The pitch I checked out over the weekend for Motley Fool Discovery: Moneymakers is a little bit bear-market focused…
“Motley Fool CEO Tom Gardner shows you exactly what stocks to buy in a downturn…with $1 million on the line! ….
“… for the first time in 10+ years, we’re not in a bull market anymore.
“The last few months have rocked the stock market, the economy, and our entire country.
“Parts of the U.S. are experiencing some kind of lockdown, business has plummeted across the country, plunging many into ‘demand shock’… the sudden drop in demand for goods and services.
“Causing waves of uncertainty about the economy and the stock market.”
I don’t know when that was written, but it feels a bit more like November 2020 than April 2021.
Regardless, what is it they’re pitching with this Moneymakers service? I don’t think I’ve ever written about this one, but it’s one of the many Discovery “portfolio” services from the Motley Fool — instead of getting a newsletter once or twice a month, and a historical portfolio of hundreds of stocks from a big newsletter like Stock Advisor, you get a more targeted portfolio of 10-25 stocks along with regular updates, additions and subtractions, and usually some more specific guidance about portfolio allocation. You also pay a much stiffer price, in this case $1,300 for the first year, and don’t get a refund guarantee like you would with Rule Breakers or Stock Advisor or their other “entry level” newsletters.
Unlike the “Extreme Opportunities” portfolio services that are usually offered at about the same price (retail is $1,999/yr), this one is not a sector portfolio (those Extreme ones focus on entertainment, AI, fintech, etc.), but is more focused on one of Tom Gardner’s favored strategies.
For the cynical, it might seem like they’re spreading the Gardner brothers ever thinner, probably because they’re the only “name” folks at the Fool who really drive attention — if you want to follow the kinds of stocks Tom Gardner buys personally or for the Motley Fool, your first thought would no doubt be the Stock Advisor newsletter, where Tom and his brother David each endorse one stock per month. That’s typically pitched at $49 for new subscribers, but the upgrades from there are numerous… you can focus on founder/owners in the Discovery: Ownership Portfolio ($1,999) or Discovery: Partnership Portfolio ($1,999), his “best of the best” stocks in the Discovery: Everlasting Portfolio ($2,999) or Discovery: Everlasting Stocks ($299), his Motley Fool One ($13,999!) that gives access to all of the services and exclusive access to some stocks … or, now, this Discovery: Moneymakers service ($1,399, presumably renews at $1,999) that uses a “Buffett-inspired” strategy.
Upgrades and high-end portfolio services are where the money is, so I guess that’s no surprise, but it’s still a lot of newsletters and portfolios to oversee (to be fair, as I count, Gardner still falls far short of Paul Mampilly’s record over at Banyan Hill, I believe Paul is now selling 10 different services… if you’ve seen someone with even more than that, do please give a shout).
But anyway, what do they mean by that “Buffett-inspired” strategy? Here’s how they put it…
“Moneymakers is The Motley Fool’s first and only solution centering around what Warren
Buffett has declared his #1 investment factor
“The strategy Tom Gardner has used to create Motley Fool Moneymakers is one that the greatest investor of all time and one of the richest humans in modern history, Warren Buffett, has made a staple of his entire career….
“Warren Buffett says he judges businesses and investments on one thing…
“It’s not the CEO…
“It’s not the share price…
“It’s not their price-to-earnings ratio…
“It’s their ability to raise prices and control the market.
“Here’s Buffett in his own words:
‘The single most important decision in evaluating a business is pricing power. If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business….'”
Can’t argue with that. And since everyone is on pins and needles a little bit about future inflation fears, we should note that “pricing power” is probably the single best strength a company can have during a burst of inflation — if you can raise prices faster than your costs are rising, inflation need not be a terrible weight on the income statement.
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But I’ve gone off on a tangent a bit, I’m afraid… there was a tease in there, not just a sales pitch for a newsletter — the Foolies have an insurance stock to hint at, and yours truly is a sucker for insurance stocks… so let’s dig in and see what it is they’re teasing… this is from one of their Market Pass emails over the weekend…
“DISCOVER ONE OF OUR BEST STOCK PICKS THAT EARNED OVER $400 MILLION IN LESS THAN A YEAR!
