The Markel (MKL) annual report is up on the website and as usual it’s a really good read. Markel seems to be on fire, doing really well. They grew BPS +14% in 2014 versus +13.7% for the S&P 500 index (total return) and +8.3% for BRK (BPS). The equity portfolio also did really well, up +18.6% in a year that a lot of hedge funds and value investors didn’t do too well.
Markel is getting more and more invested in the non-insurance business (like BRK). Adjusted EBITDA for the Markel Ventures segment (the non-insurance business) was $95.1 million in 2014. They note in the letter to shareholders that back as recently as 2004, MKL’s underwriting profit (which is pretty much the same as EBITDA) was $72 million. So the non-insurance business is bigger now than the insurance business was ten years ago. Well, there was a big merger (Alterra), but still.
MKL does a great job of describing what they do and how they do it in the letter. I am not going to get into much detail, but I thought I’d make some comments about MKL in general.
First, just a reminder of how MKL makes decisions on capital allocation. It’s nice when it’s written out like this clearly:
Capital Allocation
I just grabbed the first sentence of each paragraph or section that talks about what MKL does with their capital:
- First, we look to support organic growth in our existing
insurance and Markel Ventures operations. - Second, we can pursue acquisitions in the realm of
insurance or non-insurance businesses (that should
cover it). - Thirdly, we acquire publicly traded equity and fixed
income securities for the dual purposes of supporting our
insurance operations and earning good returns on our
capital. - Our fourth and final choice for capital allocation happens
when we believe that the repurchase of our own shares
creates better returns than any of the first three choices.
How They Pick Stocks
This is the same thing written every year, but is always good to remember:
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. You’ll find this language in every
Markel annual report since 1999. We believed in this
approach since the beginning. We just started explicitly
stating it in the annual report that year. Expect this
language to continue in future annual reports.
Long Term Performance
I like looking at things over the long term and it’s great when there is consistency and comparability over the years with a company. MKL is a great company to follow because they have the letter to shareholders going back to 1986 posted on the website, and their annual reports have financial metrics also going back to 1986.
Here is a table of MKL’s BPS growth and equity portfolio performance over the years versus the S&P 500 index (total return). I also put BRK (BPS basis) in the table as a comp. I actually did this for an earlier MKL post and I just updated it.
At the bottom, I put the 5, 10 and 20 year returns. And in the spirit of looking at things “through-the-cycle”, I also put the respective returns since the two recent peaks, 1999 and 2007. The MKL equity portfolio return only goes back to 1990 so I don’t have a “since 1986” for that. But I think we have enough data here to be impressed with the performance there.
| MKL | ||||||||
| S&P 500 | equity | |||||||
| BRK | w/dvd | difference | MKL | vs. S&P | vs. BRK | portfolio | vs S&P 500 | |
| 1987 | 19.5% | 5.1% | 14.4% | 36.3% | 31.2% | 16.8% | ||
| 1988 | 20.1% | 16.6% | 3.5% | 97.9% | 81.3% | 77.8% | ||
| 1989 | 44.4% | 31.7% | 12.7% | 26.8% | -4.9% | -17.6% | ||
| 1990 | 7.4% | -3.1% | 10.5% | -12.1% | -9.0% | -19.5% | -7.0% | -3.9% |
| 1991 | 39.6% | 30.6% | 9.0% | 51.8% | 21.2% | 12.2% | 26.9% | -3.7% |
| 1992 | 20.3% | 7.5% | 12.8% | 29.8% | 22.3% | 9.5% | 13.1% | 5.6% |
| 1993 | 14.3% | 10.1% | 4.2% | 37.5% | 27.4% | 23.2% | 28.7% | 18.6% |
| 1994 | 13.9% | 1.3% | 12.6% | -7.6% | -8.9% | -21.5% | -3.3% | -4.6% |
| 1995 | 43.1% | 37.6% | 5.5% | 53.1% | 15.5% | 10.0% | 29.7% | -7.9% |
| 1996 | 31.8% | 23.0% | 8.8% | 24.9% | 1.9% | -6.9% | 26.9% | 3.9% |
| 1997 | 34.1% | 33.4% | 0.7% | 32.6% | -0.8% | -1.5% | 31.4% | -2.0% |
| 1998 | 48.3% | 28.6% | 19.7% | 18.2% | -10.4% | -30.1% | 13.3% | -15.3% |
| 1999 | 0.5% | 21.0% | -20.5% | -10.9% | -31.9% | -11.4% | -10.3% | -31.3% |
