Y So Cheap?

Alleghany (Y) announced earnings earlier this week; BPS is up +9.4% in the first six months to $451.65/share.  The stock is trading at $417.70/share so is trading at around 0.92x BPS.  The stock market is down 1.5% since then, so maybe less of a discount now.   But it does look cheap. 

Interestingly, book value was up 6.9% but thanks to share repurchases (2%+ of outstanding), BPS went up +9.4%.  

I guess in this market that seems expensive, why not repurchase shares at below book value?  That makes a lot of sense.  

  

Is 0.9x BPS Really Cheap? 

OK, so the question is, should Y trade at or above BPS?  I always liked Y; their annual reports, how they think, how they operate etc.  But they have always been a little bit on the conservative side for my taste.  The annual reports read like gloom and doom reports, and I always wondered if that would get in the way of good performance.  Warren Buffett is conservative too, but he'll back up the truck when he sees something he likes regardless of the outlook.   

Anyway, here's a look at Y's BPS performance over the years and the P/B ratio of the stock:

Y Long Term Performance and P/B Ratio

So it looks like Y has always traded at around BPS since 1987.   It traded above book in 1997 and 2000 (bubble times?) and most recently between 2004 and 2007 (peak of the credit bubble).  So judging from that, we can't really expect Y to trade very much above book in a normal environment.  The business model sort of evolves and has changed over time so we can't really say for sure.  But a prudent expectation is for Y to trade at around BPS over time.   Their big transformational merger with Transatlantic also increases the size of a business that comes with low multiples (many reinsurers, even with much higher ROE than Y trade at or below BPS). 

Long Term Relative Performance

Now let's take a closer look at the long term performance of Y.  Getting long term BPS change for Y is sort of a pain because of their 2% stock dividends they used to pay (so you can't just compare BPS values in different years to each other like you can with BRK or MKL.  Someone should ban these stock dividends that make comparisons a pain!) 

This is really not that surprising given the extremely conservative nature of the folks at Y.  Check this out: 

For the 26 years since 1987, Y has actually underperformed the S&P 500 index total return.  Y's BPS grew +9.6%/year versus a total return of +10.7% for the S&P 500 index (and +17.4%/year for BRK; I put BRK's BPS growth there just for fun). 

Y also underperformed in the 20 year time period. The five year time period is sort of irrelevant because that is off of the financial crisis low and is more a function of how far down something went during the crisis.

So that's really disappointing. 

But Wait! 

Weston Hicks became CEO in December 2004, so the important performance metric here might be to see how he has done.  In the above table, I put the returns for Y, S&P 500 and BRK since the end of 2004.  By this measure, despite Y's (to me) overly conservative and gloomy-doomy world view, Y has outperformed the index by +1.2%.  

Other interesting metrics are returns since previous market peaks.  This can also be pretty telling.  Since the peak (on a year-end basis) in 2000, Y has outperformed the S&P 500 index by +5.5%/year, and since the 2007 peak by +0.4%.

Here's a nice chart from a June investor presentation: 

Y also talks about risk adjusted return in their annual report.  It's not the most important thing for me, but it may be of interest to others who are more worried about the stock market.  

If you are going to invest in a stock but are worried about the stock market, you may want to invest in a business that is almost overly conservative and has a world view that is very gloomy.  This way, you can rest assured that they won't overreach for performance and get hit in a bear market (or I should say, get hit too hard in a bear market). 

Y has proven itself over time through various insurance cycles (huge events in the past decade+), some bear markets and a 100-year event financial crisis.  So in that sense, I would view Y as on the safe side of things. 

Of course, with insurance, you can never really know.  All surprises tend to be on the downside.

Why Not Other Insurers? 

OK, so why bother with Y when we have BRK and MKL?  Well, BRK and MKL are really good investments. It's amazing how well BRK has done even in recent years given it's size.  So I won't argue there.  I won't say Y is better than BRK/MKL.  But I still like it, even though I may not give it a big allocation (again, just due to their seeming over-conservatisim). 

There are plenty of other insurance companies with higher ROE's trading at book or less.  So why not look at the others? 

Well, I am more interested here in Y as an investment conglomerate than as an insurance company.  I look at them more as value investors.  I think a lot of us who follow Y, MKL, FRFHF and others think of it the same way.   So yes, there are other insurance companies that are very good businesses. 

Conclusion

I think Y is a solid investment.  It may not trade much above BPS in the near term; their stated goal is to increase BPS 7-10%/year over time, and I think it's great if they can achieve that and worth BPS if that is the case. 

With BRK now trading at 1.4x book and intrinsic value expected to grow at 10% (on the high side, I think), Y is not so bad at 0.9x if it can achieve 7-10%/year growth in EPS.  (How many mutual funds can you name that have long term records comparable to Y?  And even if you find some that do, fund returns are pretax (you would have had to pay taxes on dividends and capital gains along the way). 

Either way, this is an interesting situation to watch as there have been changes since the Transatlantic merger which I tend to view as positive (more disclosure etc.).  Check out the financial supplement they put out on their website, for example.   Also, their interest income is increasing due to their investments with Ares.  I know there is added risk in reaching for yield here with risk spreads as low as they are, but the folks at Y, given their conservative nature, would no doubt keep overall exposure in check.