The teaser pitches from Dan Ferris tend to get a lot of attention from Gumshoe readers, both because there aren’t all that many of them and because the big Stansberry marketing machine sometimes pushes them pretty hard… and I have a lot of sympathy with Ferris’ general “value investing” strategy, and do sometimes find his commentary to be convincing, including occasional presentations at investing conferences and in his podcast. I’m sure we disagree on a bunch of things, but I have ended up buying a few of the stocks he has teased over the years.
Will I be doing so again today? Let’s see what he’s hinting at in ads for his Extreme Value newsletter (currently “on sale” for $999, renews at $1,500/yr, no refunds).
Ferris is a Graham-reading “value investment” guy, to be sure, and he makes a point of saying that he holds out for prices that include a margin of safety, and hates buying what’s popular. Here’s a little taste of how he promotes himself:
“I look at The REAL value of a stock versus its CURRENT value.
“There are hundreds of ways to do this…
“And similar strategies are extremely sought after by savvy investors.
“Legendary hedge fund manager, Seth Klarman, wrote a book on the subject that sells for $1,050 on Amazon. And it doesn’t even give you actionable advice… it talks about theory alone.”
Seth Klarman is the manager of Baupost, a hugely successful hedge fund, and he is one of the more widely-followed “value” gurus out there — though his book is quoted at those crazy prices just because it has a fad following among people with too much money on their hands, and was out of print. You can find pirated copies of it online, I’m sure, and the occasional library will still have a copy (most of them have been stolen), but I wouldn’t bother — it’s somewhat interesting, but it’s also mostly about having discipline and a process, and it’s 30 years old now. Do read up on and listen to Klarman speak if you get a chance, and read his annual reports or other letters to Baupost investors when those get leaked to the public, but don’t kill yourself to spend a thousand bucks for (a probably stolen or photocopied facsimile of) the book.
And, of course, Ferris isn’t just following the same value precepts as Klarman…
“Our proprietary method is a unique way to not just determine the real value of any business, but determine exactly how large of a safety net we have.
“And I never go near any investment that doesn’t present a huge, glaringly obvious safety net.”
Which leads into the bait…
“And right now, we’re seeing what’s likely the single best Margin of Safety set up of the past 24 years…. on a single stock… that could make you 16.5 times your money…
“The reason why involves a business model that’s made Stansberry readers an absolute fortune over the years…”
He implies that this industry will get through COVID just fine…
“COVID-19 is perhaps the most economically devastating event since World War II, and I don’t know when or if we’ll ever see something like this again.
“The damage this virus has done is far from over…
“If you don’t put a plan in place immediately, you’re almost certain to face tremendous financial hardships…
“People will get sick, businesses will fold, and entire industries will crumble.
“But unlike other businesses, like meat packers and metal refiners, the business I want to tell you about can keep functioning at full capacity during the pandemic.
“And if you can take a stake immediately, I believe you could see up to 1,550% over the long term.”
So what, then, is the industry? What’s the stock?
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“… there’s a reason that even Porter calls companies in this industry, ‘the most powerful businesses on Earth.’
“Because when purchased at the right time, and at the right price… there’s nothing like it.
“For example, coming out of the dot-com crash, this same stock surged more than 693%.
“And since the financial crisis of 2008, it’s gone up another 479%.
“It’s because, frankly, there’s almost no better business model in the world.
“Most companies like this get paid to use other people’s money.”
And since this is value investing, we’ve got to squeeze in a reference to Warren Buffett…
“… in 1951, when Warren Buffett was still a student at Columbia University, he put more than half his net worth into a single stock in this sector.”
So what’s that industry? Ferris is referring to insurance — a boring industry, for sure, but one that tends to be adored by those with a value investing bent… both because Warren Buffett has built Berkshire Hathaway mostly on the back of insurance companies, and because it’s one of the few businesses where you get to invest other peoples’ money and reap the returns for yourself (and sometimes even have them pay you for the privilege).
So we’ve got a couple clues about the specific stock he’s hinting at, including those returns following the last couple market crashes. What other hints does Ferris drop in his ad?
He refers to employee ownership, which is a nice endorsement…
“And at this company we’re talking about today, 60% of employees are shareholders.
“In other words: They have SKIN in the game.”
And then he makes a somewhat odd reference, which also counts as a clue…
“It’s obvious to me that they take things VERY seriously. It’s reflected in their revenue.
“They bring in an unheard of 21.6% of their market cap annually.”
