A Cheap Financial Stock for Extraordinary Price Gains

Fairfax Financial Holdings Ltd. (TSX:FFH) is a curious stock that moves differently from the U.S. and Canadian stock markets. This potentially makes Fairfax a good candidate to trade while adding diversification to investors’ stock portfolios.

The Business

Fairfax’s business model is similar to Berkshire Hathaway’s (NYSE:BRK.A)(NYSE:BRK.B). It has an underlying insurance business that generates float as a source of low-cost capital to invest for higher returns. Fairfax’s insurance businesses operate on a decentralized basis, which allows Fairfax to focus on capital allocation.

In the first half of the year, Fairfax’s insurance businesses were profitable. It had a consolidated combined ratio of 96.9% for its insurance operations. The combined ratio of <100% implies profitability.

According to Prem Watsa, the chairman, CEO, and founder of Fairfax, the company can achieve a 15% return on shareholders’ equity with a 95% combined ratio and a 7% return from the investment portfolio.

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BlackRock: A Rock-Solid Stock To Add To Your Dividend Portfolio

BlackRock (NYSE:BLK) has a long growth runway thanks to its large-exposure to passive investments. Moreover, it’s trading at a good value today and offers a secure yield of 3%.

BlackRock is a Long-Running Winner

BLK has been a long-term winner, delivering 15-year total returns of 15.8% per year versus the S&P 500’s 7.4% return in the period. Its 10-year returns of 13.5% per year also won against S&P 500’s 12.9%.

BLK’s earnings can appear a bit bumpy but in reality is slow growth periods occurring after high-growth ones. For example, it had three years of double-digit rate growth followed by a slowdown in 2015 and 2016. Then, high growth resumed in 2017. What’s important is that its long-term growth is intact. For example, from 2007, before the last financial crisis hit, to 2018, the company’s earnings per share increased by 11.5% per year on average.

Dividend

BlackRock’s consistent earnings growth has allowed the stock to begin paying a dividend in 2003. This year marks its 16th consecutive year of dividend growth. BLK’s five- and 10-year dividend growth rates are 11.3% and 15.5%, respectively.

With a payout ratio of ~48%, there’s a big buffer to protect BLK’s dividend, which is currently good for a yield of 3%. Investors can also expect dividend increases in the future to more or less match its earnings growth rate.

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Why Altria trades at a 28% discount to Philip Morris

At ~$41 per share, Altria (NYSE:MO) trades at a P/E of ~10 and offers a yield of ~8.1%. At ~$72 per share, Philip Morris (NYSE:PM) trades at ~13.9 times earnings and offers a yield of 6.5%. Why is MO cheaper than PM?

One reason is MO’s bigger debt levels, such that its S&P credit rating is “BBB”, which is much worse than PM’s “A” rating.

Another reason is that investors are worried that a MO-PM merger would lead to essentially a dividend cut for current MO shareholders. PM currently offers a 6.5% yield that’s 20% lower than MO’s current yield.

Since the merger could be a potential all-stock, merger of equals, based on Tuesday’s market close prices, the combined market cap of Altria and Philip Morris would be ~$190.3 billion.

Additionally, based on the percentage of their current market caps the combined company’s annual payout would be ~$4.14 per share with a share price of ~$59.54 for the combined company. This implies a yield of ~6.95% for the combined company.

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