Industry-InsuranceInvestment Ideas & Company Research

Markel (MKL): A Compounding Machine

Our financial goals are to earn consistent underwriting profits and superior investment returns to build shareholder value” – Markel 2013 Annual Report

Markel is an outstanding business currently in its 85th year of operations. It is an excellent insurance company with a history of underwriting profits. It is also a superb investment company with a history of above average investment returns. Markel had an outstanding year in 2013, basically doubling the size of its insurance business and investment portfolio in an acquisition that the market hasn’t seemed to fully value yet. I think the shares are priced not just fairly—but cheaply—at a valuation level where investors have the chance to partner with one of the great long term compounding machines of the past 3 decades and achieve investment results for a long period of time that will at least equal—and possibly exceed the comprehensive returns on equity and growth in book value that the business achieves.

I’ll discuss my opinions on Markel, but first a quick overview of the fundamentals inherent to the Property and Casualty insurance industry, for those who need a quick primer. For those that don’t, feel free to skip ahead…

Insurance—Desirable Business Model Leads to Subpar Returns

Insurance companies have a unique feature that most businesses lack. Most businesses have one main source of capital to invest—namely the capital that the shareholders invested into the business. But Markel—and other insurance companies—have two:

  • Shareholder Equity
  • Reserves from Policyholders

Insurance companies have the added benefit of being able to accept money from customers (premiums) long in advance of the requirement to pay for the losses associated with that revenue (claims).

Of course, this concept is referred to as float—or the policyholders’ money that an insurance company gets to invest after receiving the premiums but before paying the claims.

Buffett made this concept famous, and he describes it often in his letters—here is his quick explanation in the most recent annual report:

“Property casualty insurers receive premiums upfront and pay claims later… This collect-now, pay-later model leaves P/C companies holding large sums—money we call “float”—that will eventually go to others. Meanwhile, insurers get to invest this float for their benefit. Though individual policies and claims come and go, the amount of float an insurer holds usually remains fairly stable in relation to premium volume.”  

Although technically a liability, float is really an incredibly valuable asset—so much so that the industry at large is willing to lose money on underwriting in exchange for the access to this float. The concept is somewhat similar to a bank that collects deposits at a cost of say 3% and invests or lends those deposits out at say 6%–profiting from the 3% spread. Unlike banking however, it is possible for insurance companies to reduce their cost of float down to zero—or in rare cases even below zero cost. In other words, instead of having to pay 3% to gather funds, some insurance companies actually breakeven on their underwriting, meaning that this float is effectively “free”—like a bank that has no costs associated with gathering deposits.

Breaking even on the underwriting might not sound like a terrific situation, but it actually is quite valuable in the insurance business, as it effectively allows the business to use other peoples’ money to invest for its sole benefit. It’s effectively like taking on a partner who supplies your business with capital but asks for no equity stake nor charges you any interest—effectively this breakeven result creates an interest free loan for the insurance company.

In some rare situations, an insurance company not only breaks even on the underwriting, but actually makes consistent profits. This pleasant situation results in two possible streams of income:

  • Underwriting profits
  • Investment profits

The company in this rare situation actually gets paid to hold and invest their policyholders’ funds—like a bank that somehow charged depositors interest for the privilege of keeping their money at the bank.

Insurance—Competition Creates Mediocre Returns

Unfortunately for insurance companies, the nature of capitalism is such that this valuable business model combined with relatively low barriers-to-entry creates intense competition in the industry. Each insurance company understands how valuable this float is, and so they fiercely compete for a piece of the industry’s premium volume and the float that accompanies it.

This intense competition leads to companies being very willing to write business at a loss just to access this valuable float. These factors have led to very mediocre returns on equity over time for the industry as a whole.

Buffett again:

“Unfortunately, the wish of all insurers to achieve this happy result creates intense competition, so vigorous in most years that it causes the P/C industry as a whole to operate a significant underwriting loss. This loss, in effect, is what the industry pays to hold its float. For example, State Farm, by far the country’s largest insurer and a well-managed company besides, incurred an underwriting loss in nine of the twelve years ending in 2012… Competitive dynamics almost guarantee that the insurance industry—despite the float income all companies enjoy—will continue its dismal record of earning subnormal returns as compared to other businesses.”

The P&C insurance industry has long operated at a combined ratio well over 100—meaning collectively insurance companies lose money on their underwriting. The combined ratio measures the total insurance costs (expenses and claims) as a percentage of premiums. A combined ratio of 100 is breakeven—meaning that the total expenses equaled premiums. Over 100 is an underwriting loss, below 100 signals an underwriting profit. 

Moats in a No-Moat Industry

But some businesses—Berkshire certainly being one—have carved out competitive advantages in this cyclical industry with commodity-like economics. Some businesses are able to consistently operate at an underwriting profit, which creates enormous value for shareholders over time. When combined with good investment skills, this combination can create an incredible compounding effect.

How do insurance companies create this advantage?

There are a few answers to that question, but one major factor is the willingness to walk away from business that will not result in profits. This is harder than it sounds, because it involves willingly lowering current revenue—something that most executives and almost all Wall Street analysts don’t like. But companies that are able to actually reduce their underwriting volume during soft markets are able to preserve their capital and their profitability. Every insurance company understands this, but few are willing to walk away from business. It is difficult for executives of insurance companies to willingly shrink their revenues when their competitors are growing theirs. It is also difficult for insurance employees—who are paid on commission in some cases—to willingly walk away from current business—even if it is the best thing to do for the long term interests of shareholders and employees.

However, a select few businesses have created incentive structures and an owners’ minded culture that allows them to be able to operate in such a profitable manner.

Berkshire obviously is one example of this—compounding shareholder value at 20% annually for half a century.

Markel is another example.

Introduction to Markel—A Value Compounding Machine

Markel was founded in 1930 and initially focused on insuring taxi cabs in Norfolk, Virgina. It was a family owned and operated business for decades until it went public in 1986, but even to this day it has largely maintained its culture as a family run business.

Markel is a compounding machine. It has grown book value by 20.1% per year since its IPO in 1986, thanks to three main ingredients:

  • Consistent Underwriting Profits
  • Superior Investment Results
  • Excellent Long-term Owner/Managers

The three pronged approach has resulted in enormous shareholder value creation over time, even when compared to better-known compounders such as Berkshire Hathaway.

