A letter to my son:
Mommy and Daddy are so proud of you! You did such a wonderful job on your Bar Mitzvah. I am going to give you a timeless present. If you take care of it, I believe it will multiply in value many times over your lifetime.
31 years ago, your grandparents bought me a computer for my Bar Mitzvah for about $3,000. I loved that computer and would spend hours on it playing games and writing programs using a software application called BASIC (just like the hours you spend on the Xbox playing Fortnite). Within three years, my Bar Mitzvah computer was obsolete, and I think we gave it away for nothing. If only my parents had bought me just one share of Berkshire Hathaway instead; at its low in 1987, the year of my Bar Mitzvah, one share was around $3,000. Today, it trades for about $300,000. Abe, your gift is three shares of Markel Corporation.
Chris Davis of Davis Funds (an investor who Daddy respects very much) said, “[Markel is] a growth company disguised as an insurance company…[with] a terrific culture…I like the cyclical opportunity in financials right now, but if you want to build wealth, you want to look at the secular success of companies.” He expects Markel’s normalized book value growth to be in the low to mid-teens (12%-14%) over time. The company trades at 1.7 times book value—a premium to peers. “As it should,” according to Davis.
Given the unbelievable success of Warren Buffett’s Berkshire Hathaway, it is surprising to us that more companies haven’t tried to replicate its accomplishments. There may never be another Berkshire Hathaway, but Markel is certainly trying to follow the same path.
Markel is copying Berkshire’s plan to a T; run a specialty insurance and reinsurance company with discipline and a focus on profits, not volume. Invest the insurance premiums in quality publicly traded securities instead of just bonds. Also, buy and operate private businesses involved in manufacturing and services. The only missing ingredient is using its float to invest in equities— and that may come one day too.
Like Berkshire, Markel has a terrific track record of underwriting profits and is disciplined enough not to write business when conditions are competitive. Over the last 15 years, its combined ratio has been above 100% three times. This is a rare achievement. The combined ratio shows how effective an insurance company is at pricing its insurance premiums. When a combined ratio is below 100%, the insurer makes money underwriting insurance. Most insurance companies lose money regularly writing insurance premiums and hope to make it up on the investing side. Markel generally makes money both ways—underwriting insurance and investing the premiums.
Markel seems to have figured out the secret to delivering insurance profits. And one can chalk that up to its culture of underwriting discipline. Unlike other insurers, Markel compensates its underwriters based on the actual performance of their book of business over time, not based on who can underwrite the most insurance contracts. As a result, its employees are incentivized to do what is best for its shareholders.
Most insurance companies use third parties to manage their investment portfolio. Also, most insurance companies invest their portfolios primarily in bonds. Not Markel. Markel’s investments are selected by Tom Gayner, its President and Chief Investment Officer. Tom has been with Markel for many years, and his investing performance speaks for itself. Markel’s public equity portfolio has outperformed the S&P 500 by about 2.5% annualized over the last 27 years.
Almost 60% of Markel’s investment portfolio is currently invested in equities. The rest is in short-term bonds. Gayner aspires to get the equity proportion up to 80%. He is a buy-and-hold investor and utilizes a four point approach:
Invest in a profitable business with good returns on capital that doesn’t employ too much debt;
Invest in a company where management has character, integrity and ability;
Invest in businesses that have attractive reinvestment opportunities;
If you find a company that has all three of the above, make sure you don’t overpay.
At the end of 2017, Markel had an investment portfolio that exceeded $20B.
Investing in private companies
Like Berkshire Hathaway, Markel recently started to buy private businesses to operate. It calls this division Markel Ventures. It already owns 17 operating businesses that employ over 12,000 people. Similar to Berkshire, Markel is looking to buy good quality businesses for a fair price, and let the management that built those businesses keep their jobs to continue the growth.
When we put all the pieces of Markel together, we believe its stock is worth close to $1,400 a share. Daddy uses a lot of math and assumptions here so I won’t bore you with all the details. All I will say is that I bought you shares of Markel at $1,150 a share and we think the stock is worth a lot more than that.
Let’s compare an investment in Markel’s stock to Tom Gayner’s four point checklist.
In my opinion:
Markel is a profitable business with good returns on capital
It is run by management with character, ability and talent
It has a long runway of reinvestment opportunities
Finally, I believe we can buy the stock today at a discount to its net worth.
Abe, I can’t believe you are now a man. My only request: please don’t sell any of your Markel any time soon. Happy investing!
P.S. Daddy bought some Markel for himself too, and I’m not selling. In 31 years, if you want to sell the stock, we’ll discuss.
May 24, 2018