth of European demand, and that's just Mozambique. The other thing is that there's one fifth of the penetration testing compared to OKd soil. So they just haven't dug into the African soil like they have all the other rest of the countries. So who knows what other kind of buried treasures are in there, whether it's petrochemical or rare earth minerals.


There's all kinds of opportunities there. We just don't even know yet. Now, let's talk a little bit about infrastructure. In the US, we use 19 times the electricity measured in kilowatt hours per capita than Africa does. US has six point two times the rail density. The bricks, which are Brazil, Russia, India, China, have five times the road density of Africa. So there's lots and lots of opportunity for useful infrastructure to be built to improve the quality of life there.


And what's interesting is that one hypothesis is that technology is really going to help out because you're going to be able to avoid a lot of the potential cost of infrastructure that we currently have. So imagine skipping over land lines and going right to cell phones. Africa already actually has the most mobile payment accounts of any continent, so they've taken banking to their phone faster than we have in the US. So a little quiz here. How many African companies are there with more than one billion dollars of revenue?


Oh, my God, I have absolutely no idea.


OK, so the average guess is 50, but the actual number is more than four hundred. So to give you a little context, there are four hundred people per retail establishment in the US. There are sixty thousand people in Africa per retail establishment. So it doesn't take a lot of us foresight to imagine a simple business like Wal-Mart or McDonald's or 7-Eleven being able to grow rapidly in that kind of environment under the right conditions.


So let's take all those numbers. What do we do with them? Right. Like, I think we have a reasonably sound argument for that. There are some strong tailwinds, but how do we participate in that? Right. So that's when I happen to see that Fairfax had launched a fund specifically to invest in Africa. And I trust them to do the due diligence on the ground that I'm. Not able to do ten thousand miles away, and I know that they have sort of a value tilt, which is what I'm drawn to, and they will be investing on my behalf in Africa.


Now, Fairfax, the parent company, owns fifty nine percent of Fairfax Africa. So they have invested almost 60 percent of the funds that are in that fund came from the parent company. Now, there's a transaction that's going to be coming up soon that they're voting on that will diminish them down to thirty two percent, most likely if it gets approved. But they're still going to retain fifty three percent of the voting rights. So they're still in charge of this thing.


But it's not perfect. There are some issues. Nothing's ever perfect. So to operate the fund, Fairfax, the parent company, charges management fees on the fund and it's a half a percent for uninvested money and one point five percent on invested money. And for that fee, they have to provide a CEO and a CFO and manage these investments. Now, there's also Fairfax can earn performance fees, which is 20 percent above a five percent hurdle measured every three years.


The good news is today that hurdle is a long ways away from where we are. It's actually they're not eligible for any performance fees until it's back up to 11 dollars and eighty one cents, which is like light years away from where we are today. So this new transaction with this company called Helios is my understanding is the economics will now be shared with Helios and that Fairfax is effectively outsourcing more of the boots on the ground to a group that's been doing this since 2004.


The other thing you can do is actually buy Fairfax, like what we were talking about as a hedge to your expense structure in Fairfax, Africa, because now you're owning the fees that are being paid. So there's a lot to like here. And we'll get into a little bit more probably in a minute about valuation. But that's a good place to stop. I used to own Fairfax, I also used to own shares in Fairfax, Africa, but I remember my thesis for that was very different.


I saw a lot of the same growth factors as you saw, and I wasn't too concerned about the downside protection. Also, my perception was a lot smaller in Fairfax, Africa.


But what I really liked about Fairfax Africa in preparing also here for the interview and reading through their financial statements as opposed to a company like Berkshire Hathaway, it's a lot simpler to go through the individual investments one by one simply because there aren't too many. Atlas, Marrawah, Fairfax, Africa owns more than four percent. Stake would be an obvious place to start. But I also remember reading up on South African grain storage, Nigerian banking topics that definitely started outside by several combatants, to say the least.