Here are the results of Markel’s per share book value compound annual returns vs those of Berkshire and the S&P 500:

MKL vs. BRK and SP 500

As the compounding of book value goes, so goes intrinsic value and so goes the stock price. MKL’s stock price has compounded at 17.1% over 27 years since the IPO, turning a $10,000 investment in 1986 into $705,596 in 2013:

MKL Long Term Chart

I like to think about Markel as a holding company with three distinct business lines:

  • Insurance
  • Investments
  • Operating Businesses (Markel Ventures)

Markel is a very disciplined underwriter with a history of underwriting profits (Markel’s 28 year average combined ratio is an incredible 96%). This profitability is as rare as it is valuable in the insurance business. It provides Markel with cash flow from insurance operations, but more importantly, it means that the float—the money that belongs to policyholders from premiums that are reserved for future claims—is effectively free money for Markel to invest for the sole benefit of shareholders. It’s like a massive loan that bears no interest and doesn’t have to be paid back!

As long as Markel remains a profitable underwriter over time, it will have two main buckets of permanent capital to invest:

  1. Float
  2. Shareholders’ Equity

The former is conservatively allocated to mostly short duration fixed income securities—bonds. The latter is invested in long term securities—namely stocks. Markel invests a much larger portion of its equity into stocks relative to most P/C insurance companies. This means higher returns for the investment portfolio over time, and it means above average book value compounding, which correlates over time with the intrinsic growth in value of the enterprise.

It also means slightly more volatility—which is probably why most insurance companies prefer not to own equities. But Markel’s logic is the same as Buffett’s and most value investors—volatility is not risk. Risk is the uncertainty of losing permanent capital—not the temporary fluctuation in the quoted value of that capital.

I’m surprised that after 49 years of 20% annual returns at Berkshire Hathaway that more companies don’t follow this relatively simple model.

Not Just Stocks & Bonds, but Businesses—Markel Ventures

In addition to stocks and bonds, Markel also allocates capital to privately owned businesses. The company recently established an entity called Markel Ventures, which is the vehicle that holds wholly-owned and partially-owned operating businesses.

Markel Ventures is only a very small piece of the overall Markel pie, but it is rapidly expanding—revenues grew 40% last year as new businesses were acquired. I believe this will be a significant source of value for Markel in years to come as the vehicle begins to throw off greater and greater free cash flow for Markel to reinvest.

Markel invests in businesses using the same principles it uses to buy stocks—similar to how Buffett thinks about investing in public and private businesses.

So how does an insurance company—a business in an industry known for subpar returns—create above average returns on equity and high book value compounding over three decades?

Competitive Advantages at Markel

Markel is unique—an insurance company with various competitive advantages. A few of these advantages are:

  • Long-term Owner-Minded Management—Markel’s managers are experienced, disciplined, and very conservative in their underwriting, investing, and reserve policies.
  • Culture—management has established and maintained a culture that promotes long term oriented thinking in every aspect of their business that benefits shareholders, customers, and employees.
  • Niche Insurance Markets—it has specialized expertise in markets where many other insurance companies don’t write
  • Size—it is one of the largest players in its markets with a long term history—which gives it scale advantages as well as customer loyalty (customers in these hard-to-place risk categories know Markel is one of the largest and most secure counterparties in their markets)
  • Disciplined and Profitable Underwriting—willing to shrink premium volume in soft markets
  • Superior Investment Skills—Tom Gayner is a high quality value investor and Markel allocates a larger percentage of its shareholder equity (i.e. permanent capital) to equities than most other insurance companies

Let’s explore a few of these advantages that have carved out Markel’s ever widening moat over the years…

Competitive Advantage #1: Management and the Markel Culture

“One of the primary reasons for (our) success is that we have a large group with a long tenure… Another important fact is that all Markel associates own stock in the Company, and many have very significant investments.” –1997 Shareholder Letter

Markel’s history goes back to the 1930’s when the company was founded. For most of its history, the business was family owned and controlled. It went public in 1986 to provide liquidity for some of the cousins and other relatives who were not interested in owning an insurance company, but the principles of the Markel family are very much intact today.

These principles—honesty, integrity, customer service, and work ethic among others—can be evidenced by listening to management and observing their behavior over long periods of time. I’ve gone through every shareholder letter since the IPO in 1986, and it is very clear that they put a top priority on maintaining the culture that the founding family established decades ago.

This type of qualitative analysis is often deemphasized, and this type of rhetoric is common at almost every company. But at Markel, this isn’t just rhetoric—it is how they actually run their business. And this culture creates a competitive advantage for a few reasons, but one is that employees think like owners—and they operate with the long term in mind.

Many of the letters from the 1980’s are written by executives that still are at the company playing a major role today. Employee turnover is very low. This means that executives are given the freedom to think beyond quarterly, yearly, or even 2-3 year results. They are thinking 5, 10, even 20 years down the road. They own stock in their company, and their compensation is highly tied to long term incentives such as 5-year CAGR of book value. Employees at lower levels are also incentivized this way—underwriters are not incentivized to write business at any price—they are incentivized to write profitable business.

This creates a culture of owners working together to build value.

Competitive Advantage #2:  Niche Markets

“By focusing on market niches where we have underwriting expertise, we seek to earn consistent underwriting profits, which are a key component of our strategy. We believe that the ability to achieve consistent underwriting profits demonstrates knowledge and expertise, commitment to superior customer service, and the ability to manage insurance risk.” –2013 Annual Report

Warren Buffett mentioned at a recent shareholder meeting that one of Berkshire’s huge competitive advantages is that they have no competitors in certain activities they engage in. Markel’s insurance business is founded on hard-to-place risks, which by definition are lines of insurance that relatively few insurance companies participate in.

This means they insure things that other insurance companies don’t. Throughout its history, Markel has indeed insured such unusual risks such as classic cars, boats, event cancellations, children’s summer camps, horses, vacant properties, new medical devices, and even things such as the red slippers Judy Garland wore in the Wizard of Oz.

Markel has specialized in these niche markets for decades, and has built up both experience and a brand name among customers and prospective customers as one of the largest players in these specialty markets. Their size, their expertise, and their capacity to insure these risks that others won’t have given Markel a sizeable advantage over competitors. Most don’t want to compete in these lines. Those that do try to enter these lines often lack have the specialized knowledge that Markel has built up over time.

Competitive Advantage #3: Disciplined Underwriting

 “In tough markets, we will need to be extremely disciplined and willing to walk away from underpriced business” –2013 Shareholder Letter

This has been the philosophy at Markel for three quarters of a century. And it’s not just ubiquitous rhetoric that you hear from most P&C management teams—the results show Markel management “walks the walk” as well, producing remarkable results relative to the overall P&C insurance industry:

MKL-Underwriting

These are incredible underwriting results, especially when taking into account the enormous growth in premiums that Markel has achieved over the years. Growth in premiums often do not equate to growth in per share intrinsic value, but as management said in the 2013 Shareholder Letter:

“Our compensation as senior managers, and our wealth as shareholders of the company, depends on profitable revenues, not just revenues. That said, when it comes to profitable revenues, more is better.”

