Valuing Markel

In my previous post I valued Berkshire Hathaway using Tom Gayner’s valuation method, which he described in a Value Investor Insight interview from 2012.  So I figured  I might as well put Markel’s numbers into the spreadsheet and see what we get.  Before I get to that here’s a quick summary on Gayner’s valuation method for those who didn’t read the last post.


 

Valuation Method Summary

Gayner breaks down the business valuation into three parts:

  • underwriting profits
  • investment returns
  • non-insurance normalized earnings  

He then applies a range of returns to insurance premiums earned, the investment portfolio and also estimates normalized earnings for the operating businesses.  Finally he takes the sum of all three parts and applies a multiple of 10x, 14x and 18x.  I changed things up a bit, but most of it is self explanatory.


 

Markel’s Investment Returns

I decided to adjust the investment portfolio returns down (vs what I used in the Berkshire model) to a base case of 5% with a low of 3% and high of 7%. Historically Markel has achieved higher investment returns (see below):

  • 5-yr annual return:  7.4% 
  • 10-yr annual return:  6.2% 

I’m being conservative with Markel for a few reasons.

1. Markel has an unusually large fixed income allocation due to the acquisition of Alterra  

When the investment portfolio from Alterra was inherited by Markel the total investment portfolio went from $9.3B in 2012 to $17.6B in 2013.  It almost doubled!  Alterra’s $7.9B investment portfolio consisted mostly of fixed income securities and a hedge fund portfolio that was subsequently liquidated.  This diluted Markel’s equity allocation, which currently sits at roughly 55% of shareholder equity.  Obviously having less invested in equities and more in bonds will lead to lower returns.  Historically Markel’s equity returns have outperformed fixed income returns by a wide margin.

  • 5-yr annual return: Equities, 20.4%   Fixed Income: 4.7%
  • 10-yr annual return: Equities, 13.4%   Fixed Income: 4.6%

2. Markel doesn’t use float to invest in equities like Berkshire 

Markel invests in equities with shareholder equity only; whereas, Berkshire uses both shareholder equity AND float.  Markel’s float is mostly invested in fixed income securities that match Markel’s insurance liability durations.  In a Gurufocus interview from 2011 Gayner explained why Markel does this vs. investing in float like Berkshire:

TG: “Berkshire has a much bigger balance sheet than Markel and a much bigger base of equity compared to its insurance liabilities than we do. As such, they can allocate more of the investment portfolio towards equities. Over time, if we continue to grow and build up our equity capital we should be able to move in the same direction as Berkshire.  Furthermore with a rising interest rate headwind and potentially lower forward returns from stocks I’m lowering expectations for conservatisms sake.”

I thought that last part was very interesting.  I’ve seen Gayner state that his preference is for equities to be 80% of shareholder equity, but I’ve never heard him say they would like to eventually invest the float.  This strikes me as another under appreciated benefit to the upside that could juice returns further as Markel grows in scale.  For now though, returns have and will most likely be lower than Berkshire’s.

3.  Rising interest rates

With such a large fixed income portfolio the obvious drawback is as interest rates rise the existing fixed income values will fall.  And theoretically equity returns should be lower in the future.  This combination would put a drag on investment returns going forward.  On the other hand as rates rise (assuming it continues) Markel’s investment income will rise too. But for the sake of conservatism I’m lowering return expectations.

Markel is being proactive by keeping durations lower than normal and waiting.

From the 2014 Annual Letter:

“We continue to own a portfolio of fixed income securities which mature faster than what we expect from incoming insurance claims. We will continue to maintain this modest override from our normal design until such time as interest rates are higher than current levels. We just don’t think we are being paid appropriately to take the risks of owning long-term bonds so we won’t do it.”

On rates rising over the long term:

“We normally don’t try to predict interest rates but we can use common sense to say that we believed they were too low during the last few years, and now they are trending back to a more normal level. Consequently, we too will trend back towards a more normal bond portfolio over time. This should increase our investment income substantially in the years to come.”

Again, a little off subject, but Gayner and co. are aware of the rate environment and as with insurance underwriting they are being disciplined by waiting for a price that warrants the risk taken.


