Fairfax Financial (TSX:FFH) is a Canadian financial stock operating mainly in the insurance sector. Often referred to as “Canada’s Berkshire Hathaway,” it has a long-term track record of successful compounding.
One thing about Fairfax Financial that stands out as peculiar to many investors is its dividend. At US$15, it is paid in US dollars rather than Canadian dollars, despite FFH being exclusively listed on the Toronto-Exchange and legally domiciled in Canada. This is a rather unique feature, presumably intended to attract US investors. Additionally, the stock’s yield (about 1.013%) is low by the standards of TSX financial stocks.
Now, you might think it odd to ask whether a given stock is a buy for its 1% dividend yield. That’s lower than the TSX’s yield – who would want that?
While it’s true that FFH’s yield is low, the company has achieved significant compounding over the years by keeping the payout low. With a mere 6.8% payout ratio, the company retains considerable amounts of earnings to re-invest in itself. The end result has been a track record of consistently outperforming the TSX Index. So while you’d never buy FFH stock for its dividend, you could take the stock’s low dividend yield as an indicator of its overall strategy – and that winds up being a compelling reason to buy.
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Fairfax’s business explained
Fairfax is at its heart an insurance company. It is mainly involved in property and casualty insurance, as well as re-insurance. These are both fairly lucrative sub-sectors of the insurance industry, especially for companies that “do it right.” Fairfax operates in both the U.S. and Canada under different brand names, which makes it a geographically diversified company. The company has a 93.9% combined ratio – lower than 100% is considered ideal. So, FFH appears to have many things going for it.
Why the low yield may represent opportunity
While Fairfax Financial’s low dividend yield is not an attractive thing for income investors, it may signal opportunity for other types of investors. The low yield and payout ratio mean high retained earnings, and retained earnings can be used to re-invest in the business. By the looks of it, Fairfax has done well reinvesting its retained earnings over the year, having compounded its key income/balance sheet metrics at the following rates over the last five years:
- Revenue: 11.1%.
- Net income: 36.5%.
- Earnings per share (EPS): 41.5%.
- Book value: 21.5%.
Pretty decent rates of growth here for a five-year period, indicating that Fairfax Financial is investing its retained earnings well and delivering value for shareholders.
Valuation
Having seen many things that Fairfax Financial has going for it, you might assume it to be a mighty pricey stock. However, it is not so pricey going by valuation multiples, trading at:
- 9 times reported earnings.
- 0.98 times sales.
- 1.4 times book value.
- 7.7 times operating cash flow.
Pretty decent multiples on the whole. And, the more Fairfax Financial reinvests in itself, the more its earnings and cash flows will grow over time. So, FFH stock appears to be worth it today.