What? Why would it be “unheard of” to have revenue be about a fifth of the market cap? That’s just a little strange… and doesn’t seem like it could be from the magical influence of having employees be shareholders. More on that…
“In fact, there’s only 17 other stocks, in the ENTIRE stock market, that trade around the same market cap and bring in the same massive amount of revenue.”
OK, so maybe it’s technically a little bit unusual for a company to trade at exactly this price/sales ratio at this specific market cap, but that’s just an accident of nature. Roughly a third of all companies are valued at less than 6X sales, for a variety of reasons — maybe they’re not growing as fast as average, or just have a business that has lower margins than some. Heck, about 20% of companies trade for something well below 2X sales, including some hugely important large cap firms — that measure by itself doesn’t really tell you much.
But there’s a good hint hiding in there — Ferris then gives examples of the peer-sized companies, including IR, CBOE, GDDY and CTLT, so we now know that this is a company that’s somehow in the insurance business, with a market cap somewhere in or near the $10-15 billion neighborhood when it comes to market cap… and trading at something probably in the range of 4-6X sales.
“It’s not just the industries that make these businesses successful… It’s the combination of the incredible revenues, putting other people’s money to work, and having a massively incentivized staff.
“And to make things even better, I estimate the company we’re talking about today has a REAL value that’s priced 40% higher than its current share price…
“Which gives us an enormous margin of safety.”
OK, that’s more of an inducement than a hint. What else does Ferris say? The urgency of a “value” pick is often hard to really emphasize, and that hurts marketing (newsletters need to convey some urgency, otherwise you’re not going to pull out your credit card — and if you pause to think it over, a marketing pitch usually loses it fizzle quickly), so his “urgency” here is that the stock could rise out of his “buy range” before you have a chance to get in…
“Keep in mind, this business is trading very close to the maximum price I recommend you pay. As of today, it’s within a few dollars.
“So if you’re interested, I urge you act quickly, but do not chase this stock, as risk and valuation move in the same direction.”
And, he says, he’s not letting the secret out anywhere else… so it’s probably a stock he hasn’t writtena bout publicly…
“If you’re thinking I might divulge more details of this opportunity in an interview… the Stansberry Digest… or my weekly podcast… that simply won’t happen until it’s too late for you to get into this stock.”
That’s about it, though, that’s what we get for clues… so what’s the stock? Thinkolator sez this is… Brown & Brown (BRO), the big insurance brokerage. And, sadly, I won’t be buying it today — since I already own it, and added a bit to my position just last week, so I’m embargoed from trading in the shares for a few days.
Brown & Brown isn’t an “easy” value stock that’s hated or wildly undervalued — it’s not trading at a downtrodden price, and in fact at $45 a share is within a few percent of its all-time highs — but I’d agree that it’s a reasonable value here because of the strength of the company, the strong insider leadership, and the setup in the insurance business.
First, let’s match up those clues so we can be sure the Thinkolator is correct, and I’m not just daydreaming up a match because it’s a stock I already own.
On their website, in emphasizing the “ownership mindset,” this is what they say about themselves (my emphasis on that last sentence):
With the financial stability and sustained growth of an industry-leading brokerage, your success depends heavily on your efforts to be the best YOU possible. We strive to provide opportunities for teammates to have ownership in our Company and create personal wealth through participation in our Employee Stock Purchase Plan (ESPP), our 401(k), and long-term equity grants. Remarkably, over 60% of our teammates invest in our Company.
And BRO is one of only a few companies in the insurance business that have a market cap in that $10-15 billion neighborhood and have recently been valued at about 5X sales (or in Ferris’ words, with sales at 21.6% of their market cap — as of June, BRO’s trailing sales for the past 12 months were 21.5% of their market cap). Don’t get too hung up on that, revenue grows fairly slowly (about 4% over the last year, growth slowed quite a bit last quarter), and sales were as much as 40% of the market cap at some points in the past decade (because the market cap was lower, not because the sales were higher).
The only other near-matches on that front are Erie Indemnity (ERIE), which is the publicly traded agent network, basically, for the Erie Insurance Exchange, and a couple foreign insurers (Admiral Group in the UK, Gjensidige Forsikring in Scandinavia)… but when you look at the past returns teased, BRO is the obvious match. Ferris says that it had returns of 693% coming out of the dot com crash, and 479% coming out of the 2008 crash — it would take a lot of chewing on data to match those numbers precisely, particularly since we don’t know whether Ferris means the market lows or the lowest point for those particular stocks, but we should be able to come close for a match. Those foreign ones did not have returns anything like what Ferris teases out of the 2008 or 2000 crashes, and ERIE actually had returns that were substantially higher than BRO’s coming out of the 2008 crisis (peak returns of almost 800%, vs. just under 500% for BRO, so very close to the teased 479%), but far lower than BRO coming out of the 2000 crash (peak returns of about 100%, vs. nearly 700% for BRO — again, a good match for 693%).
