When it comes to ultra-long-term holds, very few companies make the cut in my book. A typical investment horizon for my stock picks is anywhere from two to five years. Beyond that, fundamentals and macroeconomic conditions make it difficult to forecast with any meaningful accuracy. While Buffett's Berkshire Hathaway has long been my No. 1 pick in this arena, I believe now there is an even greater lifelong hold for the patient investor.
On Friday of last week, Fairfax Financial (NASDAQOTH: FRFHF.PK) hosted its second-quarter conference call. The takeaway: typical Fairfax-style understated goodness.
For the quarter, the insurance company's combined ratio -- a measure of its underwriting profitability, with figures less than 100 indicating a net positive outcome -- was 97.5%. Compare that with the industry standard of 106%, which means that when all is said and done, the industry on average loses money on its underwriting. Berkshire Hathaway's (NYSE: BRK-A ) (NYSE: BRK-B ) GEICO typically earns an even lower ratio of less than 95%. One of Buffett's great prides is Berkshire's nearly unrivaled ability to profit from underwriting -- essentially giving his company a negative cost of capital with which to invest in his many holdings.
Compared with the prior year, net premiums for Fairfax were up a respectable 14% to $1.57 billion in the second quarter. While many Fairfax critics drew attention to the company's 100% equity hedge, it paid off in the quarter's tumultuous market. While equity investments suffered a loss, the hedges and other investment-related activities earned the company a net of $71.5 million.
Fairfax has $8 billion in cash and short-term investments. Clearly, it's waiting for the right time to strike, as 30% of its portfolio is essentially liquid cash.
RIM of fire
Chairman and CEO Prem Watsa's most controversial investment to date is Research in Motion (Nasdaq: RIMM ) . As I reported early last week, Watsa doubled his stake in the beleaguered tech firm.
Prem Watsa is known as a deep-value investor. His buys have been slow and calculated, and they should continue to create tremendous long-term value for the company. Though Research in Motion only makes up a small portion of the $24 billion portfolio for Fairfax, the roughly $370 million investment could be a significant value driver for Fairfax in the latter half of this decade. (Other major holdings are Johnson & Johnson and Level 3 Communications.)
After news of the investment, along with further negative data from RIM, speculation suggested Watsa was looking for a profit in the sale of the company and its portfolio of patents. This is not the case. Since the beginning of his investment in the company, Watsa has emphasized that he is invested in RIM's long-term future and the potential for a turnaround. While most analysts have doomsday forecasts for RIM, I like management's decision to downsize employee head count and narrow the company's focus.
Fairfax also holds on to a relatively large number of U.S. Treasury bonds. This investment is in line with Watsa's call that U.S. and European economic woes are far from over.
The better of two kings
This is not to say that Buffett or Berkshire are in any way a bad investment. I firmly believe that Berkshire will earn investors stable and market-beating results over a 10-year horizon and beyond.
Still, I prefer Fairfax. In a future article, I will more directly compare Fairfax and Berkshire -- from their investment holdings to the performance of their insurance subsidiaries. For now, Fairfax's solid dividend and stacked yet well-hedged portfolio make it an income-producing holding with great capital-appreciation potential.
And as for valuation, Fairfax trades at 1.1 times book value, the most popular metric when looking at insurance companies. Berkshire is more expensive at 1.2 times book, though there is built-in downside protection due to Buffett's promise that he will aggressively buy back stock if Berkshire hits 1.1. I like Fairfax's cheaper price combined with Watsa's deep-value stock picks, which have extraordinary payoff potential.
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