by Travis Johnson, Stock Gumshoe | May 17, 2019 1:01 am
I’ve been seeing ads for the Motley Fool’s Stock Advisor Canada service recently that catch the eye… mostly because they promise what we all want, the ability to find that one stock that will turn your small investment into a life-changing fortune.
They do this by starting with the story of “Forty-dollar Frank” ….
“When a Nevada man nicknamed, “Forty-dollar Frank” first purchased his dream vacation home in Tahoe, he gathered his family on the porch for a group hug… and to give thanks to one stock.
“The Wall Street Journal reports that Frank is just one of thousands of ordinary investors who have become millionaires thanks to this same stock.”
And that will probably sound familiar to those who’ve been aboard the good ship Gumshoe for any length of time — “Forty-dollar Frank” is one of the more well-known early investors in Berkshire Hathaway, so named because he bought his first share for $40 in the 1970s and enjoyed the life-changing gains over the following decades as the stock price climbed (that was well before the “B” shares existed or were split — B shares, the ones that trade around $200 now, were created in 1996 as 1/30th of a Berkshire share to make investing in Berkshire more accessible, and then were split 1-to-50 to make the acquisition of Burlington Northern possible about 10 years ago — so Frank bought “A” shares for $40, each of which now represents 1,500 “B” shares, and those A shares are now trading at about $300,000 each).
I’m a happy Berkshire shareholder myself, though I didn’t buy my first share until 2005… so it’s not likely to offer me life-changing returns (and I’m a little guy who started out even littler, so I only own “B” shares). That’s OK, but, like everyone else, I’d be delighted to find the “next Berkshire”… and that seems to be what the Foolies are teasing here.
Sadly, we don’t get a lot of clues… so can we narrow this down? Here’s what the pitch says:
“Iain Butler, the Chief Investment Advisor of Motley Fool Canada, is convinced that he’s found a stock just like this for Canadian investors that could be a “millionaire-maker” in its own right…
“Because it’s following very closely in the footsteps of “Forty-dollar Frank’s” stock – yet it’s 29,479% cheaper to buy as of today.
“And Iain is so confident in this potential “millionaire-maker” that he’s just issued a rare strong buy alert on this remarkable company.”
So that’s one clue. What else? We’re told that…
“the balance sheet of this company is an absolute fortress….”
“it’s already made three exciting acquisitions over the past year alone worth well over $1.4 billion.”
So that’s a pretty big company, and it can somehow be pitched as similar to buying Berkshire years ago.
That “29,479% cheaper” number doesn’t mean anything real, of course, you can’t be 29,479% smaller or lower than something else, since, of course, reducing in size is limited to 100%… but that’s common terminology that pitchmen use, so it probably just means that the stock in question would have to rise 29,479% to be the size of Berkshire Hathaway. Which really just means that the stock being teased is 1/300th the size of Berkshire.
If that were a real assessment, you’d have to use market cap — and Berkshire’s market cap is about $500 billion, so that would mean the stock in question would have a market cap of about $1.7 billion. Small, but not teeny.
They could easily be referring to share price, though, since that is often the fixation that folks have with Berkshire Hathaway and its crazy $304,000 share price (again, for those A shares). If you did the same calculation there, you’d be looking at a share price of about $1,034.
So it’s either a stock with a $1.7 billion market cap, roughly, or one with a per-share price of about $1,034.
I bet you can guess where we’re going with this. $1.4 billion in acquisitions in twelve months is not likely for a company that has a current market cap of $1.7 billion, though we’ll check to make sure, so I’m guessing that we’re dealing with a stock that has a roughly $1,000 share price. And is somehow “similar” to Berkshire Hathaway.
Yes, I know, that rings a big ol’ bell. But let me send the Thinkolator out to check those clues a second time, and we’ll sit and twiddle our thumbs while it cogitates… OK?
Still with us?
OK, we’re back… those aren’t definitive enough clues for us to be certain, but the Thinkolator points us right at the stock you’re probably already thinking of: Markel (MKL), so often teased as a “baby Berkshire” that it is probably one of the stocks we’ve seen teased more than any other in the 12 years that Stock Gumshoe has been publishing.
And, yes, it’s also one of my largest personal holdings — second only to big papa Berkshire Hathaway itself. And has been in my portfolio almost as long (I first bought Berkshire in 2005, Markel in 2006, though I’ve added to those positions many times over the years).
I added a little bit to my Markel holdings recently when it dipped to my “worth a nibble” price of about $1,050 (my shorthand over the past year or so has been that I’m happy to nibble below 1.5X book value, and would buy more aggressively below 1.4X book… though book value is gradually becoming less important to Markel, thanks partly to their strategic shifts and acquisitions).
