A word comes to mind whenever I read of an acolyte attempting to replicate a master. The word is epigone – an inferior imitator. Imitation might be the sincerest form of flattery, but imitators rarely exceed the original.
To call Prem Watsa, chairman and CEO of Toronto-based Fairfax Financial Holdings (OTC: FRFHF), a Warren Buffett imitator might be unfair, but the word can’t help spring to mind upon initial inspection.
Fairfax Financial’s foundation is insurance – property and casualty and reinsurance. Berkshire Hathaway’s (NYSE. BRK.a) foundation is insurance – property and casualty and reinsurance. Both companies use interest-free insurance float to invest in the stock market. Watsa will allocate large sums of insurance float to a single investment; Buffett does likewise.
Fairfax Financial refuses to split its stock; Berkshire Hathaway has never split its stock. Watsa writes long, elucidative chairman’s letters to Fairfax Financial shareholders. Buffett has written similarly to Berkshire Hathaway shareholders, only decades longer than Watsa.
So, you understand why “imitator” comes to mind. You’ll understand why “epigone” shouldn’t come to mind after a glance at the graph below: Fairfax Financial has easily outdistanced Berkshire Hathaway since the start of the millennia.
Yes, Watsa has patterned Fairfax Financial after Berkshire Hathaway. But differences exist, and these differences contribute to the share price divergence.
Fairfax Financial Pays a Dividend
Dividends are the most notable difference. Fairfax Financial pays a dividend, $10 per share annually. Berkshire Hathaway never has, and likely never will with Buffett at the helm. I’ve long argued that Berkshire Hathaway should pay a dividend (read here and here). Buffett has long argued against paying a dividend, and his investing record would appear to support his argument.
Then again, the chart graph above would appear to support my argument. Dividends are a useful tool for managing capital structure. By removing excess cash, dividends help keep returns on invested capital high. Just as important, they keep the joint manageable. And by keeping the joint manageable, the universe of investment options remains expansive.
Too much cash has constricted Buffett’s universe to a sliver of possibilities. To keep the needle moving, Buffett must invest billions of dollars in one shot. Because Berkshire Hathaway sports a $356-billion market cap, anything less than a multi-billion-dollar investment is meaningless. The need to sop up so much cash with a single investment vastly reduces the number of investment options.
If you vet Berkshire’s recent buys, it’s the stuff of every large-cap mutual fund: Phillips 66 (NYSE: PSX), Apple (NASDAQ: AAPL), Liberty Media (NASDAQ: LMCA), Kinder Morgan (NYSE: KMI), Kraft Heinz (NASDAQ: KHC), International Business Machines (NYSE: IBM). You might be the greatest stock picker ever, and Buffett unarguably is, but if your investment options are limited to those of every efficient-portfolio-theorist mutual fund manager, what’s the point?
Fairfax Financial, in contrast, is a much smaller investing vessel, considering that its $13-billion market cap is a fraction of Berkshire Hathaway’s. Buffett might be a better stock picker than Watsa, but Watsa has many more options – encompassing choice and strategy.
Both Buffett and Watsa take a concentrated approach to investing. Berkshire Hathaway owned 49 different stocks as of June 2016, but the top five accounted for 70% of portfolio value. Fairfax Financial owned 33 different stocks. The top five accounted for 80% of portfolio value.
Berkshire Hathaway’s top five comprise the usual hidebound blue-chip suspects: Kraft Heinz, Wells Fargo (NYSE: WFC), Coca-Cola (NYSE: KO), IBM, and American Express (NYSE: AXP). Fairfax Financial’s top five include the yawner IBM, but the others are off-the-beaten-path contrarian fare sporting significantly smaller market caps than Berkshire Hathaway’s top five: Blackberry (NASDAQ: BBRY) (the largest holding), Kennedy Wilson Holdings (NYW: KW), Resolute Forest Products (NYSE: RFP), and Overstock.com (NASDAQ: OSTK).
Fairfax Financial: Lean and Nimble
Fairfax Financial really reminds me more of Berkshire Hathaway 40 years than Berkshire Hathaway today. Fairfax Financial is lean and nimble; few investments and strategies are off limit.
Such was the case for Berkshire Hathaway In the late 1970s. Buffett ran a very concentrated investment portfolio composed mostly of smaller contrarian stocks, much like Fairfax Financial does today.
From 1977 through 1983, Buffett rarely pushed Berkshire Hathaway’s stock portfolio beyond 10 issues. During that time, Berkshire Hathaway’s share price galloped along at a 50% average annual rate.
Fairfax Financial’s share price hasn’t galloped along at a 50% average annual rate over the past six years, nor would I bet that it will gallop along at a 50% average annual rate over the next six years. But if I were to bet which company had the better chance of galloping along at a 50% average annual rate, I know I wouldn’t bet on Berkshire Hathaway.