Brunch with Markel

Markel hosts a brunch each year following the Berkshire Hathaway Annual Meeting, and has done so for 25 years now — during which time the company has grown considerably, from a small $100 million family-controlled specialty insurance company just starting to explore value investing with their new portfolio manager, Tom Gayner, to a $12 billion international and diversified insurer that, though it still has significant participation from the Markel family, now features Tom Gayner as co-CEO.

I’ve held Markel for a decade or so, almost as long as I’ve owned Berkshire Hathaway, and this weekend was my second time participating in the Markel Brunch. It’s held at the Hilton in Omaha, just across the street from the giant arena where Buffett and Munger held court for six hours the day before, and it is, in substance, essentially designed to do the same thing as the Berkshire meeting: give Markel shareholders a chance to understand the company better by asking questions and listening to the opinions and answers of Markel leadership. This is a nice thing to do, but it’s also good for the company — Markel’s business model, with their focus on long-term results and patient growth with little regard for quarter-to-quarter fluctuations, requires a base of capital (investors like you and I) who have “bought in” to the plan. Hearing from the horse’s mouth makes it a lot easier to buy in, and since there’s heavy overlap between Markel and Berkshire shareholders it’s no surprise that there were about 1,000 people at the brunch… or that Tom Gayner estimated that they represented a large portion of the equity owners of Markel.

I really like the company and their management and their culture, which they try very hard to institutionalize, but the stock has been disserved, I think, by their fairly constant promotion as the “next Berkshire” — people are so obsessed with finding the next Berkshire Hathaway that they occasionally get too excited about Markel and drive the shares up to what I think are unsustainably high price/book valuations.

Why price/book value? Well, mostly because book value growth is the metric Markel uses, and because it is, as they reiterated today, the “least bad” way of simply assessing the value and progress of the company. Markel has a large insurance operation that has been consistently profitable and that they’ve grown (mostly through acquisition) over the years, they have a large portfolio of both fixed income and equity investments, including their insurance “float” (premiums paid in that they haven’t yet paid out as claims), and they have a growing (but still small) subsidiary of controlled non-insurance businesses. It’s not necessarily true that book value is a fair approximation of Markel’s real worth, but it’s in the ballpark — and growth in book value over time is the best way to assess their performance — and that growth has tailed off considerably as the company has grown.

This is the chart of Markel’s growth in book value (blue line) over the long term, which gives me quite a bit of confidence that owning Markel will likely continue to be wise. I’m certainly not selling.

MKL_chart1990

And this is the chart that gives me some qualms about buying more Markel RIGHT NOW — you can see that over the past year or two, the stock has become unhinged from book value growth and has taken off to new levels, it’s now trading at 1.6x book value, as high as almost any of the somewhat similar large specialty insurers, almost all of whom have also had a tremendous run over the last year or two… and quite a bit higher than most.

MKL_chart

That doesn’t necessarily mean Markel is going down — it has traded at well over 2X book value for extended periods of time in the past when enthusiasm was high, and I bought some of my shares in the mid-2000s during such a time (though Markel was far smaller then)… and have no complaints about “overpaying” for that position, since it has increased in value several fold — but investing for the long term doesn’t mean you should ignore the price you pay, and Markel at $900+ is quite close to what I think is likely to be a peak valuation.

I will probably never tell anyone to sell this stock, since I’ve bought in to their model and their plan and their culture and I think they’ll continue to be excellent long-term stewards of my capital (and, importantly, because I don’t trust myself to sell in 2006 at 2X book and buy back in 2010 at 1X book — I’ve rarely been so nimble or well-timed in my trading), and I suspect that those who are thinking about a 20-year time horizon will still find Markel a profitable investment even at this elevated valuation, as I was after buying some of my shares near the 2006 highs and waiting several years for them to recover… but I wouldn’t “go big” with a new Markel position here.

There was a good Morningstar critique of Markel a couple weeks ago, if you’d like a more pessimistic take (they think Markel is overvalued because of the “baby Berkshire” comparison, and that W.R. Berkley (WRB) is a better bet) — here’s a taste of their analysis:

“We think the primary reason Markel draws interest is how it differentiates itself in terms of capital allocation. Most insurers actively return the bulk of their free cash flow, given the maturity of the industry. Markel retains the vast majority of its capital; its goal is to compound this capital at high rates of return over a long period and create value for shareholders. However, this is easier said than done, and we think the company’s record is mixed. We think expecting the company to repeat Berkshire Hathaway’s performance is overly optimistic. In recent years, the company’s largest moves have been to acquire Alterra and a variety of noninsurance operations. We’re skeptical that these moves have created value. The addition of Alterra dramatically increased the company’s exposure to reinsurance, a highly volatile area where we think it is difficult to build a moat. Further, based on industry overcapacity and recent pricing in reinsurance trends, we’re concerned this acquisition could prove ill-timed. The company’s noninsurance acquisitions do not appear to have created shareholder value, with these operations earning about a 6% return on invested capital over the past four years….

“We believe the company’s perceived ability to generate alpha on the investment side is the primary attraction for many investors. CIO Tom Gayner has an impressive record, as he has beaten the S&P 500 by almost 2 percentage points on average over the past 10 years. We like his investing approach, as it closely mirrors our methodology. However, we think the company