Please talk to us about how you analyze Fairfax, Africa's investments and also the process of widening your circle competencies. Let's talk about circle of competence for a minute. It's really about finding and interpreting information and how do you do that? I think I don't know if you know this, but 18 percent of the matter in the universe is visible and the other eighty two percent is dark matter. And I've wondered if that same ratio actually applies to these businesses that we study.


Maybe we get a glimpse at 18 percent of the relevant facts based on what's reported to us. But there's another. Eighty two percent of this person doesn't like this person inside the company or this competitor's coming for the company. And we don't even know it. There's all kinds of very relevant facts that we probably don't have access to. And there's always more than we can know than being outside passive shareholders. And this is especially true if you're 10 thousand miles away from where all the action is happening.


So what that requires a lot of trust in management. And to be honest, it's been a little rough for Fairfax Africa so far. You have to take a very, very long view and trust that these guys did not get really dumb overnight all of a sudden. And then the other thing, too, is that the price that you pay, you can mitigate a lot a lot of problems with the price that you pay. So, in fact, there's a great quote by Buffett who says that price is my due diligence.


So if you get enough low enough price, it requires less hurdle of having to understand every single little intricate moving piece of inside of an investment thesis. So really, the bigger question is, how stupid do you think the Fairfax guys are? And do you trust more the recent market quotes that they have to mark their book to? Or do you trust their long term analysis of what they're working on? So really, it's a question of how efficient do you think markets are?


So let's look at some of the numbers here that are inside Fairfax, Africa, their public investment in Atlas Mara. They've put in one hundred and fifty nine million dollars. They're carrying it on the books at thirty four million dollars. So that's an 80 percent haircut. Their investment in Sigge, they put in fifty five million dollars. They're carrying it at six million. That's a 90 percent haircut. Their loan book. Eighty seven million carried it. Seventy nine percent or seventy nine million.


That's a 10 percent haircut. The private equity side. Eighty seven million carried sixty three million. That's a twenty eight percent haircut. Fill Africa. That's a thirty five percent haircut growth capital. Seventy five percent haircut. So all total. They have five hundred nine million dollars that they've deployed and it's carried on the books at two hundred ninety nine million dollars. So that's a forty one percent haircut. So you have to ask yourself, is fair value really that forty one percent loss or do these guys know what they're doing and these are just more short term quotation losses.


That's really I think, one of the key things of untangling this investment. So, Jake, when you're looking at a company like this, how do you account for the currency risk that the company is going to obviously go through for the local currency that they're dealing with versus converting that back into dollar returns? Yeah, I mean, that's a great point. In just the first six months of twenty 20, Fairfax Africa recognized twenty six million dollars in losses just from foreign exchange.


I think my counter to that would be that no fiat currency is a layup in today's world. The dollar is the reserve currency now, but that's not etched in stone. There could be a day where maybe that actually helps. And for me personally, I have plenty of assets and liabilities denominated in dollars in my portfolio. So I don't mind getting some other exposure to other currencies. All the research I've done on hedging indicates that it tends to balance out with the costs over time and that there's no real advantage to it.


The other thing, too, is that a weaker currency can actually be a plus sometimes because it can make your exports more attractive in a country. So there can often cause a little export economic boom because of a devaluation. So it's not a hundred percent clear that it's all a problem. And like I said, there's no fiat currency that is really backed by much of anything these days. So if someone knew where the great currency was that that could solve all these problems, I'd be all ears.


The Fairfax Africa is a fairly new stock have only traded since February twenty seventeen and as you also mentioned before, Jake, the performance of the stock hasn't been as hoped.


Having said that, do you see Fairfax Africa as a long term compounding company, or is it more similar to what Warren Buffett would call a Shikarpur? Yeah, I mean, it's not liquidating, so I wouldn't really consider it in the the cigar butt category, but it definitely qualifies as a 50 cent dollar, I think. And I'll walk through the math on that. So right now, the book value is six dollars and sixty two cents per share, which is equates to three hundred ninety million dollars total.