 

Markel Valuation

Markel’s historical combined ratio is 96%, they had a 95% combined ratio in 2014 and so far in 2015 (through Q3) have an 89% combined ratio.  Due to fairly consistent underwriting profits I kept underwriting returns at 4%, the same as Berkshire’s.  I used 2014 net cash earnings for Markel Ventures opposed to Gayner’s use of EBITDA; and as previously discussed, I lowered investment returns to 5% for the base case.

Screen Shot 2015-12-23 at 8.35.31 PM

 

The base case shows a FV of $1,215 per share with 38% upside from Tuesdays close of $879.85.  Fair value here would imply 2.2x book value, which is at the upper end of Markel’s historical range.  Seems a little rich, but the assumptions aren’t overly ambitious.  If you play around with the assumptions you’ll see (especially when compared to Berkshire) just how much investment return drives the overall intrinsic value for Markel.

At base case $81 EPS Markel trades at:

  • 10.9x comprehensive earnings
  • 14.7% ROE

If we take the base case assumption down to 4% investment returns we get a FV of $1,014 (15.3% upside).  If we take it down to 3% we get a FV of $814 (-7.5% downside).  Of course you can also play with the multiples.  If Markel is only getting 3% returns on investments does it deserve a 15x multiple?  So for me this one is a bit tougher than Berkshire.  The range of outcomes are greater no doubt.


 

A few other thoughts on Markel’s bright future:

1. Markel Ventures growth

I didn’t forecast any growth for Ventures in the model because a) disclosure is minimal and b) it’s still a fairly small part of Markel. EBITDA for 2014 was $95m which comes out to just 8% of the estimated total net profit.  Also, it’s just too hard to forecast (at least for me).  But we can still look at what has happened so far.  Ventures has grown significantly over the years with 30% annual revenue growth since 2005.  Adjusted Ebitda has grown significantly as well.

Screen Shot 2015-12-23 at 9.06.33 PM

(BTW if you’re questioning Gayner’s use of EBITDA I recommend you check out The Brooklyn Investor post I linked to at the bottom)  

Again, this is off a pretty small base and at the moment is still a small part of the business, but I think Ventures could play a large part in Markel’s growth over the next decade.  Gayner said at a recent Markel brunch that if Ventures was outside of Markel they would earn greater than 20% ROIC.  Ventures gives Gayner yet another avenue he can allocate capital to and should provide consistent cash flows.  

2. The Leverage Ratio

The leverage ratio is currently 2.45x, which is at Markel’s low end historically.  If leverage increases to the historical average of 3.5x (or up at all), returns will be magnified.

3.  Increased portfolio mix towards equities

This one ties into the previous bullet.  Gayner has said in the past that their target goal for equities is 80% of shareholder equity (currently at around 55%).  This could be viewed as a nice tailwind for future returns as the investment portfolio mix moves toward equities, but that also depends on your view of the market and Gayner’s ability to beat it.  Additionally, as I quoted earlier, Gayner believes at some point Markel will be able to invest the float in equities a la Berkshire.  Currently Berkshire has about 65% of it’s investment portfolio in equities (rough estimate); whereas Markel has only 23%.  Bottom line, an increase in equity allocation could be a significant tail wind for returns in the future.


 

Conclusion

I do think that Markel’s stock could take a breather and pull back some.  Berkshire did just that in 2015.  It peaked around $150 after a pretty impressive multi-year run up and then receded back down to the $127 range (now ~$131).  If Markel is a large percentage of your portfolio than maybe trimming wouldn’t be a bad idea.  I did this with Berkshire when it was around $150.  I sold 20% of my shares as it was encroaching on 13% of my portfolio, then Berkshire stock dropped down to $127-128 where I bought the shares back.  A rare and lucky “trade” for myself.  This approach allows you to take a little off the table in the short term, but still participate in the long term compounding of a great business.  That said sitting on your hands might be the best bet.

In my original post on Markel I had a FV range of $800 to $1200 using a few different valuation methods.  I’m pretty comfortable saying that at today’s price Markel is at least fairly valued.  I know that opinion is not very popular lately, especially on twitter.  Some people are worried that Markel is getting expensive after the rather quick run up in the last year or two (65% return in 2 yrs).  This strikes me as shortsighted if you believe Markel is truly a great company that can compound overtime.  How many times in Berkshire’s history did people get burned by selling when they thought the stock was slightly overvalued.  Of course Markel is not Berkshire, but I tend to believe the business model is one built to compound overtime in the same vein as Berkshire.  In my opinion there is quite a bit of optionality in Markel’s future.

