by Travis Johnson, Stock Gumshoe | May 25, 2017 5:13 pm
Nicholas Vardy[1] has been pitching this “secret” stock for a few years now — I first noticed his ads along these lines back in 2015, when he called the stock a “Buffett clone”[2] that had beaten Berkshire by 70%, and then looked at it last year when he started using that “greatest wealth compounding machine” line and touted the potential for 27% annual gains[3], doubling every three years.
Now, wisely, he’s gotten a bit more restrained and is pitching “just” 17.24% annual returns (“double your money in just over four years”), and he’s selling a different newsletter this time… but it’s all still about the same stock.
I don’t want to waste too much of your time, since this is a teaser we’ve solved before, but we should share just a few of the hints from the ad to give you an idea of what Vardy is saying as he tries to sell you on his Smart Money Masters[4] newsletter… here’s a taste:
“There’s a company I want to tell you about that has gotten so good at using their secret revenue stream that…
“Since 1986, it’s beaten Dow returns 11 to 1…
“Since 2012, it’s averaged annual gains of 17.24%…
“Since 2015, it’s crushed Berkshire’s annual returns by nearly 3 to 1…
“In fact, for the 31 years that this company’s been traded publicly, its shares have appreciated an average of 16.9% each year.”
And Vardy uses Buffett’s favorite term, “the float,” to explain the secret of this company’s returns — float is what juices that compounding power, of course, and if you don’t know what it is you probably haven’t been a Berkshire shareholder or follower or involved in many insurance stocks. “Float” is really just the extra cash that’s sloshing around insurance companies — the premium money that they’ve taken in but not yet “earned” because it has to be held for potential future claims. Until claims come in and they have to pay out that cash to settle the claims, the insurance company gets to use the cash and profit from any investments they make with that cash… and, if the insurance company is able to underwrite at a profit (ie, pay out less in claims and operating expenses than they take in in premium payments), then they are actually paid to use this “float” money and it works as double-bonus leverage[5].
It’s sort of like using margin in your brokerage account, but if you underwrite profitably (have a combined ratio of under 100), then the margin is not only free, you’re paid to take it. And if you have a strong and recurring insurance business with highly predictable annual premiums rolling in, then you also don’t have to repay that “loan” of float — there’s no margin call and no maturity, not unless you suddenly stop writing new business or the insurance claims are so dramatic that they cut into both your cash reserve and your actual investment portfolio.
That’s why the float, while it’s actually a liability on the balance sheet, is, at least as Buffett argues it, an asset. This has been one real “secret” to Buffett’s success, though not, of course, the only reason Berkshire has succeeded. And we’ll get you your solution now, without dredging our way through the rest of the ad (you can see it here if you want to check the details) — this company Vardy is teasing does indeed emulate Berkshire Hathaway in tone and temper and strategy, this is another pitch about Markel Corp. (MKL).
Which is a midsize niche property and casualty insurance (and reinsurance) company — and one of my favorite stocks as well, I should confess, and a major portion of my portfolio [6](though smaller than my Berkshire holdings). Markel probably has the distinction of being most-often promoted as “baby Berkshire”, though there are a pretty large group of stocks that occasionally get that moniker foist upon them — and it is definitely the company that most embraces the similarity.
They don’t call themselves “baby Berkshire,” of course, but they try to speak to shareholders in ways similar to Warren Buffett[7] (even holding a “Markel Breakfast” meeting to host their shareholders in Omaha during the Berkshire Hathaway Annual Meeting each year, with the executive team answering shareholder questions), they emulate Berkshire’s focus on growing real value per share over long periods of time (and incentivizing management to do that), and, like Berkshire, they are focused on investing in both public and private companies to boost their investment returns beyond the goals of the traditional bond-heavy portfolios at most insurance companies (though both hold tons of bonds as well, of course).
I’ve owned Markel for over a decade, and have bought shares at both bargain prices below book value and at overinflated prices near 2X book value, and it has all worked out very nicely over the long term — but, frankly, I’d rather pay bargain prices, and Markel ain’t a bargain right now.