| 2000 | 6.5% | -9.1% | 15.6% | 49.6% | 58.7% | 43.1% | 26.4% | 35.5% |
| 2001 | -6.2% | -11.9% | 5.7% | 7.7% | 19.6% | 13.9% | 16.9% | 28.8% |
| 2002 | 10.0% | -22.1% | 32.1% | 6.7% | 28.8% | -3.3% | -8.8% | 13.3% |
| 2003 | 21.0% | 28.7% | -7.7% | 19.1% | -9.6% | -1.9% | 31.0% | 2.3% |
| 2004 | 10.5% | 10.9% | -0.4% | 19.8% | 8.9% | 9.3% | 15.2% | 4.3% |
| 2005 | 6.4% | 4.9% | 1.5% | 3.5% | -1.4% | -2.9% | -0.3% | -5.2% |
| 2006 | 18.4% | 15.8% | 2.6% | 32.0% | 16.2% | 13.6% | 25.9% | 10.1% |
| 2007 | 11.0% | 5.5% | 5.5% | 15.4% | 9.9% | 4.4% | -0.4% | -5.9% |
| 2008 | -9.6% | -37.0% | 27.4% | -16.2% | 20.8% | -6.6% | -34.0% | 3.0% |
| 2009 | 19.8% | 26.5% | -6.7% | 27.2% | 0.7% | 7.4% | 25.7% | -0.8% |
| 2010 | 13.0% | 15.1% | -2.1% | 15.5% | 0.4% | 2.5% | 20.8% | 5.7% |
| 2011 | 4.6% | 2.1% | 2.5% | 7.9% | 5.8% | 3.3% | 3.8% | 1.7% |
| 2012 | 14.4% | 16.0% | -1.6% | 14.7% | -1.3% | 0.3% | 19.6% | 3.6% |
| 2013 | 18.2% | 32.4% | -14.2% | 18.2% | -14.2% | 0.0% | 33.3% | 0.9% |
| 2014 | 8.3% | 13.7% | -5.4% | 14.0% | 0.3% | 5.7% | 18.6% | 4.9% |
| 5 year | 11.6% | 15.5% | -3.9% | 14.0% | -1.5% | 2.4% | 21.6% | 6.1% |
| 10 year | 10.1% | 7.7% | 2.4% | 12.5% | 4.8% | 2.3% | 12.4% | 4.7% |
| 20 year | 14.3% | 9.9% | 4.5% | 16.5% | 6.6% | 2.2% | 12.7% | 2.9% |
| Since 1986 | 16.4% | 10.4% | 6.0% | 19.8% | 9.4% | 3.4% | 12.3% | |
| Since 1999 | 9.4% | 4.2% | 5.2% | 14.8% | 10.6% | 5.4% | 11.3% | 7.1% |
| Since 2007 | 9.4% | 7.3% | 2.1% | 10.8% | 3.5% | 1.4% | 10.1% | 2.9% |
This is a pretty amazing record. MKL’s BPS growth outperforms the S&P 500 index and BRK in every time period except for the five year return (lags the S&P 500 index). BPS has outpaced both the S&P 500 index and BRK by wide margins since both the 1999 and 2007 peaks. The equity portfolio also outperformed the S&P 500 index by pretty wide margins in all time periods. The 700 bps outperformance since the 1999 peak is pretty impressive as is the five year return.
BPS versus Change in BPS
In recent annual reports, MKL has talked about how BPS has been an important metric when MKL was an insurance company, but that this is less and less the case so BPS won’t be as important as in the past. They want us to focus on the change in BPS instead of the level itself. This is sort of what Buffett is saying too about BRK’s BPS (even though he has a different way of showing intrinsic value).
There are things that change BPS but don’t show up in earnings, so they feel the change in BPS over time shows the real earnings power of the company.
So what does that mean for us? If we take that at face value, then we can just look at the change in BPS over time as earnings and then slap an earnings multiple on it to get a valuation. It’s definitely true that EPS is not very useful in companies like MKL; it’s the comprehensive income that matters. And that is reflected in changes in BPS.
What’s MKL Worth?
So then, let’s see what MKL is worth if we look at a “normalized” earnings rate and a P/E multiple. MKL’s BPS is around $544/share now. Last year was a pretty strong year in the stock market and it was very quiet in the insurance world (not a lot of big events) so earnings might be above trend.
But over time, MKL has grown BPS at double digit rates. The five, ten and twenty year returns were around 14%, 13% and 17%/year. Maybe the 20 year rate of return is skewed higher by the early years. So we can use 13%-14%/year. Let’s say 13%.
If, over time, MKL can grow BPS at 13%/year, that implies comprehensive EPS of around $71/share. If MKL traded at the market P/E, say 17x, that would value MKL at $1,200/share. The long term P/E of stocks in general has been around 14x (for the past 100 years or so). Put a 14x multiple on $71/share gives us a fair value of MKL of around $990/share.
MKL is now trading around $780/share.
Here is this idea laid out in a table. The percentage is the growth in BPS (or comprehensive ROE) over time of MKL and the top row is the P/E ratios. So to get the fair value of MKL using the various assumptions, just look for the figure in the table. For example, if MKL has a normalized comprehensive ROE of 13% and trades at a 14x P/E, MKL would trade at $990/share.