Competitive Advantage #4: Equity Investing

“We have a larger portion of our portfolio allocated to common equities than many property/casualty insurance companies. Although we recognize the short term impact (of higher volatility), we are confident our strategy will enhance shareholder value in the long term.” –1992 Shareholder Letter                                                                                   

Like value investors, Markel believes that equating volatility with risk is nonsensical. They look at their shareholders’ equity as permanent capital, which implies that they can invest that capital with a long term view, and their philosophy is that stocks—specifically quality companies at fair prices—will outperform bonds over long periods of time.

This strategy has worked. Here is a look at the average annual returns that the investment portfolio has produced—with a side by side comparison of the steadily rising increasing value as shown in the per share book value and stock price:

MKL-20 Year Key Data

MKL-Key 20 Year Numbers

Tom Gayner, Markel’s CIO, runs the investment portfolio, and is a well-known student of value investing and the principles of Warren Buffett. Gayner’s equity results would put him in the top 10% of just about any mutual fund category.

Gayner invests in equities using a simple four point filtering process that is rooted in the principles of value investing. He likes to look for:

  1. Profitable companies that produce high returns on capital
  2. Management that is both talented and honest
  3. Businesses that have sizable reinvestment opportunities (compounding machines)
  4. A fair price

Although the level of performance might not seem to rank him among other superinvestors, it certainly adds enormous value when combined with the structural advantage of negative cost float (“better-than-free” leverage) that Markel uses.

Superior Investments Results + Zero-Cost Leverage (Float) =  Outstanding ROE

For example, at the end of 2013, Markel had investments $1,259 per share, and net investments (after subtracting all debt) of $1,098 per share. They also had leverage (investment assets/equity) of 2.6—which happens to be well below Markel’s historical leverage level.

This leverage means that if Markel’s overall portfolio averages 5.0% after tax, the portfolio will gain $63 per share, which represents 13.2% of book value. If leverage increases to a level of 3.0 invested assets to equity (historical average is 3.5), then the contribution to ROE from the investment portfolio gets to 15%. Because of Markel’s consistent ability to produce underwriting profits as well as a growing revenue stream from Markel Ventures, these investment results can be thought of as a “back of the envelope” conservative proxy for comprehensive ROE and book value growth.

Another “back of the envelope” way to look at it: if Markel can produce breakeven underwriting results (including interest charges) and can produce 5% after-tax investment returns, then Markel is priced at around 9 times comprehensive earnings ($595/$63 comprehensive EPS: basically the change in equity which includes income as well as unrealized gains on investments that bypass the income statement).

Of course, leverage works in both directions, but thanks to Markel’s underwriting practice and long-term orientation, their lumpier than normal earnings will likely lead to far superior value creation over time.

When discussing this “leverage”, remember—As long as Markel underwrites profitably over time, this “leverage” provides capital that is both free and permanent. Markel’s overall balance sheet is very conservatively capitalized, with a debt to equity ratio of around 34%.

Over the past 20 years, Markel has produced pretax average annual investment returns—in both stocks (13.1%) and its overall portfolio (7.0%)—that far exceed the investment returns that most P&C companies achieved over that period of time. Much of this has to do with outstanding stock investing.

As Gayner said in the recent shareholder letter:

“Our equity portfolio has added immense value to our total returns over many years and we think our long standing and consistent commitment to disciplined equity investing is a unique and valuable feature.”

Alterra Acquisition and Equity Allocation

Markel acquired Alterra on May 1st, 2013. The company is referring to this merger as “transformational” as it not only nearly doubled the insurance business, but also increased the size of the investment portfolio from $9.3 billion to $17.6 billion.

The acquisition not only increased the size of the investment portfolio, but also significantly altered the allocation profile between stocks and bonds. At year end, Markel had just 17% of its portfolio in stocks, vs. around 25% a year ago.

Put differently, Markel had just 49% of its shareholder equity invested in stocks, compared to a management stated target of around 80%.

As Gayner said on the 2nd Quarter 2013 Conference Call:

“The addition of the Alterra portfolio was a sluggish (reallocation of investments), and it is appropriate for you to assume that we will methodically and opportunistically guide the equity investment percentage back up to the historical levels over time.”

This reallocation will be a catalyst for sizable increases in Markel’s investment returns, ROE, and book value over time.

Bringing It Together—Great Company, Great Price

“At Markel, underwriting and investing are working from the same blueprint. The principles that support profitable underwriting are the same ones that lead us to superior investment returns and, in turn, help us build shareholder value. These important principles are: maintaining a long-term time horizon, discipline, and continuous learning.” –2006 Shareholder Letter

The thesis really boils down to the fact that we have a great business that has compounded book value at 20% annually since its IPO thanks to the following key attributes:

  • Long term owner friendly managers
  • Profitable, conservative insurance operations
  • Superior investing results

Markel is a compounding machine and should be able to continue to replicate this formula for years into the future.

And to add a cherry on top, the stock is actually priced cheaply relative to normalized earnings and Markel’s own historical price to book ratio:

  • Markel’s current P/B Ratio: 1.24
  • Markel’s long-term average P/B Ratio: 1.73

The low price is surprising considering how well the company is positioned to grow its insurance operations, investment portfolio, and private business holdings via Markel Ventures.

The price to book (P/B) ratio is at the very low end of the 28-year range:

MKL Long Term Price to Book Ratio

So the current valuation is just 71% of the long term average valuation and don’t forget, the denominator in this multiple has grown at 20.1% per year since 1986!

I believe Markel is an outstanding opportunity—with or without multiple expansion. So I think the long term business prospects are much more important to consider than short term catalysts, but I do think that the reallocation of Alterra’s portfolio along with Markel’s strength to take advantage of the inevitable return to a hard insurance market will provide a tailwind to the current valuation.

To illustrate the power of compounding, let’s assume book value grows at rates between 10-14% annually over the next 5-10 years (significantly lower than Markel’s long term historical range). Let’s also assume a valuation multiple between 1.5 (also conservative vs. long term average of 1.73 P/B ratio):

  • Book Value Grows at 10%
    • Book Value in 5-10 Years = $768 to $1,237
    • Stock Price at P/B of 1.5 = $1,152 to $1,856
    • Stock Price CAGR in 5-10 Years: 12.0% to 14.1%
  • Book Value Grows at 14%
    • Book Value in 5-10 Years = $918 to $1,768
    • Stock Price at P/B of 1.5 = $1,452 to $2,652
    • Stock Price CAGR in 5-10 Years: 16.1% to 19.5%

I think there are arguments to be made for higher compounding as well as higher valuations, but I think these are reasonable possibilities.

