Investment Competence
How would you describe the investment style of Hamblin Watsa?
Our investment philosophy at Hamblin Watsa rests on the principles of value investing championed by Ben Graham and practiced by Warren Buffett and John Templeton. We have a long term value oriented approach to managing money, which results in our viewing the risk of capital loss within a portfolio differently than how other investment managers may view it. We do not worry about the short term fluctuations of the market, focusing instead on the long term asset values of our investments. We look at markets declining as an opportunity to buy good assets cheaply, or in other words, an opportunity to buy one dollar for fifty cents, as my old friend Peter Cundill would say. Similarly, when market exuberance sends prices well above our estimation of value, we don’t buy, and we might sell. This long term approach takes solid research and courage and conviction, because you are regularly acting differently from the prevailing market sentiment and you may initially, and sometimes for quite a while, suffer unrealized losses until the market ultimately validates your investment choice. Simply put, a clear understanding of the fundamental value of our holdings allows us to go against the crowd. It is lonely at times, but it works. Warren Buffett is the most well-known practitioner of this brand of long term value investing. We have long admired his skill and investment returns. But the most important idea I got from Mr. Buffett – and it was Francis Chou (who later became a young employee at Hamblin Watsa) who brought this idea to me – is that Warren Buffett, like Larry Tisch and Henry Singleton before him, realized that owning insurance companies would allow him to significantly increase the profits of those companies by exercising his investment skills on those companies’ float (the “float” is basically the premiums collected but not yet used for paying claims or expenses).
Governance and Stewardship
“The objective of our Annual Report is to provide you with enough information so that you can get some idea about (a) what Fairfax is worth; (b) our ability to meet our obligations (in other words, our financial soundness); and (c) how we have done given the hand we have been dealt.
Most of this report deals with (b) and (c) but I would like briefly to discuss (a). What is Fairfax worth? In the 1995 Annual Report, I mentioned the concept of intrinsic value or what a company is worth. Intrinsic values do not fluctuate as much as stock prices and are based on the earnings or future cash flows from a company B the earnings or future cash flows that can be distributed to shareholders after the reinvestment requirements of the business for capital expenditures and working capital requirements. Broadly speaking, for our insurance and reinsurance business, capital expenditures and working capital requirements are minimal and so our earnings are free to be distributed to shareholders. So, the future earnings for Fairfax will determine the company’s intrinsic value.
On the other hand, the book value of a company shows the net amount of moneys that have been invested in the company over time. Return on shareholders equity, i.e. return on book value, is the link between book value and intrinsic value as future earnings will be determined by the return on shareholders’ equity. When a company like Fairfax earns more than 20% on shareholders equity then, given that long term interest rates are below this figure, the intrinsic value of the company will exceed its book value and its stock price will reflect its intrinsic value over time. So while stock prices fluctuate in the short term B reflecting the twin emotions of fear and greed B in the long term they always reflect underlying intrinsic value. This is how we view the link between book values, intrinsic values and stock prices. We have given you a framework to value Fairfax but you will have to come up with your own number for intrinsic value.”– Prem Watsa in his 1997 letter to shareholders