Markel Fair Value Given Comprehensive ROE and P/E Ratio
| P/E | |||||||
| %growth | 8 | 10 | 12 | 14 | 16 | 18 | 20 |
| 8% | 348 | 435 | 522 | 609 | 696 | 783 | 870 |
| 9% | 392 | 490 | 588 | 685 | 783 | 881 | 979 |
| 10% | 435 | 544 | 653 | 762 | 870 | 979 | 1,088 |
| 11% | 479 | 598 | 718 | 838 | 957 | 1,077 | 1,197 |
| 12% | 522 | 653 | 783 | 914 | 1,044 | 1,175 | 1,306 |
| 13% | 566 | 707 | 849 | 990 | 1,132 | 1,273 | 1,414 |
| 14% | 609 | 762 | 914 | 1,066 | 1,219 | 1,371 | 1,523 |
| 15% | 653 | 816 | 979 | 1,142 | 1,306 | 1,469 | 1,632 |
| 16% | 696 | 870 | 1,044 | 1,219 | 1,393 | 1,567 | 1,741 |
| 17% | 740 | 925 | 1,110 | 1,295 | 1,480 | 1,665 | 1,850 |
| 18% | 783 | 979 | 1,175 | 1,371 | 1,567 | 1,763 | 1,958 |
| 19% | 827 | 1,034 | 1,240 | 1,447 | 1,654 | 1,860 | 2,067 |
| 20% | 870 | 1,088 | 1,306 | 1,523 | 1,741 | 1,958 | 2,176 |
Of course, this table can be converted so that the output is not a fair value for MKL, but a fair value P/B multiple. This way, we can use the table to value other companies (like BRK, Y etc.):
Fair Value P/B Ratio Given Comprehensive ROE and P/E Multiple
| P/E | |||||||
| %growth | 8 | 10 | 12 | 14 | 16 | 18 | 20 |
| 8% | 0.64 | 0.80 | 0.96 | 1.12 | 1.28 | 1.44 | 1.60 |
| 9% | 0.72 | 0.90 | 1.08 | 1.26 | 1.44 | 1.62 | 1.80 |
| 10% | 0.80 | 1.00 | 1.20 | 1.40 | 1.60 | 1.80 | 2.00 |
| 11% | 0.88 | 1.10 | 1.32 | 1.54 | 1.76 | 1.98 | 2.20 |
| 12% | 0.96 | 1.20 | 1.44 | 1.68 | 1.92 | 2.16 | 2.40 |
| 13% | 1.04 | 1.30 | 1.56 | 1.82 | 2.08 | 2.34 | 2.60 |
| 14% | 1.12 | 1.40 | 1.68 | 1.96 | 2.24 | 2.52 | 2.80 |
| 15% | 1.20 | 1.50 | 1.80 | 2.10 | 2.40 | 2.70 | 3.00 |
| 16% | 1.28 | 1.60 | 1.92 | 2.24 | 2.56 | 2.88 | 3.20 |
| 17% | 1.36 | 1.70 | 2.04 | 2.38 | 2.72 | 3.06 | 3.40 |
| 18% | 1.44 | 1.80 | 2.16 | 2.52 | 2.88 | 3.24 | 3.60 |
| 19% | 1.52 | 1.90 | 2.28 | 2.66 | 3.04 | 3.42 | 3.80 |
| 20% | 1.60 | 2.00 | 2.40 | 2.80 | 3.20 | 3.60 | 4.00 |
So from this table, we see that if we think MKL’s normalized earnings level is 13% and trades at a 14x P/E multiple, it should trade at 1.8x BPS.
Of course, this is just one way to look at this. There is a problem with this sort of analysis if there is too much financial assets on the balance sheet.
For example, if MKL sold everything and then just owned an S&P 500 index fund, then one can argue that the long term return of the stock market is 10% and so the normalized comprehensive ROE of MKL is 10%. Slap a 14x multiple on that and suddenly, the S&P 500 index fund is worth 1.4x BPS. (Financial alchemy!). Well, there are taxes. And obviously, noone would put a 14x multiple on this entity.
So again, it’s just one way to look at things. We have to be careful not to create alchemic value (that won’t be realized).
But otherwise, MKL is an above average company and has a very good long term track record outperforming the market (on an earnings or value creative basis), so at least a market multiple is not unreasonable. If today’s market P/E is too high, then we can at least use the long run market average.
Float Better than Equity
And here’s another thought. Someone posted a comment in my BRK post that float is better than equity. I don’t want to get into that discussion here too much, but it’s an old argument. Basically, since BRK makes money on the float (negative cost of float), it’s better than equity. And float also grows (or at least has grown until recently; going forward, I don’t know if we can bake growth into any valuation cake as Buffett seems to be talking down any expectation of float growth and is insisting on at worst, a very slow decine in float).
So if that’s the case, float shouldn’t be deducted against assets in any valuation. The two column approach to BRK valuation basically assumes that float is as good as equity since full value is given to investments held per share.
Where am I going with this? Well, MKL too has a really good long term underwriting record. So is float as good as equity for them too?