So I can’t say this is a 100% certain match, but it’s close enough for me.
What, then is the appeal of Brown & Brown (BRO)? It is not, after all, really an insurance company — they don’t collect “float” or have a pool of investments that they’ve built with other peoples’ money, like the best insurance conglomerates do, they do share very minimally in underwriting profits sometimes, depending on their deal with the insurers, but they are basically a huge collection of local insurance agencies, under one roof. They sell insurance, they don’t write it, so they’re in that “best business ever,” to some degree, but they’re a service company within that sector.
I don’t want to reinvent the wheel, and I went into some detail in covering BRO (and a few competitors) back when I first bought shares in June, so I’ll just excerpt part of what I wrote to the Irregulars at that time… this is from a June 12 Friday File I called “The Relative Safety of Agencies” — the price has gone up a little bit (12% or so) and the story has changed marginally (they’ve reported another quarter of earnings, with revenue growth down a bit, though there were no surprises), but it’s basically the same company it was a couple months ago:
I’m reasonably confident that insurers with strong underwriting and discipline will come out of this OK in the end, but it might take many years to rebuild the business and let them earn a higher stock market valuation like they had begun to see over the past two years… I’m a bit more certain that the insurance agencies will do quite well. They benefit from rising rates for insurance, since commissions are generally a percentage of prices, and from rising complexity and more customer awareness of insurance policy specifics, especially among business customers, since complexity urges people to learn more and speak more to agents and consultants instead of relying on ‘standard’ policies… but they don’t actually carry the insurance risk, so although they’ll see declining business if GDP falls, in general, they don’t face meaningful claim liabilities.
There are a bunch of large and strong companies in the agency space, and I’ve rarely covered them and haven’t owned them in the past — the publicly traded stock in that space that I’ve been most impressed with over the years has been Brown & Brown (BRO), though larger Arthur J. Gallagher (AJG), Willis Towers Watson (WLTW) and Marsh and McLennan (MMC) could reasonably argue the point that they’ve been better investments sometimes….
Chris Mayer had a nice post on Brown & Brown a couple months ago, highlighting the strong free cash flow generation, the generally steady history of growth fueled by many small acquisitions, and high insider (and founding family) ownership, so that’s a good place to start if you haven’t followed the industry. They talk a good game in their annual letters — which is important in reinforcing the long-term culture of a company and setting investor expectations… and they’re more consistent and much smaller than MMC or WLTW. The closest real comparison seems to be AJG, which like BRO has typically traded at a price to free cash flow ratio in the high-teens, and that’s also the company that has come closest to approaching (and sometimes beating) BRO’s stock market performance in recent years.
The big-picture risk for Brown & Brown and others in this space is that the business might be “disruptable” — most agency-type businesses in different parts of the economy have seen some disintermediation over the past decade as technology startups have tried to take the place of the agent-customer relationship. Insurance companies and their agents represent an inefficiency in the marketplace to some degree — agents step in between the customer and the product and they take a large slice of the money as a result, mostly from sales commissions. Still, that risk is probably overblown — that inefficiency is what opened the door to “direct sale disruptors” like Progressive and GEICO in the personal lines insurance market, particularly in auto insurance, and it has clearly made a big difference in the marketplace… yet pretty much every town still has several successful insurance agencies who are pillars of the local business community and sell plenty of insurance to people and small businesses. And plenty of huge companies with more traditional commission-generating agents, like Allstate and State Farm, still do very well, too, even in the directly competing auto and homeownership markets where offerings are very close to being standardized and commoditized. Change is still happening, but it happens more slowly in a lot of businesses than we might imagine, and the big players can sometimes evolve with or lead the change.
BRO, AJG, and MMC have all beaten the S&P 500 handily during this decade-long bull market, and WLTW has also done pretty well, but if we’re considering an investment today it’s probably worth looking at what that insurance agency type of business looked like during the last recession.
This is the revenue for those four from the beginning of 2007 to the end of 2010, which encompasses the collapse of the financial system and the beginning of the recovery (though financial firms, like insurance companies, generally came back a little more slowly than other stocks)…
That’s pretty remarkable stability for AJG and BRO at a time when a lot of insurance companies were posting substantial drops in revenue (MKL, TRV and WRB all had their incoming revenue fall during that three year period, for example). Here’s what their stock prices looked like through that great recession…
So again, they average out to be about the same as the broader market (that’s the S&P 500 in purple) — BRO recovered a little more slowly, AJG a little more quickly.