How does it match? Well, they have done some good-sized acquisitions over the past two years. The insurance-linked securities fund manager Nephila was acquired by Markel last fall for $975 million, along with the leather handbag maker Brahmin (terms not disclosed), and in the second half of 2017 they acquired insurance services company State National ($919 million) and ornamental plant grower Costa Farms (terms not disclosed, Costa had annual sales of about $500 million). (They also bought SureTec Financial, a surety bond company, for $250 million — but that closed two years ago, so we can’t really stretch to include that one).
Those amounts don’t match up exactly with $1.4 billion in acquisitions over the past year, and there were not really three acquisitions within the past year (there were two in 2018, so you’d have to add a few months of 2017 to get the third in), but if you tinker with the timeframe a little bit, or use a reference point from six months ago instead of today, you can get there. Whether or not you consider those acquisitions “exciting” is another matter.
Markel is about 1/35th the size of Berkshire, with a market cap of roughly $14 billion, so it is genuinely small in comparison… though not nearly as small as the 300:1 relation of Berkshire’s A share price to Markel’s share price that matches the “29,000%” bit of the tease. Total company size matters, of course, but share price does not tell you anything about company size or growth potential — if Markel decided to split their shares 10/1 the stock would be trading at $103 instead of $1,030, but it wouldn’t change the size or prospects of the company at all… and if you look at the B shares for Berkshire, you’d notice that Markel actually trades at 5X the price of a Berkshire B share though is, of course, not larger.
And as I noted, this is a match, and it’s a stock that’s also been similarly recommended by Tom Gardner over at the Motley Fool flagship here in the US (he has teased it, too, we covered his Markel pitch most recently last year), but it’s possible there’s a better match somewhere. There are some other companies that could logically be possible matches for those limited clues, and in the “spirit” of the tease…
The Canadian foolies have often spoken fondly of serial acquirer Constellation Software (CSU.TO, CNSWF), which often buys dozens of smaller software companies each year, but they only spent about $600 million on acquisitions in 2018, and it’s a tougher comparison to make to Berkshire Hathaway in terms of style or strategy (Markel really directly emulates Berkshire in many ways, including holding an annual Q&A for shareholders in Omaha the morning after the Berkshire Hathaway annual meeting — a pretty extraordinary move for a company based in Richmond, VA, but a clear nod to their guidestar and the company with whom they share many shareholders).
And if you want to stay in Canada (Motley Fool Stock Advisor Canada tends to recommend half US companies, half Canadian), then the obvious connection is to Fairfax Financial (FFH.TO, FRFHF), which is also often teased as a “baby Berkshire” and comes close to matching the clues… but not as specifically close as Markel (it’s not particularly near $1,030 per share, nor a market cap of $1.7 billion, and they have not recently done any substantial acquisitions… though they do make investments regularly). I also own Fairfax, though I sold some shares recently and have lost some confidence in Prem Watsa’s investment strategy.
Markel is a specialty insurance and reinsurance company that has historically been known for insuring niche markets, where pricing is often stronger (there aren’t 40 different companies offering to insure summer camps and barbershops, like there are for typical homes and businesses, so there’s less competition), and they have juiced the returns they get from profitable underwriting of that insurance by investing their capital and “float” more aggressively than many insurers, with a larger allocation to equities (“float” is just the money they receive for insurance coverage that has not yet been paid out for claims). In the past decade or so they’ve expanded into other insurance coverage as they’ve grown and acquired other insurance companies, including some reinsurance, and also started a Markel Ventures arm that buys up non-insurance businesses to diversify their investing — again, emulating Berkshire Hathaway’s penchant for buying up private operating businesses and not just investing in the stock market (of their recent acquisitions, Costa and Brahmin are part of Markel Ventures, with Costa in particular being a very large purchase, while State National and Nephila are more directly related to their insurance businesses).
I like that Markel is getting more into asset management in insurance, which is a fee-based business and also a way for them to directly get something like reinsurance coverage (selling catastrophe bonds, etc. — outside money coming into insurance has been a strong trend for many years now as money managers look for “non-correlated” returns), though it’s also that catastrophe bond business that has taken the shares down a bit, with Markel CatCo under investigation by regulators for its management of writedowns during the record 2017 catastrophe year. The CatCo brand has obviously been hurt, but I think Markel’s business in this area, led by Nephila, will continue to grow nicely and generate cash flow without requiring much capital — which, along with their larger acquisitions in Markel Ventures, gradually helps make “book value” a less compelling valuation metric.
