Note from Managing Editor Allison Brickell: Whether it’s the tulip bulbs of the 1600s… the dot-com bubble of the 1990s… or the rabid GameStop traders of today…
Market mania tends to share a common theme. Investors fall in love with a stock’s exciting story or feel compelled to jump on an already full bandwagon and pledge, despite all the warning signs, that “this time it’s different!”
Nicholas Vardy has often written about this theme in Liberty Through Wealth. And now he’s bringing it to the MoneyShow Virtual Expo! On Wednesday, February 17, Nicholas will give a lively presentation about the key lessons for investors from previous “disruptive” revolutions.
The expo will run from February 16-18. Click here to register and learn more.
I’ve written a lot about Warren Buffett in the past.
I’ve pointed out that the share price of Berkshire Hathaway (NYSE: BRK-B) has lagged the S&P 500.
Berkshire Hathaway has now trailed the S&P 500 Index over the past 15 years – if only by a hairbreadth.
Still, Berkshire’s historic success attracted many imitators.
Foremost among them is specialty insurer Markel (NYSE: MKL).
Modeled on Berkshire Hathaway, Markel developed an outstanding reputation among investors over the past 35 years.
Of course, Markel’s strong investment returns have helped.
But it seems almost like Markel’s luck ran out about five years ago.
Following a 9.61% drop in 2020, Markel’s trailing average five-year annualized return has tumbled to just 2.9%.
After beating Berkshire for close to 30 years, Markel has trailed both the returns of the S&P 500 (16.05%) and Berkshire (11.92%) since 2016.
Has Markel lost its way?
Or does Markel’s lagging performance represent a once-in-a-decade opportunity to pick up the “Baby Berkshire” at a knockdown price?
I believe that Markel has plenty left in its investment gas tank.
Let me explain.
Markel: A Model Student
Much like Berkshire, Markel is a specialty insurance holding company.
Markel’s “Baby Berkshire” nickname is apt.
Both Markel’s underwriting business and its investment strategy look to its big brother Berkshire for inspiration.
Markel even holds a shareholder brunch in a conference room in Omaha, Nebraska, each year – on the day after Berkshire Hathaway’s annual meeting.
Markel has insured everything from classic cars, boats and event cancellations to children’s summer camps, vacant properties and new medical devices.
Markel even insured the red slippers Judy Garland wore in The Wizard of Oz.
The company is a star performer in the insurance business.
Markel averages a “combined ratio” of just under 96%. It takes in more money in premiums than it is paying out in claims. That is surprisingly rare among insurance companies.
Markel’s Secret Weapon
Like Berkshire, Markel has the deck stacked in its favor when it comes to investing.
Like all insurance companies, Markel has the option to invest the insurance premiums it receives.
Most insurance companies invest this “float” in low-risk fixed income instruments.
Like Berkshire, Markel invests a much larger portion of its float in stocks. This means higher returns for Markel’s investment portfolio over time – although at the price of higher volatility.
Tom Gayner, Markel’s longtime chief investment officer, is a dyed-in-the-wool Buffett disciple.
Gayner invests in stocks using a simple four-point formula based on the principles of value investing. Gayner looks for…
- Profitable companies that produce high returns on capital
- Management that is both talented and honest
- Businesses that have sizable reinvestment opportunities to become compounding machines
- A fair price.
For many years, Gayner’s approach delivered even better results than Berkshire.
From Markel’s initial public offering in 1986 through 2016, its book value per share grew at 20.1% per year.
That was nearly double the S&P 500’s return of 10.3% and far above Berkshire’s 16.7% rate.
As a result, Markel’s share price rose from $8.33 at inception to $982 in May of 2016.
Then, Markel’s returns stumbled.
In the five years ending September 2020, Markel’s average book value per share grew at just 7.5% – a third of its earlier rate.
Markel trades at around $990 per share. It has barely budged since May 2016.
Why Markel Will Prevail
Many investors once viewed Markel as a “set it and forget it” investment.
But after five years of lagging performance, Markel is tougher to buy.
Yet my contrarian instincts tell me that Markel’s next five years will be far better than the past five.
First, Markel’s core insurance business remains stable.
Markel earned premiums of $1.39 billion in the third quarter, up from $1.3 billion in the same quarter a year ago.
Even amid the pandemic, Markel took in more in premiums than it paid out.
Second, Markel’s $22.3 billion stock portfolio has averaged 15.2% annual returns in the 10 years ending in 2019.
That compares with a 9.4% average annual gain for the S&P 500.
Markel’s stock price may have stagnated. But its stock market investments have not. Eventually, Markel’s investment success will filter through to its share price.
Third, Markel is cheap.
Markel’s current price-to-book ratio stands at 1.18. That’s its lowest multiple of book value since 2012.
Yes, Markel had exposure to COVID-19-related losses in 2020 as varied as wedding cancellations, Wimbledon and the Olympics.
But as the pandemic fades, I expect Markel’s multiple to expand back toward its long-term pre-2016 level of around 1.7.
The bottom line?
Markel is a premier insurer with a profitable insurance business. It also boasts impressive returns on an actively managed stock portfolio.
Markel also has a market capitalization of $13.35 billion. That’s a mere 2.5% of the value of Berkshire Hathaway. It does not struggle with size as Berkshire does.
At its best, Markel offers a Berkshire-style investment combined with the nimbleness of a midcap stock.
So, yes, it’s been a frustrating five years for Markel shareholders.
But I’m betting that the next five years will be better than the last.
Click here to watch Nicholas’ latest video update.