Check out this long term data (from the annual report). The gray area to the right is stuff I calculated myself for reference. The other data is directly out of the annual report:
| Gross | Port | 5-year | Written | |||||||||
| written | Comb | Inv | per | SH | CAGR in | Closing | prems/ | Inv | Price / | |||
| prems | ratio | port | share | equity | BPS | BPS | price | P/B | equity | lev | inv/share | |
| 1989 | 44 | 78% | 79 | $14.54 | 60 | $11.69 | na | 0.00 | 0.73 | 1.32 | 0.00 | |
| 1990 | 412 | 81% | 411 | $77.27 | 55 | $10.27 | na | $11.75 | 1.14 | 7.49 | 7.47 | 0.15 |
| 1991 | 406 | 106% | 436 | $81.77 | 83 | $15.59 | 35% | $22.00 | 1.41 | 4.89 | 5.25 | 0.27 |
| 1992 | 304 | 97% | 457 | $84.64 | 109 | $20.24 | 34% | $31.25 | 1.54 | 2.79 | 4.19 | 0.37 |
| 1993 | 313 | 97% | 609 | $112.55 | 151 | $27.83 | 25% | $39.38 | 1.42 | 2.07 | 4.03 | 0.35 |
| 1994 | 349 | 97% | 622 | $115.45 | 139 | $25.71 | 17% | $41.50 | 1.61 | 2.51 | 4.47 | 0.36 |
| 1995 | 402 | 99% | 927 | $170.95 | 213 | $39.37 | 31% | $75.50 | 1.92 | 1.89 | 4.35 | 0.44 |
| 1996 | 414 | 100% | 1142 | $209.20 | 268 | $49.16 | 26% | $85.00 | 1.73 | 1.54 | 4.26 | 0.41 |
| 1997 | 423 | 99% | 1410 | $257.51 | 357 | $65.18 | 26% | $156.13 | 2.40 | 1.18 | 3.95 | 0.61 |
| 1998 | 437 | 98% | 1483 | $268.49 | 425 | $77.02 | 23% | $181.00 | 2.35 | 1.03 | 3.49 | 0.67 |
| 1999 | 595 | 101% | 1625 | $290.69 | 383 | $68.59 | 22% | $155.00 | 2.26 | 1.55 | 4.24 | 0.53 |
| 2000 | 1,132 | 114% | 3136 | $427.79 | 752 | $102.63 | 21% | $181.00 | 1.76 | 1.51 | 4.17 | 0.42 |
| 2001 | 1,774 | 124% | 3591 | $365.70 | 1,085 | $110.50 | 18% | $179.65 | 1.63 | 1.64 | 3.31 | 0.49 |
| 2002 | 2,218 | 103% | 4314 | $438.79 | 1,159 | $117.89 | 13% | $205.50 | 1.74 | 1.91 | 3.72 | 0.47 |
| 2003 | 2,572 | 99% | 5350 | $543.31 | 1,382 | $140.38 | 13% | $253.51 | 1.81 | 1.86 | 3.87 | 0.47 |
| 2004 | 2,518 | 96% | 6317 | $641.49 | 1,657 | $168.22 | 20% | $364.00 | 2.16 | 1.52 | 3.81 | 0.57 |
| 2005 | 2,401 | 101% | 6588 | $672.34 | 1,705 | $174.04 | 11% | $317.05 | 1.82 | 1.41 | 3.86 | 0.47 |
| 2006 | 2,536 | 87% | 7524 | $752.80 | 2,296 | $229.78 | 16% | $480.10 | 2.09 | 1.10 | 3.28 | 0.64 |
| 2007 | 2,359 | 88% | 7775 | $780.84 | 2,641 | $265.26 | 18% | $491.10 | 1.85 | 0.89 | 2.94 | 0.63 |
| 2008 | 2,213 | 99% | 6893 | $702.34 | 2,181 | $222.20 | 10% | $299.00 | 1.35 | 1.01 | 3.16 | 0.43 |
| 2009 | 1,906 | 95% | 7849 | $799.34 | 2,774 | $282.55 | 11% | $340.00 | 1.20 | 0.69 | 2.83 | 0.43 |
| 2010 | 1,982 | 97% | 8224 | $846.24 | 3,172 | $326.36 | 13% | $378.13 | 1.16 | 0.62 | 2.59 | 0.45 |
| 2011 | 2,291 | 102% | 8728 | $907.20 | 3,388 | $352.10 | 9% | $414.67 | 1.18 | 0.68 | 2.58 | 0.46 |
| 2012 | 2,514 | 97% | 9333 | $969.23 | 3,889 | $403.85 | 9% | $433.42 | 1.07 | 0.65 | 2.40 | 0.45 |
| 2013 | 3,920 | 97% | 17612 | $1,259.26 | 6,674 | $477.16 | 17% | $580.35 | 1.22 | 0.59 | 2.64 | 0.46 |
| 2014 | 4,806 | 95% | 18638 | $1,334.89 | 7,595 | $543.96 | 14% | $682.84 | 1.26 | 0.63 | 2.45 | 0.51 |
Inv port = Investment portfolio
SH equity = Shareholders’ equity
Inv lev = Investment leverage (total investments / shareholders’ equity)
Price / inv/share = Stock price divided by investments per share
Combined Ratio
The combined ratio at MKL for various time periods (average) are:
Since 1989: 98.0
5 year: 97.6
10 year: 95.8
20 year: 99.6
The combined ratio has been under 100 in all time periods. If BRK’s float is as good as equity, I would argue that this is also true at MKL.
