TIP832: Fairfax Financial (FFO.TO): The Berkshire Of The North w/ Kyle Grieve & Shawn O'Malley

Fairfax Financial has compounded book value and share price at over 18% per year since 1985 and earnings per share at roughly 15% per year since 1986, a track record spanning approximately 40 years. Kyle Grieve describes founder Prem Watsa as the manager most similar to Warren Buffett he has ever analyzed, noting that Berkshire Hathaway has compounded book value at just under 20% annually since inception, making the comparison close but not exact. Watsa took control of a near-bankrupt Canadian trucking insurer in 1985 and grew its float from $13 million to nearly $41 billion today.

Fairfax's most celebrated trade was a bet against the housing bubble using credit default swaps on AIG, Swiss Re, and Munich Re. The firm spent nearly five years and $500 million before the position paid off, ultimately netting $4.6 billion during the GFC, approximately four times what Michael Burry made from a comparable trade. After the crisis, however, Watsa continued hedging by shorting the S&P 500 and Russell 2000, which wiped out nearly all operating income between 2010 and 2016 and reduced book value growth to just 2% per year over that period. Watsa eventually admitted the post-GFC shorting was a mistake and swore off shorting permanently. Kyle attributes the original hedging instinct partly to a Graham-like psychological scarring, noting that Benjamin Graham's framework was shaped by living through the Great Depression and caused him to perpetually anticipate another one.

Fairfax's central competitive advantage is the return it earns on float. Its long-term return on investments is approximately 7.7%, compared to roughly 4% for the average insurance company, and this gap is what allows Fairfax to effectively be paid to hold other people's money. The 2017 acquisition of Allied World for approximately $5 billion illustrates this logic directly: Allied World had an average combined ratio of 91% but its float earned only about 4%, and Fairfax believed it could generate a 20% return on equity simply by raising that return to 7%. Kyle acknowledges that Berkshire Hathaway and Markel likely generate even higher returns on float than Fairfax does.

Insurance underwriting profits reached $1.8 billion in 2025, representing approximately 32% of operating profits, up from 18% in 2021. From 1986 until 2005 Fairfax's average combined ratio exceeded 100%, meaning it was losing money on underwriting during that period. Since 2006 it has maintained a combined ratio below 100% consistently, averaging approximately 97% over the last decade. Kyle attributes the improvement in underwriting quality to a decentralized model and long-tenured insurance presidents, noting that insurance managers need to remain through multiple cycles to be properly evaluated because the effects of underwriting decisions do not surface until years later.

Fairfax has demonstrated tactical capital allocation discipline across several transactions. It sold a 10% stake in Odyssey at 1.7 times book value and used the proceeds to repurchase Fairfax shares then trading at only 0.9 times book. During COVID-19, after shares fell approximately 50%, Fairfax purchased total return swaps on its own stock and ultimately netted approximately $2 billion in cash, much of which was redeployed into further share repurchases. Diluted shares outstanding have trended from roughly 28 million to 23 million since 2018. Prem Watsa has held a salary of approximately $600,000 since 2000 with no bonuses, no profit participation, and no equity or pension plan participation, while his 10% economic stake generates roughly $19 million per year in dividends and he controls 43.3% of voting rights.

Key man risk around Watsa, who is 75 years old, is partially mitigated by the decentralized structure he built. The board reviews succession planning annually, and Peter Clarke, president and COO with nearly 30 years at Fairfax, is identified as the leading succession candidate. Watsa stepped back as vice chairman of Hamlin-Watsa Investment Council in 2019 and investments have run smoothly since. The largest identified risk is shocks to the investment portfolio, with a 10% drop in global equity markets estimated to reduce net earnings by approximately $1 billion and a 20% drop by nearly $2 billion.

Kyle Grieve's base case valuation assumes Fairfax achieves its long-term 15% ROE target, producing a terminal value of approximately $4,600 Canadian by end of 2030 including dividends, implying roughly 14.7% annual return. The bear case assumes ROE drops to approximately 11%, applies a 1.0 times price-to-book multiple, and produces a terminal value of approximately $3,000 Canadian, implying 5.3% annual return. Probability weights of 55% base, 25% bear, and 20% bull yield a weighted intrinsic value of approximately $2,400 Canadian, which at a 20% margin of safety sits only slightly above the current price of approximately $2,300 Canadian. Kyle said he would reconsider owning Fairfax around $1,500 Canadian given insurance cyclicality and business complexity, and Shawn O'Malley characterized it as offering more limited downside than the median stock but unlikely to be a home run at current prices.