Don’t get me wrong: I’m not going to sell my shares. It would take something really dramatic to make me want to give up on this company, which is still fairly small at a market cap of about $14 billion, and still has admirable management and a strong culture of success and investor-friendliness that has persisted for decades… and I think it’s a positive that they so clearly emulate Berkshire Hathaway (to the point that they even started a “Markel Ventures” division to invest in acquiring private companies instead of just buying stocks on the public markets)… but it would also take something pretty dramatic to make me pile on and buy more shares of Markel at 1.6X book value.
I can see the temptation — just about everything is expensive right now, so why not buy a really high quality stock as long as you’re buying expensive stuff anyway?
The key, for me, is that Markel is not ever going to be a “growth” stock — they won’t post 40% revenue increases because of some surprise new line of business or gimmick product (they might post big increases, but if so it would be from another major merger, which would probably bring the shares down at least for a while)… what they will probably do is continue to increase the per-share book value at double digit rates for a long time into the future, and that’s a great thing and is worth buying. But the market has consistently insisted that Markel trade at a discounted price at least once every couple years, when catastrophes hit their bottom line or when they make an expensive acquisition that worries the market or slows down book value growth, or, as we might see before too long, when they just have a lousy year on the investment side because the market is falling. I think those are the times when the opportunistic investor should be ready to strike and buy larger chunks of great companies like Markel (or, for that matter, Berkshire Hathaway… which came so close to my buy point before the puff piece in Barron’s this past week that it made my teeth ache a little).
Frankly, I was kind of hoping we’d see a meaningful dip from Markel this year. Markel had a pretty average quarter most recently, and a pretty average year last year, without much book value growth… and yet still, the price refuses to come down very much.
This is what I wrote to the Irregulars in the Friday File[8] late last month:
“Markel (MKL)[9] reported this week as well. Their new book value per share is $620.30, so, again, it’s one of my favorites and it’s a great company, but it’s trading at a “great company price” of more than 1.5X book value. I’m happy to hold, and, indeed, happy to have this as one of my largest holdings… but call me when it falls to $800 (or roughly 1.3X book value) so I can get excited about buying more.
“If I were more nimble and timely with my trading I’d be selling MKL up here near $1,000 and buying back when it hits a rough spot… but the market loves Markel these days and it doesn’t seem to hit rough spots anymore, despite what was a very ho-hum quarter. Markel reported break-even underwriting (though that was partly because the Ogden Rate discount rate used in UK insurance award calculation went negative) and perfectly reasonable investment results, so they had a small profit, the book value per share went up by a few percent… all just lovely and what one likes to see from Markel, it’s just that it’s no fun to pay a huge premium for that. Better to buy when everyone things Markel has lost it and done something huge and stupid, or when the whole market sells off.”
So there’s where I still stand — yes, it’s a great compounding machine over long periods of time, yes, it’s one of my largest holdings, and yes, I really like the company and management and think they will continue to grow the book value per share at double-digit rates over the next decade… but price matters, and having overpaid for some of my Markel position gives me the fortitude, I hope, to wait for a good price to add again.
Of course, I could just be overthinking things or not giving Markel enough credit for transforming into a more valuable operation over the years that may deserve a higher valuation. The past five years have seen Markel’s share price pretty dramatically outperforming the per-share increase in book value, but over the past 20 years Markel’s book value per share has risen 1,000% while the shares have only gone up 780%. So you can look at it from that perspective and argue that the price has some catching up to do.
Part of that, though, is because Markel was a much smaller stock back in the late 90s and 2000s, and probably traded at over 2X book value sometimes because it was little and growing quickly, but there is something to be said for just finding a great company and buying a little bit of it every year and not trying to be too precise about timing your purchases.
Still, that only works if you’re pretty committed to holding on for a long time through dips and drops. I’m a little bit stubborn on this one because I’ve held the shares for so long and seen plenty of those dips already, and I’m looking for more — the stock is within a whisper of all-time highs in the $980s, and I’m crossing my fingers that they’ll either have a terrible quarter or announce a disliked acquisition that brings the stock down by at least 10%.