To Sum It Up

With Markel, we get:

  • Consistently profitable insurance company
  • Superior investment holding company
  • Shareholder friendly long term management
  • Cheap Price

On 3/31/13, MKL trades at $595 per share. The stock is trading at the very low end of the historical valuation range at 1.2 times book. This seems far too cheap for a company of this quality—one that has compounded book value per share at 20.1% since its IPO in 1986.

So we have a great business—and an opportunistic investment. A compounding machine that is growing intrinsic value at greater than 15% annually—available at a price that allows investors to experience an investment result that should equal—or possibly exceed—the internal business returns over the next 5-10 years.

Disclosure: John Huber owns shares of MKL in his own account and in accounts he manages for clients.

_____________________________________________________________________________

John Huber is the portfolio manager of Saber Capital Management, LLC, an investment firm that manages separate accounts for clients. Saber employs a value investing strategy with a primary goal of patiently compounding capital for the long-term.

John also writes about investing at the blog Base Hit Investing, and can be reached at john@sabercapitalmgt.com.

42 thoughts on “Markel (MKL): A Compounding Machine

    1. Hi Charles,

      The data in the post mostly comes from AM Best, MKL company filings, and BRK annual reports and filings. The combined ratio data is from AM Best.

      Also, I’d recommend checking out Berkshire’s annual reports. Much of this general industry data can also be found in those filings. For a while, Buffett summarized a roughly 20-year history of the US P&C combined ratio.

    1. I have some thoughts on it Dave… some of it might have to do with the insurance industry-and even the broader financial industry (a lot of financials are still relatively cheap when you look at very broad valuation measures like really long term P/B ratios). The P&C industry has been in a soft market since 2005, and although rates have shown some signs of improvement over the past year or two, we have yet to see a truly hard market that really takes away much of the excess capacity.

      Soft markets represent the majority (probably 70-80% or so) of the time, so it’s not unusual. But when you combine soft fundamentals with very low interest rates, and the recession of 2007-09, you get a pretty poor environment for insurance businesses.

      I think over time, this subsides and the multiple will likely expand closer to its historical average.

      However, I think a larger point could be made on Markel–and I don’t really have an answer to this one. I think a company like Markel is perpetually undervalued by the market, and I’m not sure why. I’m not necessarily suggesting this will always be the case with Markel, but it has been the case heretofore. There is no reason that a company like Markel (fairly well known with a long term track record and visible to most investors and analysts) should have continually traded at a level that allowed investors at various times over the past three decades buy the stock and achieve 15-20% annual returns over long periods of time.

      It’s similar to Berkshire… even after Berkshire traded at its highest price to book ratio in history in the mid-80’s, it was still undervalued (I’m referring to “value” as the value you receive relative to the price you pay–in future comprehensive income and growth of equity).

      Anyhow, I’m not sure exactly why some companies remain priced this way, but they do–or at least they have.

      Lots of other examples as well. Walmart for instance is an example that Peter Lynch often uses. He mentioned about how you could have bought the business a decade after it went public and after the business model was clearly proven to be incredibly successful, and the market still underestimated the value of the business (even if it looked expensive in simple static measures based on one year results, etc…)

      1. MKL is chronically undervalued because its high ROE stems from its equity investing, which is unique among insurers, and most investors miss this. Most insurers invest entirely in fixed income, so investors almost always look at returns based on net income excluding changes in comprehensive income (where the impact of the equity portfolio shows up) over equity ecxluding AOCI (unrealized gains/losses). They assume insurers have bonds which they will hold until maturity, so unrealized gains/losses in the investment portfolio are not relevant, which is all true for most insurers. If you look at MKL this way, you miss the equity portfolio benefit and its returns look mediocre. And because insurers are typically valued on book value and ROE, you wouldn’t pay more than 1.2x book, because the ROE looks like low double digits at best. The right way to look at MKL’s net income and equity (book value) is to INCLUDE unrealized gains/losses because, again, this is where the benefit of the equity portfolio shows up. And on this basis, you see that it is a high double-digit ROE company that should trade at 2.0x book or so.

        1. Thanks for the comment Josh. Yep, basically my “comprehensive” ROE that I discuss in the post, and why I think the stock basically trades around a P/E of 9 currently. Another thing that’s a large benefit for shareholders: Markel currently has $1.7 billion of unrealized gains in their equity portfolio. This amount on the balance sheet has a corresponding deferred tax liability of around $600 million or so, which represents the amount of taxes (at 35%) that Markel will have to pay if they realized these gains. So the DTL is another example of a liability that is really an asset. We get to continue to use that $600 million to create value. As Buffett has said–it’s really an interest free loan from the government with no maturity date.

          As for the valuation–I do think many underestimate the value of investing a higher percentage of shareholder equity in stocks… why most insurance companies don’t do it confounds me–I suppose too many insurance companies think like ordinary investors–i.e. volatility is risk.

          However, it amazes me that a business model is out there in the open for 20 years and it still is underappreciated. Actually if you count Berkshire, more like 40 years.

          There is really no reason why the market shouldn’t recognize it. The fact that they are using equities is well known. Similar to the Walmart example I used earlier, along with Berkshire and many others.

          Maybe the market also fears the higher volatility of equities. But whatever the reason, we don’t really need to know exactly why the undervaluation occurs, we just need to know that it does!

          Thanks for reading…

    2. I have to imagine part of the answer is that the return potential of equities is likely lower than what MKL historically enjoyed. I’m sure MKL will continue to be a relative outperformer going forward, but it seems like a stretch to expect a repeat of past performance.

      1. I’m not sure… I think they still have quite a long runway to go before size begins to materially impact performance. Theoretically, it gets harder each year as the balance sheet continues to grow, but if you look at the securities Gayner has owned over time that have provided this outperformance, they are all very liquid large caps that he could easily own if the portfolio was 10 times the current size. It will also get harder to find operating businesses to move the needle as the invested assets grow, but I don’t think that they have any reason to think they won’t be able to replicate the current performance over the next decade or so.

        After all, Buffett has been saying since the late 60’s (when he had $100 million AUM) that size is hurting his performance. But here we are 45 years later and 20% per year later and he’s still doing it. Markel is where Berkshire was (in terms of size) in the late 80’s. So there is still a long runway.