And here’s the last decade of total return for those four, compared to both the S&P 500 and the Property and Casualty Insurance ETF (KBWP)…
Other than these past few months, it’s been a time of serious and pretty steady outperformance. That’s true of many insurance companies as well, a few of whom, like WR Berkley (WRB), have beaten that KBPW index nicely, and insurance is a more obviously excellent long-term business because insurers get to profit from free leverage if they underwrite well… but as we approach what will probably be a very “hard” market again (“hard” just means rising insurance premiums), but insurance companies at the same time face a year or two of possible claims and heavy litigation expenses as a result of the coronavirus, I see more of an opportunity (and less of a risk) in the agencies at current prices.
And the two that are reasonably-priced strong businesses with long and stable operating histories, who also settle into the “sweet spot” when it comes to size (big enough to be pretty stable) and growth potential (small enough to still grow a lot over time) are Brown & Brown and A.J. Gallagher (AJG), so I’d like to start a position in one of the two — but which one?
My inclination is to lean toward BRO, given the fact that they’ve closed the gap on valuation with AJG a bit but are still a little cheaper and significantly smaller, and I remain encouraged by what I’ve read about their strong culture and family ownership. The Brown family started with a single insurance agency in Florida in the 1930s, and began to grow and acquire agencies in the 1960s under Hyatt Brown, the co-founder’s son, grooming third-generation CEO Powell Brown to take his place about a decade ago, and they have now acquired well over 500 businesses in just the last 30 years.
A.J. Gallagher has a somewhat similar history as a small insurance agency that became an acquirer, with a member of the founding family still at the helm, though unlike the situation with Brown & Brown the founding Gallagher family is not a major shareholder — J. Patrick Gallagher, of the third generation of Gallaghers to work in the company since it was founded by his grandfather, owns about 1.1 million shares (about 0.5%) and is the only meaningful family shareholder, whereas J. Powell Brown, current Brown & Brown CEO, holds about 1.1% of BRO shares and his father, J. Hyatt Brown, continues to control more than 14% of the company’s shares (and continues to serve as Chairman of the Board).
This will probably not be an exciting business, but I expect that their revenues and cash flow will be steadier than most through this recession… and could surprise nicely if people and businesses are able to pay their (likely higher) insurance premiums in the coming year. There will certainly be some relatively weak periods if the recession deepens and demand for insurance falls, or if there are fewer homes and businesses to insure, but there’s very little real underwriting exposure in the event of catastrophes — they do get a little boost to their commissions from profit sharing if underwriting is profitable, but it’s a small amount (less than 3% of commission and fee revenue last year).
Here’s a good overview of how Brown & Brown works from their 2019 Annual Report:
We are a diversified insurance agency, wholesale brokerage, insurance programs and services organization headquartered in Daytona Beach, Florida. As an insurance intermediary, our principal sources of revenue are commissions paid by insurance companies and, to a lesser extent, fees paid directly by customers. Commission revenues generally represent a percentage of the premium paid by an insured and are affected by fluctuations in both premium rate levels charged by insurance companies and the insureds’ underlying “insurable exposure units,” which are units that insurance companies use to measure or express insurance exposed to risk (such as property values, or sales and payroll levels) to determine what premium to charge the insured. Insurance companies establish these premium rates based upon many factors, including loss experience, risk profile and reinsurance rates paid by such insurance companies, none of which we control.
We have increased revenues every year from 1993 to 2019, with the exception of 2009, when our revenues declined 1.0%. Our revenues grew from $95.6 million in 1993 to $2.4 billion in 2019, reflecting a compound annual growth rate of 13.2%. In the same 26-year period, we increased net income from $8.1 million to $398.5 million in 2019, a compound annual growth rate of 16.2%.
The volume of business from new and existing customers, fluctuations in insurable exposure units, changes in premium rate levels, changes in general economic and competitive conditions, and the occurrence of catastrophic weather events all affect our revenues. For example, level rates of inflation or a general decline in economic activity could limit increases in the values of insurable exposure units. Conversely, increasing costs of litigation settlements and awards could cause some customers to seek higher levels of insurance coverage. Historically, our revenues have typically grown as a result of our focus on net new business growth and acquisitions. We foster a strong, decentralized sales and service culture that leverages the broad capabilities and scale of our organization, with the goal of consistent, sustained growth over the long term.
