No. of Recommendations: 3
From Morningstar analyst report:
“Fairfax did take a $386 million investment loss in the quarter. That included a $342 million loss from total return swaps on its own shares. While these swaps were a big winner for the company last year, this quarter showed the potential negative of this move.”
From reading analysts comments, I believe the above was the main reason for the sharp sell-off following earnings release. As I understand it, TRS allowed the company to gain leveraged exposure to gains from stock for a small premium payment. The company believes its stock is undervalued, and this a leveraged bet that its stock price will rise. This is in lieu of or in addition to accelerated stock repurchases.
These kinds of bets that Watsa frequently makes scares off many investors, even though he has a great track record of growing book value. But it does give you more occasions to buy on dips.
No. of Recommendations: 2
“Fairfax did take a $386 million investment loss in the quarter. That included a $342 million loss from total return swaps on its own shares. While these swaps were a big winner for the company last year, this quarter showed the potential negative of this move.”
From reading analysts comments, I believe the above was the main reason for the sharp sell-off following earnings release. As I understand it, TRS allowed the company to gain leveraged exposure to gains from stock for a small premium payment. The company believes its stock is undervalued, and this a leveraged bet that its stock price will rise. This is in lieu of or in addition to accelerated stock repurchases.
These kinds of bets that Watsa frequently makes scares off many investors, even though he has a great track record of growing book value. But it does give you more occasions to buy on dips.
Yes, I agree with all these points. But bottom line, the company has been doing a fantastic job of increasing insurance operating earnings, making big gains on most of its major investments and repurchasing its own shares. The 1.76m total return swaps (TRSs) mean they make $1.76m for every $1 increase in the price of their own shares, or inversely they lose $1.76m for every $1 decrease in their share price, so the C$224 share price drop from 2025-12-31 to 2026-03-31 means they lost C$224*1.76m= C$394m in Q1 (I guess there's some rounding error in my calculation.)
But this is not as risky as it might seem: First of all, they already have huge gains on this TRS position, originally established when shares were trading at C$480.62 (the shares are now at about C$2267, or US$1666.) Second, even if the share price went down $1000 to a ridiculous level like US$666 (they make US$200 in earnings every year), Fairfax would be able to cover the ~$1.76b loss without too much hardship.
The TRS position is economically no different from just repurchasing shares, so while the form of the transaction is unorthodox, the economics of it is roughly equivalent to just buying back a little less than 10% of the outstanding shares.
The important thing to remember, with Fairfax, is that they are earning about US$5b a year in operating earnings, plus whatever volatile investment gains they might make, minus some interest, corporate overhead and taxes, which came to about $4.8b last year. They currently have a market cap of US$43b, or about 1.3x book.
The unorthodox form of the TRSs is a bit of a distraction, but this investment remains a very attractive in my opinion based on fairly reliable earnings and a low multiple. I bought another 2% stake on Friday, and would have bought more if it weren't almost half of my portfolio already, and it has already bounced back and recovered more than half of what appears to have been an illogical 7% drop on Friday.
Regards, DTB