        But you do raise a legitimate point… returns do get impacted as size increases. I just think their performance will still be at a level that will yield very high returns on equity for the foreseeable future.

  1. Hey thanks for write up on Markel and the overview of the P&C insurance industry. I noticed that you make reference to Markel’s book value (most of which are tangible assets). Should the historical price to tangible book value ratio be a factor as well?

    1. Hi John, you could probably chart the progression of tangible book also. But I wouldn’t be too focused on it. The compounding of intrinsic value is what interests me about Markel. Much of that comes from tangible assets, but some comes from intangible assets as well, and I think as Markel Ventures becomes a larger portion of the pie, that will increase over time. I would refer to Buffett’s comments on goodwill and intangible value though also. And regarding book value–Markel states in this year’s letter that they basically think that investor’s should focus less on absolute book value, and more on the growth of that value over time. That implies they might feel their company is worth much more than book value, and that the best barometer of intrinsic value (although still not completely accurate) is the CAGR of that value over the long term.

  2. Thanks for your article, John.

    Both BRK and MKL buy and sell marketable securities. Are capital gains from the securities taxed at 35%? What about dividends? I recall companies get preferential tax rate on dividends. What about dividends from preferred stocks? Sorry for so many questions, I’m very new.

    1. Hi Dipsy,

      Yes insurance companies in the US are generally taxed at the US statutory rate of 35%. Certain investments (munis for instance) have tax advantages… Markel’s effective tax rate was 22% last year.

      Check out footnote 8 on page 51-53 of the recent 10-K to answer some of your specific questions on MKL’s income tax treatments and to discover more details on the reconciliation between the statutory and effective rates. Also management discussion of taxes on page 114.

  3. Hey John,

    Great write-up, well said. It is an incredible company, indeed, and I think the annual letter for 2013 was quite pointed towards the end in its attempt to tell shareholders that the company is very cheap relative to the underlying return characteristics of Markel Ventures.

    I think there is usually a Markel event in Omaha the day after the Berkshire meeting, do you ever attend that? I am making my first trip out there this year and hoping to stop by.

  4. Thanks for an excellent write-up. I read Markel’s letters about a year ago but didn’t understand the business that well until I read your blog post. I would probably buy some if it had a P/E of 7 or 8 according to your methodology. I may pick some up even at this price.

  5. John,

    Great write up. You did an excellent job in concisely explaining the key metrics and how they excelled compared to the industry.

    I am curious on how do you incorporate the comprehensive income of a P/C business to your analysis? Clearly these things can fluctuate due to gains and losses, among other things … but seems to be an important metric for insurance companies.

    1. Well, I think more in terms of long term ROE, book value growth, underwriting and investment results, but yes, comprehensive income is really part of the value that the business is producing, because it includes things that don’t flow through the income statement–namely the unrealized gains in the investment portfolio. These unrealized gains appear on the balance sheet, net of an amount that is reserved for taxes (which also is a source of value that shows up on the balance sheet as a deferred tax liability–Buffett’s “interest free loan from the US Government). Currently, Markel has around $1.7 billion of unrealized gains, meaning they have a roughly $600 million liability (the amount of the tax liability they have if they realize those gains). Each year, this amount will fluctuate depending on what stock and bond prices do, causing “comprehensive” income to rise and fall. So I don’t place much emphasis on any one year’s results, or even 2-3 year periods, as the earnings are very lumpy. Even lumpier with Markel because of their higher emphasis on equities.

      So I think more in terms of long term return on equity and investment returns and underwriting results that produce them. If you want to value the business on its earnings, you can… The earnings are very lumpy because investment returns are lumpy, so most have an easier time valuing the business on book value alone, which is okay in some cases, but in Markel that is not the best method in my opinion. I think taking the company’s advice and looking at the growth of book value over long periods of time (minimum 5 years) is a good way to approximate the value the business is creating (along with the “comprehensive” earning power over time). Any given year will be lumpy.

      1. Thank you for the response.

        I agree with your statement and your assessment into Markel (i too invest in them). Comprehensive earnings will translate into book value and looking at book value growth is easier for sure, and as you said less volatile. It just seems to me that the quality of their investment portfolio(undervalued securities compared to intrinsic) will dictate that book value growth overtime … So would comprehensive income provide some indication when the ship could potentially turn (not saying it will)? No need to answer this as I do not think there is a straight forward answer.

        Clearly, we have to rely on their 20+ year track record (which is very strong) and the Company’s ability to execute on their strategy of underwriting profitable insurance policies, having a strong, well analyzed investment portfolio, and buying companies that are cheap to fairly valued with sizable reinvestment opportunities.

  6. Hi John,

    How do you compare life insurance companies with P/C insurance companies in terms of profitability, the easiness to make money, etc? Do you have research on any life insurance company as you did in Markel?

    Thanks,
    Ruthy

    1. Hi Ruthy,

      Generally, I’m not a big fan of life companies, or even other P/C companies. Insurance is a business that is destined to produce mediocre returns in aggregate. Some companies will do better than others, but most will have a hard time earning returns in excess of their cost of capital.

      Markel is a rare bird, and one that I think is special.

      I am reading a few 10-K’s of a few life companies that appear to be quite cheap by looking at simple valuation multiples, but I have a hard time getting as excited about the long term prospects of insurance companies in general.

      Management is key. The willingness to accept lower premium volume and to willingly reduce revenue in soft markets is very rare, and it requires management that truly think long term.

      As for the life companies, I’m reading about a few of them and might comment on them after I finish my research.

      Thanks for reading!

  7. John,

    Excellent article and well constructed. I have been researching and reviewing MKL for a few weeks as an alternative/additional holding with my BRK. I appreciate the longer term analysis. My PB average for MKL over the last 5 years averaged 1.19 with the high being 1.7 in a spike. At today’s price the PB is 1.26. You indicate the Long Term average is 1.73 which seems quite high to me. 1.5 also seems a bit high for future estimate. Over the last 10 years the CAGR has been 13.04%. However, I can not argue with their LT performance but will I am more comfortable with a lower ratio and will most likely use PB of 1.2 and CAGR of 13% for conservative purposes. I will read your analysis again to make sure I am not too conservative in my estimate or if you could comment on why you think i am being too conservative.

    1. Hi Tony. Thanks for reading.

      On book value and P/B, I don’t think a 5 year period is long enough to provide an accurate “normalized” P/B ratio. If you think about the last 5 years, it includes the depths of one of the worst stock market periods in recent memory, as well as a very soft insurance market, and very low interest rates. All things that typically create pessimism surrounding insurance stocks. I think you need to look back at least 10 years, and preferably 20 years to get a better handle on how Markel is typically priced if you want to see an average valuation level. And looking back further, you’ll see that Markel has typically traded around at a valuation level around 1.75 times book.

