Since Prem Watsa took over Fairfax Financial Holdings Ltd. (TSX:FFH), it’s been an excellent ride for shareholders.
When Watsa first established control in 1985, shares of Fairfax traded just $1.52 each. Just over 3 decades later the proportion price is $731.02, with a massive run-up in excess of 20% during the last 6 months. Overall, Fairfax has returned approximately 22% each year to the shareholders.
This makes Fairfax’s main man a really wealthy individual. Based on the latest numbers from Forbes, Watsa’s personal net worth C which consists almost entirely of Fairfax shares C is comfortably over US$1 billion. Not bad for a guy who started his life in Canada by selling appliances door-to-door.
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Over time, Watsa has followed the lead of some other famous investor, Warren Buffett. Like Buffett, Watsa uses excess capital generated by Fairfax’s profitable insurance operations to invest in undervalued stocks. This capitalCcalled “float” by those in the industryCgives Fairfax a source of nearly free leverage you can use to goose returns.
But unlike Buffett, who famously doesn’t spend much time thinking about the financial state, Watsa is famous for his macro calls. He bet aggressively on overpriced stocks in 2006, buying put options on the general market and moving a lot of Fairfax’s portfolio into cash and government bonds. He also used derivatives to bet from the U.S. mortgage market.
It ended up being a really astute move. While other financial companies were scrambling to clean up their balance sheets in the wake of the Great Recession, Fairfax raked in a profit in excess of $2 billion on Watsa’s bearish bet. Watsa also used the opportunity to get undervalued stocks which were crushed through the calamity of the market.
Fresh after you have that call right, Watsa began to turn bearish again a couple of years ago. This time, rather than betting against U.S. mortgages, he’s picked a new target C one having a higher payoff.
The $100 billion man?
Watsa’s new bet is on deflation.
Essentially, he bought several large derivative contracts that shell out if the consumer price index in certain countries dips below a specific number in the lifetime of anything.
Think from it like this is an insurance deal. Watsa spends a fractionally bit (approximately $650 million) to get paid $109 billion if deflation hits america, Eu, Uk, or France hugely by the year 2022. Sure, $650 million quite a bit of money, but it is way less than 1% of the projected payout. And also the $109 billion potential payday can make an enormous difference to a stock with a current market cap of $16.2 billion.
When Watsa was first placing this bet, it didn’t seem like this type of wise decision. The Canadian economy was riding an investment and real estate boom. America was recovering nicely in the Great Recession. And Europe had successfully shrugged off its own crisis with Greece.
Oh, what a difference a couple of years makes. With stock markets around the world tanking and negative interest rates becoming commonplace both in Europe and Japan, the marketplace is beginning to cost in deflation as a real possibility. Fairfax had decreased the carrying value of its derivatives using their price of $651 million to $238 million after 2014. After the third quarter it booked an increase of $125 million because the prices of comparable contracts have gone up.
It’s difficult to say whether Watsa’s bet on deflation will end up paying off. But considering the man’s track record in calling macro events so that as an investor generally, I do not think betting against the man may be beneficial. If he ends up being right, it will be very good news for Fairfax shareholders.
The original version of this short article can be seen at www.fool.ca