And, really, this is still just a company and a management team that I really trust to make good long-term decisions and manage the company in the best interest of shareholders. That means I’m a little bit sensitive to share price in that I look to add incrementally to my position when the valuation gets a little more compelling, as it has since the CatCo debacle, though there’s certainly risk that Markel could fall another 20% if the insurance sector as a whole drops in value (or more, of course, if we have a real bear market or crash), but it also means I’m very unlikely to sell unless something changes pretty dramatically. If you want to get a quick overview of Markel, probably the best place to start is with the 2018 Annual Report here. Here’s the most recent note that I shared with the Irregulars about Markel, just FYI:
5/3/19: Markel (MKL) reported a reassuring quarter this week, getting back to underwriting profitability (combined ratio of about 95%) and posting earnings that were primarily the result of the recovery in the stock market following the swoon in last year’s fourth quarter, though revenue from their Markel Ventures arm also picked up, mostly because of acquisitions. Don’t get sucked into following earnings for Markel, that number is hugely volatile because of their large equity portfolio (with accounting rule changes, they now have to report the rise or fall in the value of the portfolio as earnings or losses even if they don’t actually buy or sell any stocks in that quarter), the real number to watch is their long-term growth in book value per share, which has tapered off in recent years (partly as they’ve invested in non-insurance businesses and in their catastophe bond businesses, which primarily uses other peoples’ capital, but also partly because insured losses have been large for a couple years), but is still decent.
No big surprises, though a good quarter seems to have reignited a little optimism. The two valuation triggers that I keep in mind these days are 1.5X book to nibble and 1.4X book value to buy a little more heavily, and now, with book value hitting $707 a share, that would be $1,060 and $990, so I did add very slightly to my MKL holdings this quarter (more on that in a minute). That number moves a lot with interest rates and stock prices even if the insurance operation gets some relative stability after a few catastrophe-laden years, but you have to start somewhere.
Markel is not ever going to offer a “$40 Frank” opportunity, not from these levels — it’s a strong company, and it might well return a few thousand percent over the next few decades if they keep it together… but it’s also a $14 billion company, and that’s not the same as getting in on Berkshire A shares at $40 in 1976.
If you want a (still optimistic) comparison, think about buying Berkshire Hathaway in the early 1990s, when it had a market cap, like Markel’s, in the $10-15 billion range… or, if you want to get a little more optimistic and adjust for inflation and the relative sizes of large companies these days, go back to maybe 1990, when Berkshire was around $8 billion. It has had great returns in the almost 30 years since, gaining about 3,000%, and that turns your $10,000 into $4 million if you sat with it for all that time… much better than the 1,000% or so you would have gotten from the S&P 500, but not as dramatically life changing as “Forty-dollar Frank’s” return — if you were lucky enough to find Berkshire when it was tiny, 20 years earlier in the 1970s, and held for 40+ years, that would have provided 750,000% returns, turning $10,000 into $75 million.
That’s why the early Berkshire investors aren’t just happily retired, they’re endowing buildings at universities…. assuming, that is, that they didn’t give up on Berkshire during one of the several long periods of weak performance the stock showed during its first 50 years (most people give up, or heed the siren song of “do something”… something to keep in mind with all those stories about the fictional investors who bought Amazon at the IPO 22 years ago and turned $10,000 into almost $10 million, would you really have been able to hold on to that stock during the several 50-90% declines it had during those 22 years?)
For what it’s worth, “forty-dollar Frank” bought his Berkshire shares in 1976, after Berkshire Hathaway had shown terrible performance for many years (it hit a high in the $90s in the early 1970s, but you could have bought it in the 1960s for $40, too). It wasn’t exciting or fun to think about at the time… though it worked out very well almost immediately, and the shares rose several thousand percent in just the next few years to hit almost $1,400 in the early 1980s — so he made 30X his money or so during a time when the broad market was flat. Can you imagine how hard it would have been to not sell after that?
All of that future possibility is made up and requires reading the tea leaves and sniffing around in the squirrel entrails to be certain you’re correct, of course, so it all seems fantastical, but the difference between 3,000% gains and 750,000% gains over an investing lifetime is dramatic — the former is above average but certainly attainable, if you’ve got patience and the world of the next 50 years looks a lot like the world of the last 50 years… the latter is extraordinary and should fuel only your daydreams, not your retirement plan.
And that’s about all I’ve got for you on this one… any thoughts on Markel, or on other companies you think offer a “maybe the next Berkshire” opportunity? Let us know with a comment below.
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