      But, even if you think that 1.2 times is a fair valuation level (which I think is far too low for a company with as much quality as Markel), you still can get a splendid result potentially as long as Markel continues to execute. That’s the beauty of these compounders. Your returns as a passive investor come from the internal compounding of the business itself, and you don’t have to rely on the market increasing the valuation it places on the stock (multiple expansion). If Market compounds at low to mid-teen levels, that’s the result you’ll see as an investor over time if the multiple stays the same (which I doubt it will).

      Thanks for reading!

      1. John,
        Thank you for your response…
        I don’t remember if you commented or not, but what is the leverage you estimate for Markel Float? In other words for BRK, the estimated leverage is 1.6. That is the beauty of insurance company float over owner’s equity.

  8. John, in your response to a comment above you wrote “Markel is where Berkshire was (in terms of size) in the late 80?s.” Markel’s book value is around $6.8 billion right now, I think. I’ve been trying to figure out when Berkshire Hathaway’s book value was around the same. Most of the widely published tables show percentage growth from year to year, but they don’t actually show the nominal book value. Do you happen to know? I’m just curious what 2014 MKL compares to in terms of BRK… early 1980s I would think.

    Thanks,
    Josh

    1. Hi Josh, I believe BRK crossed over the $6 billion in equity in 1991, when BRK’s book value was up close to 40% that year.

      1. This post is a bit late compared with the rest of the comments and the original article date, however I hope this has the potential to lead to further discussions.

        I am skeptical of comparing Markel to Berkshire at similar sizes to try to figure out potential returns going forward. Although they are insurance and operating companies, their proportion of each couldn’t be more different. With that said, I very much like Markel.

        A while back I did my own comparison of Berkshire and Markel after hearing it called Baby Berkshire so many times. My conclusion was that Markel and Berkshire had very different balance sheets. I was actually quite intrigued to find that Markel’s Balance Sheet looked a lot like GEICO’s (relative to other insurers).

        You can find Berkshire’s 1994 Balance Sheet in the 1995 Annual Report here: http://www.berkshirehathaway.com/1995ar/1995ar.html
        You can find GEICO 1994 Annual Report here: http://google.brand.edgar-online.com/EFX_dll/EDGARpro.dll?FetchFilingHtmlSection1?SectionID=975440-1249-64266&SessionID=5kjUFSHpJOQU9A7

        Quick Summary is (ignoring the non-insurance businesses of BRK and MKL)
        Berkshire had $15B in equities and $2B in fixed income and cash.
        Markel has $3.4B in equities and ~$13.7B in fixed income and cash
        GEICO meanwhile had $800M in equities and $2.3B in fixed income.

        Berkshire ratio of Equities to fixed income is almost mirrored what Markel’s is. It wasn’t that Berkshire had the majority of its float in equities either, its float in 1995 was $3.8B (couldn’t find 1994 number), it simply had a much lower ratio of float to net worth than Markel does.

        Looking at those ratios, Markel is more similar to GEICO. On top of that Markel has about $500M of shareholder equity in Ventures, that less than 10% of the company. Therefore, although the Ventures side of the business is interesting, I think it makes sense to look at Markel as an insurance company and not a “Baby Berkshire”.

        Lastly, I’d be interested in discussing Intrinsic Value. I don’t think looking at a 20 year historic Price to Book makes the most sense. Over the past 20 years, Markel’s leverage (investments/net worth) has ranged significantly and the interest rates have ranged even more significantly.

        Using a sum of the parts valuation looking at assets, liabilities and earnings I put IV at around 1.4-1.5 BV. I looked at the cash flows of Ventures, value of equities, income from float, excess value of cash/fixed income over float (this belongs to Markel), underwriting profit (assumed 3%), and cost of debt. One drawback is I do not include the value of Buffet’s Third Pillar of “This “what-will-they-do-with-the-money” factor must always be evaluated along with the“what-do-we-have-now” calculation in order for us, or anybody, to arrive at a sensible estimate of a company’s intrinsic value.” However I believe the third pillar is a positive, so it would only increase not decrease IV, but to put a value on it is difficult.

        Hopefully the comparison to GEICO and BRK is something new to you…

        Thanks,
        Jordan

        1. Thanks Jordan. Great comment. I’ll have to take some time to review the old filings. That’s an interesting viewpoint.

          For the most part, I agree with just about everything you say. I too agree that Markel is much different than Berkshire. I (like most) got interested in Markel for the same reasons, but there are major differences (the biggest of course is that Markel is a great team, but they don’t have a once in a lifetime investor like Buffett).

          Markel is a really interesting insurance company, and I think that is where a lot of the value comes from. The business model of a consistently profitable insurance company with conservative long term minded management and a quality (even if not spectacular) investment team is a very powerful model.

          I have more to say, but I’ll quickly make one brief comment: Your point on the equity portion of Markel’s portfolio is a good one, but I would point out that Gayner has mentioned numerous times that the equity portion of the portfolio will go up significantly over time. MKL management views shareholder capital as permanent capital and thus they intend to invest most of that in stocks. I think Gayner has mentioned a target of 80% of shareholder equity will be in stocks at some point. My guess is they aren’t in a hurry to up that allocation, but that could change quickly depending on market conditions.

  9. Very interesting article Mr. Huber.

    I suggest you take a look at Protector Forsikring ASA in Norway. Protector is a small insurance company in Norway operating in Property and Casualty + change of ownership insurance. Average CR since the start of the company in 2004 is 90%. Main reason for this extraordinary CR is the company’s strategy of selling insurance only through brokers, eliminating much of the expenses from having a sales department. I believe that Expense ratio is between 5-10% lower as a percentage of CR than the average of Norwegian insurance companies, but these numbers should be checked.

    For a long time illiquidity hurt Protector’s share price, however, liquidity in the share has increased substantially the last years. The stock is up 75.5% in 2014, but interestingly enough the stock is currently trading at a P/E of 9.3, P/Tangible Book of 3.5 (a little high), 5-year ROE of 29.7 (this 5-year period is of course especially strong because of the good macroeconomic state in this period so not sustainable in the long-run).

    Main risks for Protector is being heavily exposed to a real estate market (change of ownership insurance)that could significantly affect earnings negatively if a drop in prices or higher interest rates are evident in the future. In addition there is some risk in Protector’s investment portfolio as a little less than 20% is invested in equity securities and that it is a relatively small insurance company.

