Markel 2013 Annual Report

So Markel's (MKL) 2013 annual report is out.  MKL grew book value per share by +18.2%, the same as Berkshire Hathaway (BRK).    BPS is now $477.16 versus the recent price of $591, so it is trading at 1.24x BPS.

18% growth in BPS is pretty good, but they also grew BPS at a +16.5%/year clip over five years, +13.0%/year over ten years and +15.3%/year over 20 years.  Those are some pretty impressive figures.

Out of curiousity, I put all of this into the table below.  The first three columns come right out of the BRK annual report.  I added the five columns to the right from MKL's annual reports.   MKL has done better than BRK in terms of BPS growth in five, ten and twenty year time periods.

Sometimes questions come up about MKL's equity portfolio; is it really that good?  So I added the last two columns which shows the return of MKL's equity portfolio over time.   This shows some serious outperformance against the total return of the S&P 500 index over five, ten and twenty year periods.

What is interesting is that not only did they outperform in the longer time periods, but they outperformed in each of 2010, 2011, 2012 and 2013; years that were very strong in the stock market which might cause more conservative portfolios to underperform.

BRK, MKL and MKL's Equity Portfolio versus the S&P 500 Index

*Five and ten year equity portfolio returns don't match figures in table; I used the number reported in the 2013 annual report. Compounding the figures in the above table would give you +20.2%/year and +9.1%/year for the five and ten year returns. 

Five Year Test
Using Buffett's five year test, which is actually no longer Buffett's five year test, MKL has failed to outdo the S&P 500 index over the past five years, just like BRK.  So let's look at Buffett's "through the cycle" test.

Performance from 2007 peak through 2013 (and 1999-2013)
Buffett said in the BRK 2013 annual report that:

Over the stock market cycle between yearends 2007 and 2013, we outperformed the S&P 500 index. Through full cycles in future years, we expect to do that again.  If we fail to do so, we will not have earned our pay.  After all, you could always own an index fund an be assured of S&P results.  

But why stop there?  Since I'm doing the work, I might as well toss in the annualized returns for all of this since the 1999 peak so we get two whole cycles.

Here is what the above figures look like from December 2007 -  December 2013 and December 1999 through December 2013:

                                             2007-2013                     1999-2013
S&P 500 Index                    +6.3%/year                     +3.6%/year
BRK                                     +9.6%/year                     +9.5%/year
MKL                                   +10.3%/year                  +14.9%/year
MKL Equity portfolio       + 8.8%/year                   +10.8%/year

MKL's BPS grew 9.6%/year versus the S&P's +6.3%/year through this cycle; that's 3.3%/year better.  The equity portfolio also outperformed since the 2007 peak.

The comparison is even better if you look at it since 1999; MKL's BPS outperformed the S&P 500 index by 11.3%/year!  That's better than Buffett's goals during his partnership years (10% better than the index).  The equity portfolio also outperformed the index by 7.2%/year.  That's pretty big.


Other Stuff
OK, so Markel had a really good year.  They closed the Alterra acquisition, their combined ratios look good, businesses are growing etc.  I won't get into all of that here so I'll just paste a short summary from the report:

Portfolio Per Share
So here's a metric that MKL usually shows.  Portfolio per share grew to $1,259/share in 2013, versus the current stock price of $591/share.   Why is this important?  Check out what MKL has to say about this:



One common way to value BRK is the two column method.  That is to calculate the investments per share of BRK and add it to some multiple of the profits earned by the wholly owned businesses (businesses not in the investment porfolio).  This method treats insurance "float" as equity as they don't have to be paid back and BRK typically, over time, earns a profit on insurance underwriting (cost of float is negative).

MKL too has a pretty good underwriting record and has earned a profit over time.  Is their "float", then, not equity?  If it is, then MKL's intrinsic value, using the same approach as BRK's two column method, would be portfolio per share (less debt).

But I don't raise this issue to debate the two column method or whether float is equity.  It's just a thought. Hmm...

Shift in Emphasis
Here's a new, interesting thing in the annual report.  From now on, they want us to focus on BPS CAGR (compound annual growth rate) instead of BPS itself.  Here is their explanation:

And they elaborate later in the report (I just cut some stuff out, this is not the whole section so please read the whole letter): 

BPS-CAGR to Earnings and then to P/E
So obviously, a company that is growing book at a faster pace than others should be more valuable.  This is obvious.  But how much higher should the valuation be?   There are many ways to do this, of course.  One thing people would do when looking at financials is to use a 10% hurdle; if a company grows book at 8%, it's worth 0.8x book.  If it grows at 12%/year, it's worth 1.2x book.  Never mind if that makes any sense or not, but that's a quick rule of thumb thing that people sometimes look at.

Since MKL wants us to focus on the earnings/flow aspect of MKL instead of the stock (BPS), why not convert this BPS-CAGR into a sort of earnings figure?   Change in BPS, simplified, is basically comprehensive income per share; kind of like an all inclusive EPS.

So if CAGR of BPS over time is 15%, then MKL comprehensive EPS is like $72/share.   At 10x this figure, MKL is worth $720/share.  But if BPS CAGR is 15%/year, so is comprehensive EPS growth.

If the $72/share EPS is going to grow 15%/year, what multiple would you put on it?  At a very conservative 15x, MKL would be worth $1,080/share.  If MKL can really grow 15%/year, then maybe it's worth 20x p/e.  That would put MKL at $1,440/share.

Why not?

Remember, MKL has grown BPS at 16.5%/year over five years, +13.0%/year over ten years and +15.3%/year over twenty years.

So let's use 13%, then.  Comprehensive EPS would be $62, and this would grow 13%/year.  Put a 13x multiple on it (don't ask me, but growth investors like to pay the same p/e as the growth rate.  Even Julian Robertson did that in an interview a while back).   That would put MKL's value at $806/share.  This sort of makes no sense since a 13% growth rate is way better than the S&P 500 index, right?  So let's say p/e of 15-20x is more reasonable.  That's $930 - $1,240/share in value for MKL.

OK, so I am not going to tell you that MKL is worth $1,440/share, or any of the above values.  I'm just playing around with things to see what would happen.

I think the market would still view MKL as primarily a financial company (so will keep emphasizing BPS for a while, maybe until MKL Ventures gets much bigger); much of their book is still marked-to-market, and that will anchor valuations to BPS somewhat.  But maybe less and less over time.

Equity Portfolio
Oh, and I almost forgot to mention this.  MKL said that after the Alterra acquisition, their equity portfolio as a percentage of shareholders' equity went below 50%, but after building up their equity portfolio throughout 2013, it is back up to 49%.  And they said of this ratio that "we would expect it to gradually increase towards our more normal target of 80% over time".

This is very exciting.  Think about it.  To simplify, let's say that this ratio gets up to 100%.  That means that you get an equity return (better than the index if history keeps rhyming) on the total book value and everything else comes as a bonus; if interest rates go up, then the interest income is additive to this.  If underwriting makes a profit, that's a bonus too.  And if Markel Ventures keeps growing, whatever you gain on that would be on top of the equity portfolio returns.  What's not to like?  (OK, well, you would have to deduct interest expense on debt.  And things can always get ugly with some 'engines' going into reverse).

Conclusion
Anyway, MKL has grown book at a much higher pace than I thought they could in this environment of not-so-great insurance market and low interest rates.  If they can keep this up, 1.2x book looks like a pretty decent bargain!