So that’s my two cents.  I’ll leave you with some interesting quotes from Chuck Akre’s 2011 VII interview:

On rising interest rates

“Just as TD Ameritrade is a coiled spring levered to rising interest rates, so too is Markel when there’s an upturn in the insurance pricing cycle.”

On the Leverage Ratio:

“As part of that model, they constructed a holding company balance sheet which typically had $4 of investments for every $1 of book value, so that when they earned 5% after-tax on their investments, that was magnified four times and the change in book value was 20%. When pricing is soft and the business isn’t growing, that gearing ratio shrinks because they can’t add enough to the investment portfolio to maintain the 4:1 ratio. Today the gearing is more like 2.5:1.”

On valuations:

“So you’re paying around 125% of book. That is hardly expensive for a high-quality, well-run and transparent insurance company that I believe can compound book value at 15% annually. As I mentioned earlier, 200% to 300% of book is not at all out of line for this type of company in a different part of the cycle.”

 


 

Additional Info/Links:

MKL IV Spreadsheet

Markel Corp (MKL): A Conservative Compounder

Valuing Berkshire with Help From Tom Gayner

Value Investor Insight 2012- Tom Gayner

The Brooklyn Investor- Markel Ventures

Tom Gayner Gurufocus Interview 2012

Value Investor Insight 2011- Chuck Akre

Markel (MKL): A Compounding Machine- John Huber

 

Valuing Berkshire with Help From Tom Gayner

I recently came across a post by Greg Speicher from 2011 that described Tom Gayner’s method for valuing Berkshire Hathaway (h/t Value Seeker @Find_Me_Value for the link). The post referenced a 2011 Value Investor Insight interview in which Gayner discusses his valuation method for Berkshire.  It’s really a great interview with a ton of insight from Gayner.  He’s always fairly open with his thinking, but I found this interview particularly informative.  I might have to do another quick post on it.

Anyway, Greg did a great job summing up Gayner’s method by creating a corresponding valuation spreadsheet including Gayner’s assumptions.  I thought it might be interesting to update the spreadsheet and see how Gayner’s valuation method looks today with shares at seemingly cheap levels. (quick note: Greg’s original post was in July 2011; a very good time to buy BRK shares, which were around $75 per B share, 1.1x -1.2x book value and have since produced 12.4% annualized.  The price actually dropped to $65 per B share later that September, producing 15% annualized.)  


 

Gayner’s method for valuing Berkshire:

TG: “I break the business into three parts, insurance, investments and the other operating companies. For the insurance business, which is currently relatively soft but is well-positioned and well-run, I look at the level of insurance premiums running through the business and assume at the low end that it breaks even on an underwriting basis, in the middle range makes 4-5 points of underwriting profit and at the high end makes 8-9 points. For the investment portfolio, I assume it earns from 3% at the low end up to 10-12% at the high end. For the operating businesses, I look at the actual cash flow produced over the past three years and overlay my expectations over the next few years to get a range of possible normalized earnings. On all of that, I apply 10x, 14x and 18x earnings multiples to arrive at a fair-value range for the company overall.”

The TL;DR version:

  • underwriting profits
  • investment returns
  • normalized operating cash flow

Gayner then takes the sum of all three and applies a multiple of 10x, 14x and 18x.

It’s pretty simple.  What’s interesting about this method (to me) is that Gayner’s not just some hedge fund investor valuing a business.  He is essentially valuing his business, which is as close to Berkshire as it gets.


 

Valuation

 

Screen Shot 2015-12-21 at 8.53.04 PM.png

I adjusted the spreadsheet a bit from Greg’s by doing five scenarios instead of three, and used slightly different multiples.  For insurance premiums I used Q3 ttm and assumed a range of zero to 8% underwriting profits with 4% as the base case.  I estimated the investment portfolio at $196.7B, which includes all investments as of Q3: equity portfolio, fixed income, “other”, the Kraft-Heinz investment and $25B cash.  I don’t recall how much cash the PCP deal involves, but you can adjust the cash level as you see fit.  I used Gayner’s range of 3% investment returns on the low end, to 10% on the high end, with a 7% base case.  For operating earnings base case I estimated future growth of 10% annually for three years off of $12.47B ttm, and took the average earnings.  Then I took the total net profit and applied multiples of 10, 14, 15, 16 and 18.