    It is of course hard to compare Protector to big insurance companies like Markel or Berkshire Hathaway, but I do still find it an interesting case. If you get time to look at the company let me know what you think.
    Below is a link (English language is possible by clicking on EN in the upper right corner of the website): https://www.protectorforsikring.no

    1. Thanks for the comment Andy. I’ll add this to the list of things to check in on when time permits. Thanks!

  10. *In addition hard to compare to any US insurance companies as the legal environment, among other things, is significantly different. Protector outperforms other Norwegian insurance companies based on profitability and in terms of pricing. That is what my analysis is based on.

  11. John – excellent analysis. Thank you!

    I’m trying to back into this statement: “This leverage means that if Markel’s overall portfolio averages 5.0% after tax, the portfolio will gain $63 per share, which represents 13.2% of book value.”

    The 5% after-tax seems high, based on the following assumptions:
    1. float is about 150% of shareholders’ equity.
    2. Equities are about 50% of shareholders’ equity. Let’s assume Gayner can earn 8% pre-tax in stocks. After all, the market is at record highs.
    3. The combined ratio (CR) since IPO is 96 but after the first acquisition in 1990 it’s basically 100.
    4. Management has stated they have lowered fixed income exposure to (higher-yielding) corporate debt.

    If we assume a 2.5% fixed income yield (10 year treasury) and $100 of shareholders’ equity (for illustration sake to figure out “normal” ROE), then $150 of float is generating $3.75 of pre-tax dollars, $50 of shareholders’ equity allocated to fixed income is earning $1.25 of pre-tax dollars, and $50 of shareholders’ equity allocated to equity is earning $4 of pre-tax dollars. If we tax just the fixed income portion (assume equities held forever), that means ($5 * 65%) + $4 = $7 = 7% ROE on the $100 of shareholders’ equity.

    Paying 1.3x book today for normalized 7% ROE seems like a lot. Book value growth would be even lower than 7% since book value deducts the value of the deferred tax asset.

    Now, there are several ways to increase that ROE.
    1. We assume a 98 combined ratio. With premiums at 40% of float, that implies $60 of premiums and $1.2 of pre-tax underwriting income and $0.8 of after-tax underwriting income. This takes our “normal” ROE to 7.8%.
    2. Maybe they can grow float faster, but historically it seems driven by M&A, so hard to me to get much higher than 1.5x.
    3. Fixed income returns could increase with higher rates. At a 4% 10-year yield, that would be $2 more of after-tax dollars, so our “normal” ROE is now 9.8%.
    4. Gaynor could increase, as he says, the allocation of shareholders’ equity from 50% stocks to 80% stocks. It would be the first time since 2006, and that didn’t end well, but OK.
    5. Gayner could earn more than 8% on a $5bb stock portfolio. Not easy, especially given the starting point! But if that 80% of shareholders’ equity returns 10%, our cumulative new “normal” ROE = 4.4% post-tax from fixed income + 8% pre-tax from stocks + 0.8% post-tax from underwriting profit = 13.2% “normal” ROE.

    Which is EXACTLY where you believe it will go as well! But a 13% ROE is supposed to trade at 1.3x book in order to get a 10% return and book value will compound at only 10% because of the deferred tax asset. Finally, the assumptions I made to get to the higher ROE seem relatively aggressive to me.

    In other words, at $650/share or 1.3x book, Markel appears expensive – and certainly not cheap.

    Curious your thoughts.

    Thanks! Matt

    1. Matt, great comment. I think there are a couple ways to look at it… one is the track record itself (which clearly argues that a 5% return on the investment portfolio is very reasonable), and the other is to break it down using some assumptions such as the ones you outlined above…

      Generally speaking, I think you’re far too conservative with your assumptions. I wouldn’t use the US 10 year as a proxy for the income you expect to receive from the bond portfolio. I’d use the AAA corporate bond yield.

      The other thing is that I don’t think it’s reasonable to expect interest rates to be this low forever. They are at multi-generational lows. The 10 year US Treasury has a P/E of around 40 with no chance of future growth of earnings! (kidding aside, bonds are not cheap, and interest rates are certainly not normal at these low levels).

      I also wouldn’t assume Gayner (after 20 years of consistent outperformance even with a large diversified portfolio) will suddenly perform just average. But that is probably a more reasonable assumption than the interest rate assumption. (Also, don’t forget that part of the ROE is the portion of comprehensive income that is reserved for future taxes, so even unrealized gains get a deferred tax liability recorded against them).

      And the last thing is that I wouldn’t invest in Markel if you think they will only breakeven on insurance underwriting going forward. I was illustrating a breakeven scenario just to show how powerful this model can be, but I am interested in Markel because they have a history of profitable insurance operations. I would expect this to remain true going forward.

      I think of it like very simply…

      Investments per share on 3/31/14 was $1219. Shareholder equity was $491.

      So assuming Gayner gets to his 80% number, he’ll have around $393 per share invested in stocks. He’s averaged 13.1% in stocks over the past 20 years. Let’s say he averages 9% going forward–quite a slowdown from his historical record and conservative given what the S&P should average with dividends over time. This would be quite a disappointment given the quality of his investment program, but we can assume this to be conservative (note this is average, not CAGR… I use average because I want to know what the average ROE I can expect over time).

      Let’s say the other $826 will provide a yield equal to the AAA corporate bond yield (we can use the current 4.25%). The bond portfolio itself averaged around 5% in 2011 and 2012 (2013 portfolio basically doubled because of Alterra… that portfolio is in the process of getting transferred to an investment strategy more closely aligned with Markel’s historical strategy/allocations, etc…

      This means you get $35 per share from the bond portfolio and $35 from equities, for a total of $70 pretax per share. This would give you somewhere around 10% ROE, and this includes 0 (breakeven) income from underwriting and really below average returns overall considering bond yields at all time lows. That seems pretty dire. I would expect low to mid teen ROE given the historical underwriting profits.

      Now, if the investment performance is better than we expect (say 10% equities and let’s assume 6% from bonds–for 20 years MKL has averaged 7% and although it’s hard to remember higher yields, I would think that if they did 5% in 2011 and 2012, 6% isn’t unreasonable).

      Even in this “lower than historical returns but better than mediocre” return scenario, we get $88 of pretax investment earnings per share and closer to around 12% ROE–again, with 0 income from underwriting.

      Anyhow, I think there is a strong case for growth in Markel Ventures, which we haven’t discussed, and at least a couple points from underwriting.

      There are intangibles that I really think are important. It’s hard to quantify the value in the culture, but I think there is enormous value that has been built up with the long tenured management team.