And we talked already about how dramatic the mark to market losses are in there. Those are shown in that three hundred ninety million dollars. So inside of that you have eighty six million dollars of cash, one hundred and sixty one million of bonds and loans and one hundred thirty six million dollars in stocks. Now, currently there are fifty nine million shares outstanding and let's call it a three dollars and 30 cent price ish. That's a two hundred million dollar market cap implied.


So we're already at a price to Book of point five. Now, I would say that is it a compounder potentially if and when the businesses start to catch up, you start getting some investment returns. The underlying businesses within the structure start to compound. That will be reflected eventually. But this is an incredibly long term opportunity and this is a perfect thing for what I call like a coffee can approach. You buy some of this, you stick it in the coffee, can you bury it in your backyard?


You don't look at it for 20 years and you come back and you're surprised to see what happened. So, Jake, talk to us about the catalyst that has recently caused the price to to go down, and then what do you think the catalyst will be for a recovery? Yeah, I mean, the recent catalyst, I have to assume, has been like the rest of the world has recognized the economic impacts of covid and for whatever reason, the US, especially tech like we talked about, have kind of remained blissfully unaware of it.


So it's been beaten up lately. Now, a potential positive impact might be the Helios investment partners, a little background on them there, an African firm basically that started in 2004 and they run about three point six billion dollars on their platform of funds. So they're taking over operations, sharing economics with Fairfax. And I'm hopeful that this will give maybe even more opportunity to find interesting investments within Africa for Fairfax, Africa, because the guys running it have been doing this for longer than the previous managers who were doing this.


So that was announced on July 10th, this potential change. And the stock is flat in that time. So no one seems to care. I don't think anyone's looking at it. You have to recognize that this is a very low volume stock. It trades less than twenty thousand dollars per day. So and any time you have an incredibly low volume stock, you have to really take every single current market price with a very large grain of salt because there's just not many dollars behind the market movements.


So, Mr. Market, it's a very light load for Mr. Market to move the price around when the volume is that low. All the more reason why the A coffee can is probably the smart play. It's a good point, you mention having invested in Fairfax, Africa, I remember whenever I wanted to get out of the stock and it was a downward trend at the time. And and because it's so thinly traded, it can be very expensive to hit any of those bits that you see out there on the screen.


So it's definitely something to consider for investors. I also want to say that it should also be seen as an opportunity, especially for retail investors. If there's anyone sitting out there with their billions and billions of dollars, this is probably not the stock that they want to build, or at least if they want to. It's going to take years and years to build that performance. Then they could probably never get out of it unless they sell like a block to Prem Watsa himself.


But it's just something that's worth noticing. And it's just like whenever you hear about this liquidity and someone had been buying Apple stocks or Google stocks or whatnot, it's sort of like difficult to explain, like the pain that can be involved with liquidating a position or even building a position in something that's so thinly traded. So anyways, it was just a quick note that I wanted to mention. Use limit orders, be careful. Yes, use limit orders, definitely.


Be careful. Wise words for a stock like this. So the stock today is trading at three dollars and 20 cents. What is your process for estimating the intrinsic value of Fairfax Africa? So let's start with eighty six million dollars on the balance sheet in cash. Now, I'll let you make your own discounts to that. If you think that it's being mismanaged and that that 80 million dollars isn't worth what it is in those guys his hands. But I'm going to count.


It is eighty six million dollars at the top. And so far they've laid out five hundred nine million dollars in investments and it's carried it at call it three hundred million. So as a thought exercise, let's assume that the market was really pessimistic, that basket of securities. And we remarked those assets to only a 20 percent loss. But we're moving that number back up to four hundred million from three hundred million now. Four hundred million plus the eighty six million in cash.


That gives us a four hundred and eighty six million dollar value. Now, remember that the current price to book is point five one. And I would say as a base case, let's assume that you can just get one times price to book on this, which seems appropriate if it gets a reasonably managed fund. So we're adding back that 20 percent that we considered an overly pessimistic mark to market. And at a four hundred eighty six million dollar book value, that would give us a four hundred eighty six million dollars price, which is one hundred and forty three percent from where we are today.