Investments per share at MKL at the end of 2014 was $1,335. So, borrowing from BRK’s two column valuation idea, we can say that MKL is actually worth, right now, $1,335/share. This assumes break even underwriting and no value to Markel Ventures, which has almost $100 million in adjusted EBITDA.
If MKL was valued at investments per share, how would you have done over the years?
Increase in Investments per Share
1 year +6.0%
5 year +10.8%
10 year +7.6%
20 year +13.0%
Since 1989 +20.0%
This reflects total investment return and change in float.
Going forward, we would have to add the value created by Markel Ventures, which is not reflected at all in this “left column” valuation of MKL. We will have to add the right column over time as it gets bigger.
As reasonable as all of this sounds, you will notice (far right column in above table) that MKL has never traded at anything close to investments per share.
Conclusion
Anyway, MKL is a great company and is doing really well. I don’t know the correct way to value MKL, but I just looked at some interesting approaches to see what valuations I can come up with given what MKL has said in their annual report(s), on what Buffett has said about BRK etc.
I’m sort of just putting these different things together in a logical way to see what comes out.
It seems reasonable to me that MKL can trade at $1,000/share. It doesn’t seem like too much of a stretch to me. But will it ever get there? I have no idea. I just think it would be OK if it did.
Check out the report, it’s definitely worth the time!
Thanks for another terrific post. I am curious whether you have further thoughts on Markel's use of EBITDA as the primary metric to track for Ventures. It seems to me that Markel Ventures companies are not particularly asset light and that depreciation is a very real expense that we must account for. I have no issue with EBITA as an important valuation metric but unless we have reason to believe that depreciation charges at Ventures are somehow below actual replacement cost of the assets in question, I feel like EBITDA is a very un-Buffett like way of evaluating a group of operating companies.
Incidentally, EBITDA has now been introduced as a metric impacting management compensation in the new bonus plan (detailed in the proxy).
Other than this relatively minor quibble, I view Markel as the most promising of the "mini Berkshires" and trust management given the outstanding track record. It is curious that Markel commands a lower P/B ratio than Berkshire when arguably the insurance businesses are in the same league as Berkshire's and there is presumably much more runway for Markel to grow over time. I often wonder whether Markel might someday be an acquisition target for Berkshire. Certainly the market cap is within Berkshire's preferred range and if Gayner can be convinced to stay, Berkshire would get a third investment manager and another possible succession candidate. I'm excited about that when I have my Berkshire shareholder hat on, but as a Markel shareholder, I'd have to see a pretty rich valuation before getting too excited about parting with my shares.
Hi,
That's a good question. Frankly, I haven't put much thought into Ventures yet as it seems small. Also, I think it might be worth slightly more than what it's on the books for so not much impact yet on valuation of MKL as a whole.
But yes, EBITDA is a little bit of a head-scratcher, especially since Buffett/Munger keeps telling us that when someone says "EBITDA", that we should run away as fast as possible. I think he even said that this year too, but don't remember.
And yes, they said that EBITDA is basically the same as underwriting profit in this year's report but I'm not too sure of that because as you say, depreciation is a real expense.
Anyway, there is some disclosure in the 10-K about the Ventures segment so that's cool.
As for how it impacts bonuses, I agree that it's probably not the right metric by itself. But I am assuming it's a small part of bonuses anyway; my impression is that book value growth over five years is still the dominant factor.
Hopefully, this will be discussed by shareholders and maybe questions will be raised and answered at the MKL annual meeting or something.
And yes, MKL would probably be a great addition to BRK, but it's so small that it wouldn't make much of an impact. Having Gayner on board would be great, but then Gayner has done really well managing what is now a $4 billion equity portfolio. I don't know what he would be able to do with a $100 billion equity portfolio (or whatever he is allocated). Even if the portfolio is split three ways, each manager would have to manage $30+ billion and that's sort of the level (or more than the level) where many funds hit a performance wall; they are too big to really outperform in a meaningful way as their "pool" of potential investments gets smaller and smaller etc…
Anyway, thanks for dropping by.
Oh, and to use Buffett's metaphor, it seems like the MKL folks are painting an amazing masterpiece on their own and they are probably very proud of it. Even if Buffett would love to acquire them, that would be like, say, Picasso telling Braque that he likes his work and would love to incorporate his work into his own painting. Braque would probably say, no thanks, I'm working on my own thing and I don't what to become a mere footnote! My work stands on it's own, thank you very much!
MKL have specifically spoken about this before. Their Ventures businesses are in fact asset light and they argue depreciation is relatively negligible. I would prefer they use EBITA, but I don't have a big problem with them using EBITDA.
Aha, EBITDA is discussed in the 2010 letter. Thanks for pointing that out. I have forgotten about that.
Depreciation doesn't seem negligible to me and it is worth tracking it over time. We now have enough information to account for it and track ventures how we see fit, so from a reporting perspective all of the information is available. It just seems to me that EBITA would be a better metric to track to evaluate Ventures over time. However, this is a relatively minor area of value for Markel at the moment and I do trust management. The record demonstrates the value creation skills of management quite clearly.