There are very, very few property & casualty insurance companies who have averaged this kind of premium price over book value for a long time, at least in this low-interest-rate environment — I did some screening within Ycharts, and if you look at middling-to-large property and casualty insurers (market cap over $5 billion today), there are only three that have averaged a price to book valuation of over 1.3X for the past five years: Markel, Cincinnati Financial (CINF)[10], Progressive (PGR), and WR Berkley (WRB) (and Progressive really doesn’t count, it’s more of a consumer growth name and trades at 2.8X book). Chubb would be on that list if it weren’t for their big merger recently, no doubt, but that’s it, that’s the list (There are a few others, but they’re Canadian or Australian or European (Admiral Group, Intact Financial, QBE Insurance[11], Sampo). None, other than Progressive, have averaged a price/book valuation over the past five years of higher than 1.6. And if we go back ten years, Markel (and Progressive) are the only ones to have averaged a price/book valuation of greater than 1.35.
So that gives me some reassurance that we really are in rarefied air here at almost 1.6X book, and that getting back closer to their average valuation (or even a discount, if we’re being greedy) is not too much to hope for. If we were to get back to that long-term average P/B valuation of 1.35, assuming a book value today of $620 (that’s what it was last quarter), teh stock would be at about $835 per share.
I’ve got some cash ready if that happens. Fingers crossed.
P.S. If you’ve ever subscribed to Vardy’s Smart Money Masters[12], your fellow investors would love to know what you think — please click here[13] to share your thoughts, ratings, or a quick review. Thanks!
Disclosure: I own shares of both Markel and Berkshire Hathaway, both of which are among my largest individual equity positions, and will not trade in those stocks (or any others noted above) for at least three days after publication, per Stock Gumshoe’s trading rules.
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Although you have rightfully touted them in the past as a good and growing company, the real problem is the minuscule average volume (26K). I would be hesitant to even make a purchase order of 100 shares, and if one had to unload quickly for some reason, what would happen to the price? If one does not need several decimal points in order to measure ones share total as a percentage of daily volume, then watch out. But it is the same with many of the securities that are promoted by the likes of Vardy.
Few people trade in and out of Markel shares with regularity, it’s not a jumpy or high volatility stock — there should be plenty of volume for any regular investors to get in and out of the shares as they need to, just under $30 million worth of MKL shares change hands every day.
That’s similar to the trading volume of WR Berkley (WRB), for example, a somewhat smaller but similar insurer.
Probably light enough trading to keep a lot of technical traders, day traders or swing traders out of these kinds of stocks, and probably most of the quants and high frequency traders are not in it either (if they were, the volume would probably be higher), but I don’t worry about this relatively low volume.
Excellent explanation to someone who is looking only as “stocks” and not investments. MKL and BRKB are investment class positions
from non-investors
As Buffett always likes to quote actors, comedians, writers, and athletes in his annual letters to make his points, so does Markel.
In the 2016 annual letter, Markel did not disappoint, citing quotes from none other than Bruce Springsteen and former Packers football coach Vince Lombardi to illustrate the selfless culture it tries to nurture.
Bruce Springsteen: “Rock and roll bands that last have to come to one basic human realization. It is: the guy standing next to you is more important than you think he is. And that man or woman must come to the same realization about the man or woman standing next to him or her, about you. Or everyone must be broke, living far beyond their means and in need of hard currency. Or: both.”
Vince Lombardi: “Individual commitment to a group effort-that is what makes a team work, a company work, a society work, a civilization work.”
For those wishing to invest in a Berkshire-like company that isn’t so big, at 1/30th the size, Markel may be worth a look.
the the stock tanked more than two per cent today. Any idea why?
I wouldn’t say that 2% counts as a “tank” — in this case, the insurance sector as a whole was down, with many of Markel’s peers having similar movement. I’m not aware of any particular reason, though interest rates are generally a driver for insurance stocks and rate sentiment has done some shifting this week. They did announce today that they’re transitioning their CFO out over the next year, but that doesn’t seem to be meaningful at all to me.