The base case has a FV of $181 per B share or 39.8% upside from Friday’s close of $129.53 per B share  (1.79x book value).  Not to shabby.  Yes, it’s very simplistic but I think this gives a good idea of what possible.  Can Berkshire achieve 4% underwriting profit?  I think so.  7% investment returns?  Probably.  And a 15x multiple  on that is not unreasonable.

At $12.08 EPS Berkshire trades at ($129.53 per B share):

  • 10.7x comprehensive earnings
  • 12% ROE

Conclusion

The main thing I took from Gayner’s method was the visual of just how big the operating businesses are becoming for Berkshire and its intrinsic value.  Growth here should lead to a declining importance of book value multiples, which we sometimes tend to anchor to.  Gayner alluded to this in the Markel 2014 Annual Letter stating that growth in book value CAGR is the best way to measure growth in intrinsic value opposed to using absolute book value multiples.

Anyway, this is just one method of many for valuing Berkshire, but one I’ll probably continue to use if for no other reason than to model various return scenarios from the three segments.

For a good discussion on BRK valuation take a look at Value Seeker’s (@Find_Me_Value) recent tweets.  Some great detail, and interestingly a similar FV despite the very different approach.

I attached the spreadsheet below so you can adjust/play with the assumptions yourself. I’d love to hear what people think about this so feel free to comment.


Additional Info:

Tom Gayner’s approach to valuing Berkshire Hathaway

Value Investor Insight: June 2011

BRK IV Excel Spreadsheet

Morningstar BRK Report

 

 

 

Markel Corp (MKL): A Conservative Compounder

Background

Markel’s been around for close to 90 years, went public in 1986 and has compounded at a 20% annual rate since the IPO. Steve Markel is Vice Chairman along with CIO Tom Gayner and Chairman/CEO Alan Kirshner.

From the 2014 10K:

“We are a diverse financial holding company serving a variety of niche markets. Our principal business markets and underwrites specialty insurance products. We believe that our specialty product focus and niche market strategy enable us to develop expertise and specialized market knowledge. We seek to differentiate ourselves from competitors by our expertise, service, continuity and other value-based considerations. We also own interests in various industrial and service businesses that operate outside of the specialty insurance marketplace. Our financial goals are to earn consistent underwriting and operating profits and superior investment returns to build shareholder value.”

By consistently underwriting profitably MKL essentially gets paid to invest insurance premiums. This is what Warren Buffett refers to as “float”. CIO Tom Gayner uses the float to invest in equities and fixed income. He has handily beaten the market by a significant margin over many decades using a disciplined value based approach.

Quick Investment Thesis

Markel is a compounding machine with multiple ways to allocate capital effectively. They have a long history of underwriting profitably and are consistently below a 100% combined ratio. Tom Gayner has invested premiums at market beating returns and just recently began acquiring wholly owner operating companies, which is yet another avenue for capital allocation. Qualitatively Markel’s management and culture are superb. Management is long term oriented and treats shareholders as partners. Many people call MKL “Baby Berkshire” due to the similar structure and disciplined culture they share.

At todays price we are paying a better than fair price for a conservatively run business that can compound our capital at above average returns with below average risk.

A Great Company and Capital Allocator

Markel makes money basically three ways:

  1. Underwriting Profits by underwriting in a disciplined manner and forgoing writing premiums if the price doesn’t justify the risk
  2. Investment Income by investing the “float” in fixed income and equities
  3. Operating Businesses, called “Markel Ventures”, but this is currently a small portion of Markel’s profits, which I’ll touch on later.

Insurance

Most insurance companies hope to break even on premiums written. They make the bulk of their money by investing the premiums for investment income. This is also the reason why many insurance companies find it hard to turn away less than stellar premiums and end up underwriting money losing insurance deals. Markel refuses to underwrite this way, instead opting to forego premiums and wait for better pricing or look for better places to underwrite/allocate capital.

combined ratio

As we can see in the above graphic Markel has underwritten very well over the last 5 years especially when compared to the industry average (which is above 100%). In their 28-year history Markel has averaged a 96% combined ratio. This means that not only is this float an interest free loan, they are getting paid to hold other peoples money and invest it for their own benefit.