“For some businesses, getting insurance is nearly impossible!
“I mean, can you imagine how difficult it is for a mining company or even a commercial aviation company to get insurance to fly airplanes across the globe? ….
“You see, these companies are deemed too risky by many insurance companies because they carry excess risk. The probability for loss is just too high.
“So, it’s really no surprise that many specialty insurers struggle to make a considerable profit.”
That’s an odd way to get us interested in specialty insurance companies, but I guess they’re trying to point out how “above average” their teased stock is…
“… except for this one company (which owns only 1% of its industry’s market share, so far) …
“You see, this company is one our most popular stocks here at The Fool because it has shown it knows how to make money.
“Even during a pandemic!
“In fact, last year this company grew its revenue by 46% year-over-year…and achieved a quintuple vs five years prior.”
So what makes this company special?
“Where most specialty insurance companies struggle isn’t in receiving premiums, it’s in paying out claims. That’s where insurers lose all their money.
“Fortunately, this company pays out 20% less claims than its competitors!
“On top of that, it’s the only insurer 100% dedicated to this space! You see, giants like Berkshire Hathaway and Markel both invest in special insurance. But unlike them, this company is exclusively focused on it.
“I believe that market-specific expertise gives them a real advantage over companies like Berkshire and Markel …”
OK, so a small company, 1% market share, specialty insurance, pays out 20% less claims… where does that point us? That “pays out 20% less claims” bit doesn’t really make sense, so I assume what they really mean is that their loss ratio (the percent of premiums sold that they end up paying out to settle claims) is 20% lower than the competition… which would be meaningful in itself.
And we’re also told that this company is less than 1% of Berkshire’s market cap, which would mean it’s below $6 billion. So what is it?
Thinkolator sez the target of this tease is almost certainly Kinsale Capital (KNSL), a high-growth specialty insurance company that specializes in Excess & Surplus lines insurance (often called E&S… more on that in a minute).
How does it match? Well… Kinsale Capital Group has been a corporate holding of the Motley Fool for several years, and according to their disclosures it looks like they first recommended it in one of their newsletters (I don’t know which one) in the Fall of 2019.
So it’s not a brand-new idea, and the stock has roughly doubled since 2019… but we’re not time travelers — our job is to look at a stock today and into the future and judge whether it’s worthy of our money, worrying about whether we “missed” something by not buying it a year or three ago is largely a waste of time.
How else do we match? No, they didn’t “earn” 400 million last year — but they did have over $400 million in revenue ($476 million in net revenue, to be precise). And that was accelerating growth from the prior year — they did grow gross written premiums by 46% (net growth in revenue was 45%), and that was faster than the 41% in 2019, which is impressive given the economic freeze mid-year. And that “quintuple vs. five years prior” is more or less a match as long as you’re willing to do some rounding, they had revenue of $97 million in 2015 and $476 million in 2020.
And yes, they do typically almost pay “20% fewer claims” than some competitors if you want to interpret the numbers that way — their combined ratio is about 81%, and a lot of big partial competitors have combined ratios in the 95-100% range. That means, on average, that their insurance business is profitable: for every $1 in premiums they take in for selling a policy, they spend about 81 cents — about 56 cents to settle claims, and about 25 cents to operate the company. Both of those numbers are below average, so they’re more profitable than most. Whether that’s because they pay fewer claims, or just because they price their policies better, is a matter for interpretation.
So, what do we think of Kinsale today? It’s a fairly small specialty insurance company, but that doesn’t tell us all that much — there are a lot of ‘specialty’ insurance companies, that term really just means you write insurance coverage that is not commoditized, it’s not the same car insurance or home insurance that a dozen huge companies offer, where the agent checks off the boxes and gives you a quote in five minutes, and on any given day Nationwide or Allstate or Liberty will offer the best price for your particular situation.