Ventures income statement from 2014 report for reference: http://www.rationalwalk.com/wp-content/uploads/2015/03/image.jpg
I don't understand the EBITDA thing either. 25% of the number they're reporting for Ventures is pure puffery. Negligible? Markel is extremely well managed but that's unfortunately not an honest figure.
The truth is MKL Ventures looks modestly profitable – about $58m of pre-tax earnings on $552m of equity. That's OK, but doesn't quite make you jump out of your seat. I wouldn't say the gap between the IV of Ventures and book is all that high, but it'll be interesting to watch over time.
That's basically how I view Markel Ventures as well. The businesses that have been acquired appear, as a group, to have been purchased at levels that seem reasonable. I don't think we have a See's Candies equivalent yet, but these are still early days for the group. But that's also ok since the current share price doesn't really give much credit to Ventures yet beyond what is reflected in book value.
Rational, I don't think they meant that depreciation is neglible, but that capex is. Unfortunately, the cash flow statement doesn't break down capex for Ventures. Investment cash flow there is probably mostly acquisitions. So depreciation to them is like it is for, say, Seacorp Holdings, where Fabrikant insists that all maintanence capex is expensed, so depreciation should be added back for a true earnings figure.
In that case, they should be breaking out capex in the annual report, and writing about it. If you're going to use EBITDA, you darn well better make a case for yourself, and back it up.
If depreciation overstates maintenance capex, then I agree that it does not represent a true expense and some adjustment should be made. However, I haven't really seen much evidence to lead to depreciation being greater than maintenance capex. In any event, I do not really view the point as very material to evaluating Markel's intrinsic value, just as an interesting point that I think might be a good question for someone attending the Markel brunch in Omaha or the Markel annual meeting a week later in Richmond (I won't be attending either this year).
Yeah, I agree with you guys. It should be made clear, like PAH showing EBITDA versus capex etc. They probably will do that eventually, but as Rational says, it's too small now for it to matter much either way. But as long as we have enough information to figure out pretax earnings and whatnot, it doesn't matter too much to me. Of course, if it becomes an issue with management compensation, then maybe it will have to be dealt with more.
Thanks for the interesting discussion. I wouldn't have paid much attention to Ventures otherwise.
Nice write up. I think Markel Ventures deserves some more weight. They have built that up from scratch to something resembling the profitability of their core operations ten years ago. Should be a good tailwind. http://totalreturninvestor.blogspot.com/2015/03/markel-annual-letter.html
Yes, I suppose so. I will take a closer look later but a quick look didn't seem to have a big impact on total valuation yet as Ventures is reflected in BPS. This gap between intrinsic value of Ventures and stated book will grow over time, though.
Great analysis!
Why do you feel that they can earn 13% ROE? The past returns had tremendously tailwinds from stocks and bonds and even cash. Going forward I would expect Cash, Stock and Bonds to return say 1%, 3% and 5%. Add an alpha of say 3% on the stock portfolio and say a 98% CR, you would be getting closer to high single digit ROE.
What do you think?
Hi,
That's a good question. There was massive tailwinds recently, but longer term figures show massive headwinds too. The ten year figure would include the financial crisis. Since 1999, there were two nasty bear markets. Insurance had some of the worst years in history in terms of events (9/11, Katrina etc…) and a long time of soft markets in the industry, not to mention the economy not really doing that great.
So there are a lot of levers here for growth. Interest rates can normalize (even though that might cause losses in the bond portfolio). The economy can improve around the world and investment leverage can go up etc.
And they are still small enough that there are probably other deals out there. MKL has historically grown through acquisitions and that won't change going forward.
Thanks for the response.
The only headwind had been insurance losses, but even this has been more than compensated by the hard markets that followed. But I would grant you that this was probably a headwind.
As far as cash, bond and stock returns go, they averaged very very roughly about 3%, 6% and 8% over the last 20 years. That is a full 3% higher than what we face going forward. The bear markets are not really a headwind as they did not reduce the realized returns. If their investment portfolio overall realized 6% return over the last 20 years, then just based on valuations the expected return is now 3%. That is a massive headwind to overcome.
If current low rate environment is to continue far into the future, what sort of book value growth do you expect?
I am not trying to be argumentative. I struggle with this issue, since one of the very few industries that I fancy myself as being competent on is P&C and the low investment return climate is making it very difficult to see any sort of decent growth going forward for these companies.
Appreciate your thoughts.
You're right, if returns are 3% going forward it will be hard to grow book. At 3x leverage (vs. 2.5 now), that's a 9% return (before some interest expense). But that's a steady state, no growth scenario. Other things will come from growth; MKL has historically grown through acquisitions. And Ventures should keep growing, particularly if returns in insurance isn't attractive, and that is not included in the above return model.
I too worry about the low investment return environment, and that was one of my first posts about MKL. It still is an issue going forward so we'll have to see.
And the above analysis is just a thought. I would not buy MKL up to $1,000 or anything like that.
Thank you!
My thinking is more in line with your first article on MKL. You seemed to have become more optimistic on MKL now compared to that post.