The insurance segment is divided into three segments: U.S. Insurance, International Insurance and Reinsurance. As you can see below U.S. Insurance is the largest segment, but what’s interesting is Markel barely had a presence internationally just 10 years ago.

2

 

 

 

 

 

 

 

I won’t get into too much detail on insurance segments, but Markel (as mentioned in the business description) is unique in that they underwrite specialty insurance that tends to be a niche product with less competition. For instance they famously insured Judy Garlands ruby red slippers from The Wizard of Oz. Other types include:

youth and recreation oriented organizations and camps, child care operators, social service organizations, museums and historic homes, performing arts organizations, senior living facilities and wineries. “

Of course they still insure the typical types of insurance such as property, worker’s comp and professional insurance, but they pursue unique and hard to place risks.

The bottom line is when it comes to insurance Markel values underwriting profits above all else. If a certain insurance market is showing poor pricing they will simply scale back until pricing improves, which usually happens after a significant event or catastrophe. Employees are incentivized and aligned with this goal.

Investments

Tom Gayner is the CIO and chief capital allocator. If we used a Berkshire analogy he would be Warren Buffett, investing the float and shareholders equity in equities and whole businesses. Comparing Gayner to Buffett is borderline sacrilege, but Gayner is no slouch. His investment record is phenomenal having consistently beat the S&P annually for both 10 and 20 year periods. His approach to investing is explained in the annual report:

“As to our equity selection process we continue to use our durable four step process in seeking excellent long-term investments. We look for, one, profitable businesses with good returns on capital and modest leverage; two, management teams with equal measures of talent and integrity; three, businesses with reinvestment opportunities and/or capital discipline, at; four, reasonable valuations.”

Gayner’s investment portfolio embodies the above quote:

gayner.jpg

 

 

 

 

 

 

Gayner’s portfolio is comprised of great businesses that he can hold onto for long periods of time further helping compound capital by deferring taxes on investments.

As you can see below, Gayner’s performance has been quite good:

returns

Recently Markel acquired Alterra, an insurance company that predominantly invested in fixed income. The Alterra acquisition doubled Markel’s insurance business. It also increased the investment portfolio from $9.3 billion to $17.6 billion. You can see this jump in the above graphic from year 2012 to 2013 under the invested assets row. Due to Alterra’s heavy allocation towards fixed income, Markel’s portion of equity investments as a % of shareholders equity dropped to around 50%.

Gayner has stated his long-term goal is to get that number back up to 80% of shareholder’s equity. This is a nice tailwind having Gayner with more money to invest in higher returning securities.

Operating Businesses

Otherwise known as Markel Ventures.

From the 10K:

“Through our wholly-owned subsidiary Markel Ventures, Inc. (Markel Ventures), we own interests in various industrial and service businesses that operate outside of the specialty insurance marketplace. These businesses are viewed by management as separate and distinct from our insurance operations. Local management teams oversee the day-to-day operations of these companies, while strategic decisions are made in conjunction with members of our executive management team, principally our President and Chief Investment Officer.“

In very similar fashion to Berkshire Hathaway, Markel looks for operating businesses that are profitable, have little need for capital reinvestment, run by “honest and talented” management, at reasonable prices in which they can own ideally forever. Markel currently owns 15 companies including: AMF, a designer and manufacturer of bakery equipment; Cottrell, designer and manufacturer of auto transport equipment; and Parkland Ventures, a leading operator of manufactured housing communities.

In 2014 Ventures had $838 million in revenue with $95 million in adjusted EBITDA. Year over year growth in revenues for 2014 was 22% and EBITDA 13.5%. At its current size Ventures is still a small percentage of Markel, but it’s growing. It’s a great place to allocate capital and also a way of diversifying Markel’s business lines.

Capital Allocation Summary

Markel views their ability to allocate capital as a distinct advantage over most other companies. Gayner uses an example of a capital-intensive business such as a car manufacturer, which needs to keep plowing profits back into making cars no matter what the prospects look like for profits. Markel of course has multiple avenues to allocate capital that can help them succeed in any environment.