Specialty insurance might be insurance for a harder-to-insure business where risks are widely varied, like summer camps or hair salons, that’s what I used to think of as ‘specialty’ insurance and what built Markel (MKL), for example (they started by insuring jitney buses), or it might be specialty product insurance (like the contact lens insurance which built RLI Corp (RLI)), or even the oddball “hard to insure” stuff like sweepstakes or contests with absurd payouts (like Berkshire Hathaway underwriting the $1 billion prize for anyone who picked a perfect NCAA Tournament bracket a few years ago — they took that risk and the odds were overwhelmingly on their side, they probably earned $10-20 million for taking it, just like they did when they sold a policy for a similar billion-dollar contest sponsored by Pepsi a decade earlier… but not many would have the bandwidth or job security to take a risk that big). Lots of very successful insurance companies that investors know pretty well are in some way “specialty” insurers, including W.R. Berkley (WRB), Berkshire Hathaway (BRK-B), Fairfax Financial (FFH.TO, FRFHF), Alleghany (Y), and Axis (AXS), though none of them are “pure plays” — most specialty insurers grow up and eventually leak out into other businesses.
Kinsale really specializes… they operate only in the excess and surplus lines market, and primarily work with smaller businesses, with the goal of having limited competition (and therefore having more pricing power). Here’s how the company describes itself:
“Kinsale Capital Group, Inc. is a specialty insurance group focused exclusively on the excess and surplus lines market in the United States. We use our underwriting expertise to offer terms on hard-to-place risks. Our goal is to provide long-term value to our stockholders by generating exceptional profit and growth. Kinsale seeks to accomplish our goal by producing consistent underwriting profits, steady investment returns along with sound capital management. Kinsale Capital Group, Inc. is designed to be highly entrepreneurial and efficient. We differentiate ourselves from our competitors by effectively leveraging technology, vigorous expense management and by maintaining control over our claims and underwriting processes.”
Here’s how Markel describes the E&S market, for a little perspective:
“Excess and surplus lines insurance is a segment of the insurance market that allows consumers to buy property and casualty insurance through the non-admitted market. When a standard carrier decides not to write a policy, you may be able to find insurance coverage in this segment of the industry. It is also referred to as E&S, specialty lines, surplus insurance, and hard-to-place business.
“The E&S industry is comprised primarily of small to mid-size companies writing what is referred to as “main street” business. The small contractor or the owner of an older building in an undesirable part of town is the staple of the business. A few large organizations will write business such as oil refineries, aircraft liability, and property coverage on a communications satellite. However, for the most part, the industry is dominated by smaller companies.”
And here’s how Nationwide explains it:
“Simply put, Excess & Surplus lines (E&S) is a specialty market that insures things standard carriers won’t cover. The difficult or high-risk exposures in which E&S carriers specialize may range from a mobile home or a day care center to a multinational oil company. And anything in between. The specialty market is constantly evolving, so E&S companies must react quickly and maintain a high level of flexibility to adapt to market changes.
“An essential element of E&S insurance is the inside-out knowledge required of each professional relating to the coverages, conditions and exclusions offered. The market requires E&S insurance specialists to be qualified to deal with difficult exposures to loss. These specialists, otherwise known as general agents or wholesalers, are the link between the customer, the local insurance professional and the E&S carrier. They have strong market knowledge of both local and regional insurance issues.”
There are a lot of benefits to being in specialized markets — the big ones are less competition and less regulation (policies are not nearly as standardized as typical property and casualty insurance in the “admitted” markets).
There are risks and costs from being in this market, too — you can’t rely on standard forms of insurance and be a “me too” carrier who just matches other policies, you have to have expert underwriting for very specific kinds of risks, and the losses, when you make a mistake, can be quite large (that’s why they’re often called “hard to insure” businesses)… and it’s not always as cheap or easy to get reinsurance (which is basically insurance for insurance companies — they sell off some of their exposure in order to protect against truly disastrous risk).