Hi,
Yeah, I guess I do sound more optimistic. But I like things cheaper rather than more expensive. I don't stick to one way to value anything; I just like to look at things in many different ways. This post was sort of a thought experiment on "what if…". One thought lead to another etc. As I said, I most likely would not be a buyer of MKL at the above levels.
Hi kk, First, thanks for another great post. š Could you add a table comparing ROE for BRK & MKL over the years ? Thanks š
Hi,
ROE on it's own doesn't really tell much about MKL and BRK, so we have to look at BPS growth. And BPS growth for both MKL and BRK are in the table at he top of this post. Thanks for dropping by.
Thanks for another excellent post. As someone who has no financial background and has spent the past year teaching myself Accounting and Valuation, I was hoping you can expand on this point a little bit more though since I've been wrestling with it the past few days.
Management of both MKL and BRK have suggested that ROE is a better indicator of intrinsic value than EPS, EBIDTA, etc. The part I have trouble understanding is why both companies have had fairly low ROEs over the past ~ 10 years (around 7% for BRK and 8% for MKL)? Mathematically I understand that because BV is the denominator for the ROE formula, a larger BV will thus be a drag on the ROE #, but I want to know why this shouldn't be a concern for these two companies that are in fact wonderful allocators of capital.
What about these two companies makes BPS growth more important than ROE? All things equal, you're going to want a company with high BPS growth and high ROE, but those are very few and far between. I guess I'm hoping you can expand upon the interplay between these two pieces, and how they work together (or against) when valuing a company.
Hi,
ROE uses net income. In insurance companies like BRK and MKL, they make a lot of their money on investments. For some reason, dividends and interest income passes through the income statement, but gains from increased stock prices do not. But stock prices and other financial assets are marked to market, so rising stock prices increases BPS (but doesn't increase EPS).
That's the biggest difference between ROE and change in BPS at these companies.
So the traditional, headline ROE at both BRK and MKL doesn't tell a whole lot but change in BPS does. That's why I call the percent change in BPS sort of the comprehensive ROE because it includes stuff that increases BPS but isn't included in the traditional, accounting ROE.
There are other things too, but changes (unrealized gains and losses) in the investment portfolio that affects BPS but doesn't pass through the income statement (until it's realized; realized gains and losses do pass through the income statement) is that main factor in these companies…
Thanks so much for the explanation as this really clears it up and makes sense to me. Since assets get marked to market and those show appreciation for their public holding (but not private ones like See's or Furniture Mart), I now understand why Buffett claims their intrinsic value is probably far higher than BRK's stock price may indicate.
Because of accounting standards, if we see WFC and KO increase their dividend by 400% next year, then BRK's ROE will likely go up because dividends increase NI.
Are there other companies/industries where you think BPS is a better proxy for intrinsic value than the more widely accepted indicators of intrinsic value like owner earnings or FCF?
Buffett actually claims that IV is higher than book value, not BRK's stock price. But that's a different issue. If stocks held by BRK are marked to market, then BPS will not understate their value. The privately held businesses would be undervalued as those are not marked up even if earnings power goes up.
BPS is just one indicator of value. Financial companies in general are often valued using BPS because a lot of the assets tend to be marked to market or are liquid, easy to value financial assets. But still, you can financial companies earning a lot on their capital and others earning very little. You can't value both at the same ratio to BPS, so unless you are looking for a liquidation you still have to look at earnings etc.
BPS makes more sense for a well capitalized insurance company like MKL due to management's discretionary capacity with surplus funds. But if a company isn't equipped to invest in the broad market, then shareholder focus on BPS growth can produce perverse incentives. For example, a recession might impact the S&P more than a given company, but an increase in the payout ratio would turn unrealized losses into realized. And management wouldn't get credit for a smart economic decision because BPS growth is blind to opportunity costs outside of the company balance sheet.
Surprised that so few are trusting MKL, I think they have earned it from their superb management over the years. Investors forget that BRK uses non-GAAP numbers when reporting results. I think BRK gives reasonable explanations why they use non-GAAP numbers, MKL does too.
I think we all trust MKL, but it's OK to ask questions sometimes. We ask, investigate and learn. I learned something from all of this too (made me dig into MV more) so it's all good.
"Trust but verify" is a good policy to have as a shareholder of a public company even when management is fully deserving of trust. I don't think that Warren Buffett or Tom Gayner would take offense at respectful and intelligent discussions questioning aspects of the businesses they run or delving more deeply into accounting issues.
kk,
Let me start by saying your blog is always a great read, and your MKL write-ups in particular over time have been very helpful to my own thinking about MKL as an investment.
I was writing to address one aspect of your valuation which I disagree with and wanted to get your take on. I know you're playing around with numbers and only providing food for thought here and Iām wondering if Iām thinking about it correctly. In particular, when valuing "comprehensive earnings", you are putting a market multiple on it. I think youāre using 14x in your example. However, I think putting a market multiple on "comprehensive earnings" would largely overvalue MKL shares. The comprehensive earnings are mostly from the investment portfolio, and that investment portfolio cannot grow more than investment return of the portfolio itself (plus some small growth in the float in any single year) and that growth rate (of the investment portfolio, but not book value) is below the market rate of growth and therefore requires a below market multiple. Hopefully the following example helps:
Letās start with this exercise:
How much would you pay for an investment that earn 7% ROE the first year, retains 100% of the proceeds and reinvests it at 7%, effectively growing earnings 7% but with zero FCF along the way?