The weakness of the business model, like most consulting and agency businesses, is that it is entirely dependent on people. Retail insurance is a high-touch business, so their employee expenses have risen just as fast as revenue, and often faster as costs like health insurance have grown rapidly, so it is not hugely scalable and they don’t always get more efficient as they grow… but they are able to grow steadily without share issuance because they recycle their free cash flow into acquisitions and some technology-driven efficiencies, so there is still per-share growth.
The basic growth pattern for the business is that they put about a quarter of capital back to shareholders through share repurchases and dividends, and use the rest for capex (new systems, new offices, etc.) and acquisitions, with acquisitions representing by far their biggest capital allocation priority (64% in 2019). That has led to a slow-and-steady rise in the dividend, from 23 cents per share in 2015 to 34 cents in 2020 (still under a 1% yield, but growth is good).
Gallagher, in addition to being larger than Brown and carrying a heavier debt burden, is also more international — which gives them a larger acquisition pipeline (about a third of their business is outside the US — Brown just made their first acquisition in Canada, but they’re almost entirely a US company). They’ve also grown the AJG dividend a little faster, pay a higher current yield, and are on a similar pace of acquisitions (though on a somewhat larger scale, since they’re a bigger company). Like Brown, Gallagher has only had one period of actual falling sales in recent memory, in 2008-2010, and it was a very small dip and their revenue did not fall nearly as much as average commercial insurance rates fell….
I think both of these companies are likely setting themselves up to do very well over the next three or four years, and I find myself leaning more toward Brown because of the somewhat better valuation, likely better revenue growth, lower debt and generally more conservative positioning, and strong insider ownership… but I do also think Gallagher has some good potential, largely because of the international exposure.
So there you have it, looks like Ferris and I are in some agreement on this particular stock. It is not beaten down, but it has tended to be a steady performer even during rough market periods, and I expect BRO’s employees and managers to continue to build shareholder value over time. I don’t know when Dan Ferris might have first recommended the stock to his subscribers — he doesn’t dangle it as a “new” pick that is yet to be released, so his subscribers must already have this recommendation, but he does say that it’s the best opportunity he’s found all year.
If you look at free cash flow as your metric, BRO has generally traded in a range of 14-20X free cash flow most of the time, and is at 17X right now — if it gets back to 20X, that would be a share price somewhere in the low-$50s, and downside risk of 14X or so would be about $36. It could easily go above or below that range, of course, but my guess is that outside of changing market dynamics (a surge higher, or another crash), at $45 we’re probably in the middle of that valuation range, not too expensive to buy, not so cheap that you want to buy heavily… a decent valuation setup for a company that I think has a good chance of riding both economic recovery and rising insurance prices to better results coming out of COVID. Even if, of course, a deepening recession from this point might mean that they go down first. The biggest risk with BRO right here, I would argue, is that the economy could certainly tip lower, weakening the business, and we’re not buying when the stock price is particularly depressed.
That’s just my take, though, and with your money on the line it’s your thinking that matters — so do you see BRO as a 1,550% “low risk” winner someday? Think this is a great value opportunity? Think Dan Ferris (or yours truly) are wrong on this one, and that actual insurance companies or other investments offer a better buy point? Maybe even prefer some of the other publicly-traded agencies to Brown & Brown? Let us know with a comment below.
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P.P.S. About that 1,550% return teased… don’t hold your breath. I like the stock, but that’s probably an extremely long-term potential return being hinted at, and at that it is, of course, highly uncertain. Brown & Brown’s total shareholder return over the past 20 years, dividends reinvested, has been about 1,610% (with revenue rising roughly 1,000% during that time). Given that they’re now a $12 billion company (20 years ago the market cap was about $750 million), with meaningful market share in an industry that has been slowly consolidating for decades, I’d assume that their next 20 years will probably have much lower returns than the last 20 years. Doesn’t mean it’s a bad investment, but keep your expectations in check.
By way of comparison, AJG was a nearly-$2 billion company 20 years ago, and grew by “only” about 1,000%, off of a 740% increase in revenue… and Willis Towers Watson came public about 19 years ago, with a $3 billion valuation, and has had a total return of about 500% since. The bigger you are, the harder it tends to be to grow dramatically — especially for people-intensive serial acquirers like these guys, who often have to work pretty hard to grow faster than inflation. 500% shareholder return over the next 20 years would mean a compound annual return of between 9-10%, and I’d say that would be a reasonable goal to daydream about.
Disclosure: Of the companies mentioned above, I own shares of A.J. Gallagher, Brown & Brown and Berkshire Hathaway. I will not trade in any covered stock for at least three days after publication, per Stock Gumshoe’s trading rules.