But still, being able to offer a specialized product to people and companies who really need it, and without nearly as much competition, does give a lot of room for pricing power and strong margins if you underwrite well (“underwrite well” just means pricing policies appropriately for the real risk they represent — which should be a function of having both the best data and best models, and the most disciplined decisionmaking process).
And as I noted above, Kinsale, while fairly young (it was founded in 2009 and came public about five years ago), has compiled an admirable underwriting record so far — they say their combined ratio from 2015-2019 came in at 81.7%, considerably below the more diversified industry leaders like RLI (91.4%), WRB (94.8%) and MKL (95.5%) — which is particularly impressive because they grew the business very quickly over those years (their net premiums grew by more than 25% a year). That outperformance was driven partially by a lower loss ratio than most, but more of their edge came from their substantially lower expense ratio. That means they operate more efficiently, which probably comes partially from technology and partially from handling all underwriting themselves.
The financial results continue to be impressive, last year they had a combined ratio of 86.7% and return on equity of 14.7% (ROE is the key metric they like to use). They posted earnings of $3.16 per share in 2020, up from $2.41 in 2019, and they are much less dependent on investment income than most big insurance companies — for the full year they had net investment income of $26.1 million and underwriting income of $54.7 million (many big insurers made considerably more on investments than they did from underwriting last year — at Markel, for example, investments and non-insurance subsidiaries at Markel Ventures generated $1.2 billion in operating income… insurance underwriting, combined with reinsurance, generated less than $90 million in operating income). And Kinsale finished the year strong… the fourth quarter, despite some catastrophe losses, was their best quarter of the year (operating ROE of 19%, combined ratio 81.6%) and accounted for almost 40% of their profits last year.
Like RLI, this is a specialty insurer that’s much more about the operating business and much less about compounding the value of their investment portfolio or leveraging a strong balance sheet. They have $1.2 billion in long-term investments on their books to offset the risks they underwrite, which sounds impressive, but that’s tiny for an insurance company with a $4 billion market cap. Even RLI is leveraging a $3 billion investment portfolio with its $5 billion market cap, and for most the exposure to the investment portfolio is more dramatic — Markel and WR Berkley both have investment portfolios that are meaningfully larger than their market capitalization.
That’s not a value judgement, one solution is not necessarily better than another, but when it comes to stock price it means that somewhat more traditional specialty underwriters like WRB and MKL will be impacted more dramatically, on an earnings per share or book value per share basis, by their investment portfolio. With RLI, and to an even greater extent with Kinsale, the quarterly underwriting and loss reserve numbers are far more important to earnings and ROE than are interest rates or portfolio returns… which means they’re likely to be less-levered to interest rates than a lot of insurance companies, and also that they’ll be more volatile over time, because they don’t have the ballast of that huge balance sheet (or the protection of investment income at times when a big hurricane or insured losses eat up the profit in a quarter).
Here’s how CEO and founder Michael Kehoe summed it up in their last conference call:
“Kinsale’s performing at a high level due to its unique business model. To recap briefly, Kinsale controls its own underwriting in lieu of contracting it out to third parties. It focuses on the E&S market and it operates with a significant technology-enabled expense advantage. The combination of disciplined underwriting with low costs is a winner every time. The ongoing dislocation within the broad P&C market and the E&S market, specifically, is adding a tailwind to our efforts for the time being, allowing us to raise rates by double digits and grow the top line by 42% for the full year 2020. Once the market normalizes, perhaps sometime in the next year or so, Kinsale remains well positioned to continue to generate strong returns and to take market share. The only significant change we expect will be a slower growth rate, perhaps in the low double-digit range.
“For both the fourth quarter and for much of 2020, Kinsale saw a lower level of reported losses than we anticipated. We believe this slowdown in loss activity is largely due to the slowdown or the shutdown of courts around the country due to the pandemic. As we stated on our third quarter conference call, we continue to reserve as though this slowdown in losses is temporary and that there will be a catch-up period in the future. Should the slowdown in losses be at least in part permanent, we would expect a benefit in the future in the form of additional reserve redundancy.”