In the 10K Gayner laid out his thought process on capital allocation for Markel:

  1. Organic growth in existing insurance and Markel Ventures operations
  2. Acquisitions in both insurance and non-insurance
  3. Purchase stocks and fixed income to support insurance operations and earn good returns on capital
  4. Buyback stock when a purchase offers better returns than the previous three options

It’s rare to see such a clear and concise capital allocation process laid out for shareholders, especially one that makes sense.

Management and Culture

As mentioned earlier management is conservative, disciplined, skilled and extremely shareholder friendly. For example, underwriters are incentivized to write profitably and are rewarded on a multi year rolling basis for profits, not growth in premiums like most insurance companies. This is pretty rare. Essentially they are incentivizing staff to turn away unprofitable insurance. Another interesting tidbit is that every Markel employee is a shareholder. They don’t get stock options, only bonuses and discounted shares for purchase.

The culture at Markel is very unique. At the most recent Markel Brunch in Omaha Steve Markel talked about the “Markel style”:

“People who fit with the Markel style value teamwork over individual achievement; have disdain for bureaucratic processes; believe in the primacy of serving shareholders; and prefer a meritocracy to a general sort of egalitarianism.”

Alan Kishner Markel’s CEO:

“It’s OK to make mistakes at Markel, just don’t make the same dumb-ass mistakes.”

They also do a great job of explaining how to measure progress and performance for Markel. Gayner writes in the 10K:

“We measure financial success by our ability to compound growth in book value per share at a high rate of return over a long period of time. To mitigate the short-term volatility, we measure ourselves over a 5 year period. We believe that growth in book value per share is the most comprehensive measure of our success because it includes all underwriting, operating and investing results.”

To sum it up, management is top notch and the culture at Markel is legit. They are conservative, disciplined, long term oriented and are true partners with shareholders. This humble down to earth attitude combined with discipline reminds me of Berkshire and gives me comfort knowing that management can be trusted.

Valuation

I’ll use three methods to get an idea of what Markel is worth:

  1. The Two-Column Method
  2. Book Value Ranges and 5 Yr. Growth Estimates
  3. Comprehensive Earnings/ROE Method

The Two-Column Method

Warren Buffett himself has in the past suggested to shareholders that using the two-column method for valuing Berkshire Hathaway is a rough proxy of it’s true intrinsic value.

Essentially the two-column method values the insurance portion of the business by using investments per share and then adding operating earnings from the non-insurance portion of the business at an appropriate multiple.

Using the two-column method we get an intrinsic value of $1201 implying a 48% upside from todays price.

The left side of the equation is fairly straight forward, but the right side (Ventures) needs a couple assumptions regarding earnings and multiple. I decided to use pretax earnings, which required some adjustments. From net income I added back amortization, the goodwill impairment and income tax expense. This gives a clearer picture of Ventures true earning power. The 10x pretax earnings multiple is what Buffett likes to pay for good businesses and also after taxes is roughly 15x earnings (the long term market average). I believe Ventures owns above average businesses and assigning an average market multiple is fair. However, at current earnings Venture’s intrinsic value is only 3.4% of Markel’s total intrinsic value.

4 (2)

Book Value and Expected Growth

Markel has a long track record of compounding book value at high rates of return; they also have generally traded in a range of 1.5 to 2x book value. It’s a very simplistic method, but if we apply a range of growth rates in book value to the historical norm in book value multiples we can get a good idea of expected returns.

5.jpg

 

 

In the above chart I first used a range of 5-year book value compound growth rates. As you can see below, 5-year BV CAGR over the last decade has ranged from a low of 9% to a high of 18%. That 9% is the lowest 5-year book value CAGR ever at Markel, which includes the financial crisis.

6a

6b.jpg

In the past both Buffett and Gayner have alluded to a range of book value multiples that they thought represented undervalued and/or overvalued. That range is somewhere between 1.5 and 2x book value. Historically Markel has traded at an average BV multiple of 1.75.

7.jpg

In the bear case I used 9% BV CAGR at a 1.5x BV multiple and a 9.8% annual return. Both of these are on the lowest end of Markel’s historical range.