      Thanks for the thought provoking comment. Feel free to chime in with other thoughts.

        1. Charles,
          I use the data from the St. Louis Fed.

          There are a few different composites you can check. They will vary of course, but you could plug in whatever yield you think is conservative that Markel would earn in its fixed maturity securities portfolio. Historically, they’ve achieved returns greater than the AAA corporate bond yield, so I think that’s a pretty conservative proxy.

  12. John – great post, thanks for your thorough analysis. I agree MKL is a business with durable competitive advantages, excellent management and capital allocation, and high probability of compounding intrinsic value for shareholders over time.

    My question is in regard to valuation. What is your view on MKL’s intrinsic value? Another blog I follow, by Greg Speicher, commented that Tom Gayner used the following methodology to value Berkshire:

    “Gayner uses a sum-of-the-parts analysis and looks at the company in three parts: 1) the investment portfolio, 2) insurance operations, and 3) non-insurance operating businesses.”

    Have you done a similar analysis and come up with an estimate for MKL’s intrinsic value?

    According to my estimates, assuming conservative historical underwriting profitability (combined ratio of 96%), 5% after-tax investment return, and Markel Ventures’ 2013 pre-tax profits, then taxing the sum of those three pieces and applying a 14x earnings multiple, I arrive at an intrinsic value base case of $900-1000/share. Curious to know your thoughts on this type of valuation.

    Thanks again!

    1. I don’t see how MKL can be valued at $900 – $1000 per share anytime soon.
      The book is $494.00. That implies a price to book over 1.8. just to reach $900. too high for reasonable historical ratio.
      If book increases 12% in 2014 and then 12% again in 2015 and P/B ratio increases to 1.5 then $900 low end of target is achievable in 24 – 36 months.

      1. Hi Tony,

        See my reply to Clay above for more details, but I think one way to think about Markel is to consider what value you’re getting when you buy a share for $650 or whatever it is trading at currently. In this case, you’re getting some operating businesses and insurance companies, and you’re getting an investment portfolio worth $17.1 billion. If we subtract out the $2.2 billion in debt, you’re getting $1058 of investments per share (net of debt).

        I think that’s one way to look at the value.

        But generally speaking, I think that the market has a very difficult time valuing these long term compounders that have been growing intrinsic value at 15% annually for decades. For instance, you could have looked at Berkshire in 1965 and passed at $19 per share. You could have also paid 10 times that price, or $190 per share, and still made 15% annually over the next 49 years. Obviously that’s extreme, but you could run a similar calculation for Berkshire at any price in the 70’s, or even the 80’s after it became widely known that Buffett was a successful capital allocator. There is no reason the market should have priced Berkshire where it did in the 80’s, at prices that subsequently allowed investors to make 15% annual returns or better.

        The same goes for Walmart, Fairfax, Franklin Resources, Eaton Vance, Wells Fargo, and many others… these businesses had well known business models that were widely successful and well understood and widely accepted as successful businesses by Wall Street and the public at large. However, shareholders who bought them virtually at any price did very well over long periods of time, even after their success became widely known. I think the same goes for Markel, which has compounded at 20% annually since going public in 1986.

        It’s difficult for the market to value that type of compounding ability, because so much effort is placed into conventional, shorter term thinking (what’s the upcoming quarter look like, what does next year look like, what is the EPS for 2015 going to look like, what is the P/B ratio, the P/E ratio compared to comps, etc…) That type of thinking doesn’t lend itself to being able to look very far in advance, which is what you ideally want to do as a business owner (or an owner of equity securities).

        So I’m not recommending paying any price for Markel, or even $900 per share (although I don’t think it’s overvalued there). And who knows, maybe I’m wrong about Markel being able to compound at 12-14% for a long time (although it’s a great situation and one that I try to look for often, because even if I’m wrong, I’ll still likely do okay). But in general, I believe this principal holds true–the market (the vast majority of participants in the market) don’t care about 5 to 10 years out. They think statically, in terms of multiples, comps, quarters, next year or two at the most, etc…

        Herein lies our potential advantage! Thanks for the comment Tony.

    2. Hi Clay… yes, I have done that. One way you can think of Markel is to consider what you are getting when you buy a share of MKL. You’re getting a collection of profitable insurance companies, some privately owned businesses, and a large securities portfolio filled with stocks and bond. These assets are funded by float, shareholder equity, and some debt.

      One thing to consider is that if Markel generates profitability from their insurance business over time (which they have since the company was founded in 1930), then you can consider that the securities portfolio (like the securities portfolio at Berkshire) is essentially permanent capital.

      The next question is what is the net value of these stocks and bonds? If we subtract out the debt, we arrive at a collection of stocks and bonds worth about $1058 per share.

      That’s really what you are buying when you buy a share of Markel. Let’s assume breakeven operating results for the private businesses and the insurance companies (which they’ll do better than breakeven over time). You end up with $1058 per share of value.

      So using the Berkshire type sum of parts analysis, you’ll notice that Markel’s investment portfolio is much larger than Berkshire’s relative to its equity or its stock price. Obviously, Berkshire has much better earning power from its wholly owned businesses than Markel.

      I think of Markel almost like a closed end fund with better earning power (from the insurance businesses and the wholly owned subsidiaries). I think there is a case that it is still materially undervalued.

      1. Thanks John, that’s a good simple explanation of how to think of MKL. My $900-1000/share intrinsic value estimate was illustrative and certainly not something I believe should be reflected in the market price today or even in the next 12-24 months, given the near-term outlook for lower expected returns on the equity portfolio (and the low P/B multiple that market is applying given that forecast). However, over a 2-4 year period, I believe $900-1000/share is certainly achievable, even assuming very little multiple expansion.

        Looking out further, f I compound several conservative assumptions on long-term investment portfolio return, underwriting profitability, and normalized operating subsidiary earnings power, it becomes quick clear that MKL can and should achieve 10-15% CAGR in book value per share over the next 5-10 years, not including any additional upside from the inevitable hardening of the insurance industry and the resulting multiple expansion.

      2. With the recent qtr. announcement and increase in book value once again, a drop of 7% makes the stock that much more compelling.
        While I understand most here are long term investors expecting fluctuations over time, I don’t understand why the market would decrease share price after a fine quarter…unless the market is scoring short term earnings or did not react well to the 1.01% combined ratio for the qtr.

  13. Hi John

    I must say I have learned a ton from your posts here and on Seeking Alpha. I was wondering if you know of any other insurance companies in the world which use the same Berkshire- Markel model (other than Fairfax)

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