If you wanted a 10% rate of return, you would pay about 7-8x earnings to make it compelling for you, since this is an investment that āearning below the required 10% return on capitalā. It is reinvesting 100% of the return proceeds and only earning 7%.
Let's assume going forward MKL earns 7% a year on their investment portfolio which is what they have done historically (no small feat I might add), and ignore any growth in float for the moment which should be only a small additional contribution in any single year. Let's also ignore the underwriting profit and interest payments. Further, letās ignore MKL ventures, which only amounts to $2-3 per share. This is just to simplify the exercise, so that weāre only trying to find the appropriate multiple to for the earnings that are coming from the investment portfolio.
For an investment portfolio of $1,325 per share, at 7% tax equivalent returns, Markel should earn $93 per share in equity next year, growing book value by 17% ($93 per share added to $543 per share). The investment portfolio itself however should only grow at 7%, unless the extra $93 can also be followed up with an extra $232 ($93*2.5 leverage) per share growth in float through organic underwriting growth, which is highly unlikely in any single year ($3.2B in aggregate). Under a conservative scenario, we should only value the earnings on the investment portfolio, which grows at 7%, with 100% reinvestment. We determined earlier that an appropriate multiple for that asset should be around 7x, which gives me $651 per share in value. Maybe I get another $45 per share for Markel Ventures (run rate of $3 per share *15x multiple), but it seems like without further value-additive acquisitions or share repurchases, Markel may be close to fairly valued at this point? Do you agree or disagree?
Hi. Yes, your argument is basically the same argument I made when looking at valuing the investments per share of BRK a while back and I agree with it basically. That's the way financial companies are or were typically valued; some sort of 10% return.
The above analysis of MKL looks at it more as a regular company with a regular earnings multiple but it may be a little early for that.
I think the investment leverage, though, is more a function of the insurance markets, but it may be true that over time it can't keep up with growth in the investment portfolio; that's why the Ventures business gives them another value creating lever that may become more important over time.
For an investment portfolio of $1,325 per share, at 7% tax equivalent returns, Markel should earn $93 per share in equity next year, growing book value by 17% ($93 per share added to $543 per share). The investment portfolio itself however should only grow at 7%, unless the extra $93 can also be followed up with an extra $232 ($93*2.5 leverage) per share growth in float through organic underwriting growth, which is highly unlikely in any single year ($3.2B in aggregate).
I think the numbers look incredulous only because you picked a very high investment return of 7%, which is unrealistic. Pick a number half that, which is more likely and the numbers do not look so daunting.
Thanks
"I think the numbers look incredulous only because you picked a very high investment return of 7%, which is unrealistic. Pick a number half that, which is more likely and the numbers do not look so daunting."
I am the same poster from two comments ago responding to the prior post. I am not sure why you think a blended 7% is unrealistic. In fact, MKL reported 7.4% in 2014 (would have been close to 9% if it wasn't for fx headwinds), and a 5 year CAGR of 7%. Markel has only had an investment return of under 3.5% (the half of 7% that you are suggesting) twice in the past 10 years. 2008, and 2005.
Anyway, as I've thought about it more, I'm rethinking my original comprehensive income growth estimates a little. It's likely that comprehensive income should grow a little faster than the 7% assumed investment portfolio returns. This is is because they are targeting an 80% of book value in equities. So as leverage comes down as the investment book grows faster than float, the "excess book value" that isn't encumbered by float is invested in the higher returning equities securities. I think this also seems to be true historically. Therefore a higher than the 7x multiple I previously suggested, possibly 9-10x mutliple on a "normal" comprehensive income would be justified. Suggests around a $900 to $1000 fair value today for MKL (including MKL ventures). This is equivalent to the 1.75x P/B that MKL has traded at historically, on average. It's just something I was thinking about as kk wrote the above post and was trying to test my thinking with him and others here.
Your forecast of growth in book value is wildly optimistic. If you project Markel's 2015 results as a 10% return on the equity portfolio (assuming a market return of 8%), a 2.5% return on the bond portfolio, and a 2% underwriting margin, the company will be hard-pressed to grow book value by more than the market return (8% in the example above). Moreover, 2013-14's performance was helped by issuing equity at a significant premium to book value – this can be seen by comparing book value growth to tangible book value growth.
I don't know what the right assumption is; that's why I put the table in the post. You can just move your finger around the table like on a ouija board and come up with various fair valuations for MKL based on different assumptions.
Hi, Great analysis, just one quick question:
How exactly are you getting from ROE to EPS? Thanks!
I'm just using comprehensive earnings EPS as opposed to accounting, GAAP EPS. My EPS is simply the change in BPS from year to year, so it would be EPS = BPS[0] – BPS[-1].