Now, let's take an overly bearish case. We don't add back anything. We keep book value at three hundred ninety million. We take the worst price to book its ever traded at, which was in early twenty twenty, which is actually point three price to book and that gives us one hundred and seventeen million dollars implied value. That's 40 percent down from where we are today. OK, I would say that's probably a little bit overly bearish, but just for fun, let's put some bookends on this now.


Let's make a little bit of a bullish case for this. Let's assume that these guys with a thirty five year track record are not as dumb as the market is making them look right now. And we do a full add back of that five hundred nine million that's been laid out already. Let's just assume that it goes back to par. Basically, we put the eighty six billion in cash back in. And by the way, we're not assuming any returns on any investment here.


This is just to go back to par. Right. So it's still relatively conservative. That gives us a five hundred ninety five million dollar book value. And the highest price to book that it's ever traded at was in twenty seventeen, which was one point four, seven times. So let's use that as our multiple and that gives us an eight hundred and seventy five million dollar market cap, which is plus three hundred and thirty eight percent from where we are today.


So let's assume that as sort of a blended probability that our base and our bear and our bull cases, we're all equally likely. Thirty three percent chance of either of any of those three happening. Well that implies a one hundred and forty six percent expected return on those blended probabilities. So there's a lot of potential upside here. If they can sort of get things together and maybe the market stops discounting everything as hard as it has been for the things that they own.


You sort of have two layers of cheapness. You have the underlying which has gotten beaten up and very cheap, and then you have the bigger the wrapper that it comes in, which is the fund, which is also discounted heavily. So there are a few different ways to win if you get any kind of reversion to the mean use limit orders, coffee, can it buy it for your grandkids and come back in twenty fifty? And the world has changed dramatically and Africa is a very reasonable place to do business.


And there's something I find to be personally very rewarding about the idea that there are so many other people in the world who are hopefully going to have much better life experiences in places where historically it has been a pretty rough place to have been born. So let's all hope like it. Wouldn't it be nice to root for Africa to get a chance again to be kind of in the sun? It would be poetic justice for them. And I think it's always nice when you can root for both a good outcome for humanity and also for your portfolio will set.


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All right, back to the show. OK, we would really like to ensure that everyone feels that they're completely on board. We've been like talking back and forth about a limit or this and limit all of that. And for a lot of people, listen to this, perhaps new to investing. They're like, what do you mean? Like in order, don't you just buy or sell? But there were different types of order. So why is there a limit or is so important for a company like Fairfax Africa?


Well, let's say that you just put in a what's called a market order, that just means that the brokerage account will go and fill that order no matter what the price they're going to buy, whatever shares are available at whatever price. And they're going to get your 50 shares if you put in 50. Now, if you put in a limit order, it will buy as many as it can up to that particular price. So with something that's is thinly traded as Fairfax Africa is, even if you're not a big investor, you can move the price around quite a bit and change the economics and the bet that you're making without even realizing it.


If you were to, let's say, push the price up 50 percent because you weren't paying attention to your order. Now, all of a sudden, you bought shares that were 50 percent more expensive and they probably don't fit the math that you did before you put in the order. So I would say, especially in today's high frequency trading world where everyone is trying to front run everyone, I never put in market orders for anything, even liquid stocks.


I always put in limit orders. And it's just it's a better way of being disciplined.


And sometimes it bites you in the butt because you don't get as much filled as you wanted and the price moves away from you and you go, dang it, I probably would have paid a little bit more to get those extra shares, but I didn't. And that happens. But the other side is the very bad outcome where you bought a bunch of shares at a price much higher than you were anticipating and now you're like, that was not what I was aiming for.


Jake, we really, really enjoy having you on the show and we look forward to the next time that we're going to be able to do something like this, but in the meantime, give people a hand off where they can learn more about you. You know, on Twitter, I'm probably more active there than I should be, but I'm at Farnam Jake one, I do the value after Hours weekly podcast with our mutual friend Toby and Bill Brewster.