Most of the small competitors that are very heavily exposed to excess and surplus lines of insurance are a lot cheaper than Kinsale — firms like Global Indemnity Group (GBLI) or James River (JRVR) rely heavily on those same kinds of specialty insurance, though not 100% like Kinsale, but have not had nearly the success of Kinsale when it comes to ROE or premium growth (Kinsale’s founder came from James River, by the way)… and even bigger companies that have meaningful exposure to that segment, like Markel or RLI, don’t carry quite the premium price that Kinsale does.
Kinsale deserves a rich valuation, I’d say, they’ve had remarkable success in underwriting so far… but it’s also true that the company is in a really sweet spot right now operationally, with unusually high premium growth and unusually low claims activity because of the pandemic, with all insurers pretty focused on raising rates… and that probably won’t always be the case. Their growth is likely to moderate over the next year or two, and competition could come in a little more aggressively than in recent quarters, which could cause some shareholders to lose interest, and it won’t have the “value” buyers swarming if the share price drops sharply, because there won’t be some “hidden” value in the Kinsale investment portfolio or a “discount to book value” possibility — this is much more like a “regular” company, likely to be judged for its growth in operating earnings and profits and the steadiness of those results quarter to quarter.
Still, it’s a small company with really impressive operations, and it’s an insurance company that’s differentiated from other insurers both by its consistently strong underwriting and by its lack of dependence on investment returns… which might be a nice way to diversify and get a little growth booster within an insurance-heavy portfolio.
As a historically balance sheet-obsessed investor when it comes to the insurance space, I do find myself choking a little bit on that 7X book value number for KNSL, but their focus on underwriting profit and low operating costs also means that their ROE blows away the ‘big balance sheet’ insurers. But still, I’m inclined to buy some Kinsale here, it seems like a reasonable spot to park some of the profits that I took down last week from my Tiptree position (Tiptree, at least in part, is also a specialty insurer).
Competitor RLI is probably the best comparison as a “growth underwriter” in the specialty space, and is meaningfully cheaper right now on most metrics, so that’s maybe worthy of consideration too if you’re looking for exposure to the more “special” end of “specialty insurance,” both have very strong underwriting performance and high returns on equity… though RLI is a little more complicated and mature, and Kinsale’s net premium growth has been much more consistent and dramatic than RLI’s over the past five years.
Or, if you like the general idea of being a high-growth specialty insurer but prefer the property/catastrophe space (Kinsale is more focused on casualty — to oversimplify, casualty is insurance for legal liability, property is largely about physical damage), you might look at another pretty expensive newcomer in the space, Palomar Holdings (PLMR). Palomar tries to specifically insure against only the stuff that terrifies regular insurers and therefore might provide an opportunity for mispricing, like earthquakes, floods and hurricanes (the wild swings in underwriting profits and losses might give you a heart attack… but if they’re good at it, there is probably room to build a business by calculating risks differently when it comes to catastrophes).
After looking over the company in some detail for the first time in many years, as I researched this teaser, my first impression is that it’s the kind of business I’d like to own for the long term given their small market share, proven and pretty steady success, and very high growth rate. The real challenge is that they’re not cheap… and we’re paying a premium for growth at the same time that there’s a pretty high likelihood of growth slowing down (though we are, at least, 30% below the speculative highs the stock hit at the end of last year). That’s a recipe for unease for a value-focused investor, and it means we would have to go in with our eyes open, very aware that it would not be at all shocking for the shares to drop 50% from here (they’d still be relatively expensive on most metrics at that point, compared to your average specialty insurer).
But the business has been so strong for so many years, and seems likely to remain so strong in 2021 as reopening brings in new business, that I’ll trust the numbers for this high-growth underwriter and start small with a little buy here. I’ll think about adding to that if we see some more challenging times in the next few quarters… and the story could change quite quickly, they report their next quarter on Thursday afternoon, so I’ll keep it small with this first purchase.
Disclosure: Of the companies mentioned above, I own shares of Berkshire Hathaway, Markel, Tiptree and Kinsale Capital. I will not trade in any covered stock for at least three days, per Stock Gumshoe’s trading rules.