For the base case I used a 11% BV CAGR at the historical average 1.75x BV multiple. This case resulted in a 15.3% annual return.

For the bull case I felt that 1.75x BV was a more appropriate multiple than 2x BV. I then used a 14% BV CAGR, which resulted in a 18.4% annual return.

The main drawback of this method is the book value multiple can sometimes reflect Mr. Market’s mood. Despite continued success and growth of the underlying business multiples can get much lower. This happened after the financial crisis, where the market brought Markel (and Berkshire!) down to nearly book value. However, this means nothing to long-term shareholders. Over 5-10 years the multiples should reflect the underlying business. Hence why growth in book value since Markel IPOed mirrors the return on investment for shareholders over that same time period.

Comprehensive Earnings/ROE Method

The ROE method is even simpler than the last two. If we assume Markel can compound book value at 12% for the foreseeable future we can call that a 12% ROE. A 12% ROE on $560 in book value per share equals $67.20 in comprehensive earnings. At todays price of $811 that comes out to 12x earnings.

If we use the more conservative 9% ROE from earlier, we get $50.40 in comprehensive earnings. That comes out to 16x earnings.

At 14% ROE we get $78.40 of comprehensive earnings, which is 10x earnings.

Although very simple, I think this gives us a good idea of what were paying for Markel. Even at 16x earnings it’s a fair price for a great company.

Taking the base case of 12% ROE and applying an average market multiple of 15x earnings we get intrinsic value of $1008 per share.

Valuation Summary

Taking into account the above valuation methods I think an appropriate intrinsic value range for Markel is anywhere from $800 to $1200, with an average price target of $1000. At $1000 we are getting a 23% upside for a great business that should continue to compound at double-digit rates for years to come.

Risks

In the most recent Markel Brunch held in Omaha an audience member asked “What is the greatest threat to your business?”. Steve Markel first replied by saying:

“I feel awfully good about our business. It’s a challenge to think of one big danger. Which may be the biggest danger. We don’t want to believe our own bull-s— all the time.”

CFO Anne Waleski mentioned that as CFO she is paid to worry about a major event combined with a market event. I thought this was interesting because to her this is the worst-case scenario and gives us an idea of how they think. Gayner reiterated Markel’s comments by pointing to complacency as a major threat. Some may dismiss these comments as narrow minded, but I think management truly believes most risks are within themselves. The business model of Markel has so many options to grow that one threat is really hard to do significant long-term damage.

Beyond the scope of management’s thoughts some risks that come to mind are interest rate risks, inadequate loss reserves, extended soft markets, increased competition in insurance markets, a large natural disaster, a poor acquisition and inferior investment returns.

What’s great about Markel is they have been through each of the previously mentioned risks. They’ve been through both the 2000 and 2008 market crashes, are currently in a very extended soft insurance market, are currently experiencing increased competition from hedge funds in the reinsurance market, they experienced natural disasters such as Hurricane Katrina and made a poor acquisition in Terra Nova insurance. Despite encountering all these risks they’ve continued to thrive and compound book value over decades. They thrive and continue to learn from their mistakes, this is part of why Markel is such a good business.

Conclusion

If the market were to close for the next decade I can think of no better company to own than Markel. They are extremely conservative, disciplined, with a culture that incentivizes and supports such a demeanor. They think of their shareholder’s as partners and management has significant skin in the game with us.

The business model is superb and underappreciated. Buffett pioneered the use of float and Markel is one of the few to successfully replicate this idea. By underwriting profitably they are getting an interest free loan that pays them to hold the money! Tom Gayner continues to make market beating investment returns and after the Alterra acquisition he has double the money to invest. Moving from 50% of shareholders equity in stocks to 80% (Gayner’s target weight) will be a huge tailwind for Markel.

When valuing Markel Ventures I didn’t build in any assumptions for growth despite the fact that it is growing significantly on its own and more acquisitions are likely. I look at Ventures as a free option for shareholders that could be a very significant driver of value over the next decade.

Markel’s ability to compound and allocate capital, underwrite profitably, leverage float, invest at market beating returns, and buy operating businesses make this a first in class company that at worst were paying a fair price for and at best a cheap price.

 

“We want Markel to be one of the world’s great companies.” – Tom Gayner