If you want to learn more about our investment company, it's Farnam Dash Street Dotcom and all of our letters are public. I try to spend a lot of time writing good letters because I want to go back and be able to read them 20 years from now and not be embarrassed by what I wrote. And then lastly, I have my book came out last year called The Rebel Allocator, and it's a good gift for young people if they're interested in business and investing.


I actually I wanted to condense a decade plus worth of learning that I'd been doing about business and investing and write something for my kids. And then I figured, why not help everyone else out with it? So that might be a good gift idea for that young person in your life. Yeah, I could definitely echoed that sentiment. I read your book, The Roadblocked, it was a great book and actually our friend Sean Murray won a host here on the network, did interview you about that book.


And we'll make sure to link to that in the show notes. And I guess that the listener would probably notice a few similarities to a few investors that we follow closely here, including Warren Buffett and Charlie Munger and a few other people. So it's definitely a book worth picking up, and not just for you being a seasoned investor, but also if you want to give wisdom to the new generation of investors. Jake, thank you so much for your time.


We know you're super busy, so thank you so much for taking time out of your busy schedule to be speaking with Preston, you here today and the Masters podcast.


Always a pleasure, guys. Thanks for having me on. All right, guys. So at this point in time, the show will play question from the audience and this question comes from Tim. Hey, guys, Tim from Kentucky here first. I love your podcast. Secondly, I just wanted to ask you a quick question about preferred stock, specifically preferred stock issued by banks. I understand that if interest rates rose, the value of the preferred stock would go down.


But might it also be the case that there could be a benefit to the stock because the banks would benefit in the rising interest rate environment? Thanks for any insight you can provide. So, Tim, I think it's such a great question because we talk about bonds and stocks, but we seldom talk about preferred stocks, which is sort of a hybrid between the two.


So please allow me to clarify for the audience what we mean when we talk about preferred stocks. A preferred stock is similar to a bond in the sense that it pays dividends, dividends for a bond called coupon's. But the two concepts are not too far away from each other. One important difference is that the preferred shareholders receive their fixed payment before the common shareholders. But after the bondholders receive the coupons and also most often prefer, Chiat does not have a term meaning that the shares out on the market and it does not mature in theory.


In practice, the issue will often buy back at some point time in the future whenever the conditions are beneficial for the company. And then what are the similarities to common stock? Well, they have similarities in the sense that it's a piece of equity in the business. However, that piece of equity will only materialize should that company default and prefer shareholders win that case, receive the claims to the business before the common stockholders, but after the bondholders. And keep in mind that most often it is only bondholders who would be paid fully or just partly in the case of bankruptcy.


So that extra layer of safety really shouldn't matter much for you. In most cases.


As you correctly point out, the value of your preferred stock goes down whenever the interest rate go up and the intuition is easy to grasp. After the rate hike, the market can get a higher yield on bonds or other preferred stocks where you already committed your money into this preferred stock, which would relatively make the value of your preferred stock less valuable. To second part of your question about whether it will be good for the bank if Rachman's up. The answer is also yes.


So in that sense, you can argue that the news of a high interest rate as an investor in preferred stocks for a bank, it's still bad, but it's not as bad as many other industries. And you can even make the same claim for a company like Fairfax that we just talked about here today, their insurance business, everything else equal be better off with a higher interest rate. However, the implication for you as an investor in preferred stock is that the investment you made in the bank is everything else equal.


Better protect it, since the bank will make slightly more money with a higher interest rate, which would limit your risk of defaulting on your preferred share power for you as an investor, please do not see this as a tie score. The interest rate effect on your preferred stock, which is not in your favor, is vastly more important that what you will gain from that stock now being able to conduct business in a slightly more friendly environment.


So, Tim, this is this has been fun here in this question because I haven't even thought about preferred stock in a very long period of time. Typically when you see preferred stock issue, you're dealing with venture capital and people coming in with enormous resources and they're coming in to have a very special and particular interest met the for the large and substantial amount of capital that they're providing for a company that that desperately needs that capital. But for the preferred stock that's out there on the public markets that pretty much anybody can gain access to through the floor, through the appropriate broker.


I am it's just not it's just not a market that I participate in, and so when this question came up, I really remember thinking, I don't know if people are familiar with this, but Stig and I wrote a like a summary guide to security analysis. And I distinctly remember writing some of these sections in the book because when we were doing the summary guide, because Ben Graham was was also not a very big fan of preferred stock for the general public that they had access to that were being sold.


So in Chapter 14 of security analysis, this is where Ben Graham starts talking about preferred stock. And so I'm reading a section from our from our summary guide, our security analysis summary that anyone can look for this on Amazon. If you're interested in and having this, it's actually kind of a useful little book to have alongside security analysis if you're trying to actually get through the book. But this is what Stig and I concluded in our summary guide about Ben Graham's writings on preferred stock.


So this is how it goes, although Graham has periodically mentioned preferred stock before this chapter. This is the first opportunity where he clearly defines his opinions on its role in financial markets. Graham makes no hesitation in identifying his distrust for preferred stock. He claims preferred stock takes the least favorable element of bonds and packages it together with the least favorable elements of common stock. That's really kind of the the quote that I really wanted to read for you. The other thing that I tell you is when you really do start digging in the preferred stock, there's two types.


There's cumulative and then there's non cumulative preferred stock. Non cumulative basically provides the option for management to not even pay the dividend that's associated with it. So although that's a pretty small portion of the overall preferred stock that's out there, that's also something that I think you should ensure you look into and fully understand before you buy any in general. I think the reason Graham has this quote, it's pretty obvious is, is because you're getting a security that acts exactly like a bond, but it's behind the you know, if if the business fails, you're behind all those bondholders that are sitting in front of you.


On top of that, you don't have any voting rights. On top of that, you don't have any earnings rights, especially if it's non cumulative. So I don't want to steer you away from this. But but at the same time, I want you to be very cautious of this. I think that it really requires a lot of analysis. It requires a lot of thinking about what risks you're actually assuming and what could actually be paid out to you.


When you're behind the bondholders, if the company would go into a liquidation event and, you know, with the way interest rates are going these days and how they've really kind of polarized a lot of bond yields down to down really low and beyond, what would be normal, normal for any type of market condition. I'd be really skeptical that the yield that you're receiving on the dividends of a preferred stock are actually representative of the risk that you'd be assuming in the event that we would go into a big, you know, liquidity event and bankruptcies and things like that.


So just some thoughts to think about. Very interesting question. I really haven't addressed this one in a long time. I know I have some videos out there on YouTube addressing preferred stock. So those are out there as well. And I go into a lot more detail how they work and you know, how you can filter for them to find certain preferred stock. There's I might have two or three videos on it. I can't even remember because it was so long ago.


But if you search for my name and preferred stock on YouTube, they'll be sure to come up. So, Tim, for asking such an interesting question, we're going to give you free access to our top finance tool on our tool. We have a filtering mechanism that helps you find really good value picks. We also have a momentum tool that assists all sorts of really neat and interesting things there. It helps you do intrinsic value calculations based on the free cash flows that the company is kicking off and your estimates of what those might be in the future.


And it's really easy to use. So we're excited to be able to give that to you. For anybody else out there listening to this, if you want to get your question played on the show, good. Ask the investors, Dotcom, and if your question gets played on the show, you get free access to our top finance tool.


All right, guys. Preston, I really hope you enjoyed this episode of the Investors podcast. We will see each other again next week. Thank you for listening to T IP to access our show notes, courses or forums, go to the Investors podcast Dotcom. This show is for entertainment purposes only before making any decisions, consult a professional. The show is copyrighted by the Investors Podcast Network written permission must be granted before syndication or forecasting.