The Buffett Clone that Beats Berkshire by 70%...

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1 Nicholas Vardy s SPECIAL REPORT For Alpha Investor Letter Subscribers Only The Buffett Clone that Beats Berkshire by 70%...

2 IMPORTANT NOTE: This special report is for information and educational purposes only based on data as of June Do not buy or sell any investments until you have read the current issue of The Alpha Investor Letter, a current Hotline or an update from Nicholas Vardy. The Buffett Clone that Beats Berkshire by 70% 2015, by Nicholas Vardy. All rights reserved. No quotes or copying permitted without written consent. Published by: Eagle Publishing, Inc. 300 New Jersey Ave, NW 5 th Floor Washington, DC / CustomerService@NicholasVardy.com Website: No quotes or copying permitted without written consent.

3 The Buffett Clone that Beats Berkshire by 70% Dear Investor, Introduction In this Special Investment Report, you ll find one of my favorite American companies... It s a small, overlooked specialty insurer that s more profitable than Warren Buffett s own heavily insurance-weighted Berkshire Hathaway. In fact, it has beaten Berkshire handily since the late 1990s... By playing Buffett s own game better than he does! And in this report, you ll learn all the reasons why it s going to KEEP beating Buffett s baby for years to come... Including the one way this company differs from Berkshire and how that difference has allowed it to beat Berkshire s returns by 70% over the last 16 years. With that, I ll leave you to enjoy the report. Nicholas Vardy Editor, The Alpha Investor Letter

4 The Buffett Clone that Beat Berkshire by 70% Markel Corporation (MKL) is a low profile but highly profitable specialty insurer. Because of the close resemblance of Markel s business model to Warren Buffett s Berkshire Hathaway (BRK-B), analysts have dubbed Markel the Baby Berkshire. To me, it s more like a Buffett clone, as the company s structure is identical to Berkshire s in every way except one as you ll see. Before getting to that difference, let me tell you how the two companies are similar. Markel s Baby Berkshire nickname is particularly apt. Just 7% the size of Berkshire Hathaway, Markel offers the best of both worlds: a Buffett-style investment model that boasts the best of Berkshire Hathaway combined with the nimbleness of a (relatively) small-cap stock. I believe that Markel has the right people in place to replicate Buffett s track record at Berkshire. In fact, Markel already has a strong record of doing just that. One of the best-kept secrets in investing is that Markel has actually outperformed Berkshire Hathaway since the late 1990s. Markel s Berkshire Hathaway-Like Business Model Founded in 1930, Markel is a specialty insurance holding company with a profitable underwriting and investment strategy that is explicitly modeled after Berkshire Hathaway. To emphasize its philosophical connection to Buffett, Markel holds a shareholder brunch in a conference room at the Omaha, Nebraska, Hilton each year on the day after Berkshire Hathaway s annual meeting. Markel has built both its experience and reputation as one of the leading players in specialty insurance markets. Markel has insured everything from classic cars, boats and event cancellations to children s summer camps, vacant properties and new medical devices. Markel even insured the red slippers Judy Garland wore in the Wizard of Oz. And no other insurance company has insured show horses for more than 50 years. The combination of Markel s size, its expertise and its capacity to assess and insure unusual risks have given Markel both pricing power and a sustainable advantage over its competitors. Markel built its expertise in this area through its long history of acquisitions. Since the 1980s, Markel has acquired 15 separate companies, each of which operate in highly specialized areas. In 2013, Markel acquired Alterra, a reinsurer, in what it dubbed a transformative deal that instantly doubled Markel s written premiums. Equally importantly, the Alterra acquisition grew the size of Markel s investment portfolio from $9.3 billion to $17.6 billion a huge bonus given Markel s Berkshire-like investment strategy. Markel also made its first overseas acquisition with the purchase of London-based Abbey Protection in early Markel s laser-like focus on specialty insurance has made it a star performer in

5 the insurance business. Insurance premiums written have grown by an average of 18% per year over the past two decades. Over the past 10 years, Markel has averaged a combined ratio of just under 96%. As long as that number is under 100%, Markel is taking in more money in premiums than it is paying out in claims. That is actually a rarity among insurance companies, and it confirms that Markel does an excellent job in assessing the risk in the policies it writes. The Insurance Industry s Unfair Advantage Buffett critics have made a big deal of Berkshire Hathaway s unfair advantage due to its ability to invest the float it receives in insurance premiums. To really understand the implications of the float on a company s profitability, you need to understand how the insurance business differs from every other business. On the one hand, selling property-casualty insurance is hard going. Industry competition is fierce, and the products offered by various companies are pretty much identical. Furthermore, the insurance industry s record of assessing risks that is, its ability to earn money on policies sold is terrible. State Farm, the largest insurer in the United States, has lost money on insurance policies for nine of the past 12 years. On the other hand, insurance is the only business in the world where people throw money at a business for free. In every other business, companies have to borrow money or sell stock or provide some kind of good or service. Even banks have to pay depositors. In contrast, an insurance company will not only get all the capital it needs for free, but it will also be paid by its customers to accept it. Insurance companies take the premiums paid by policyholders the money that belongs to policyholders from premiums that are reserved for future claims and invest them into a range of financial assets. This is the infamous float. Insurance companies can do this even though they don t really own most of the money they re investing. This is a classic example of leveraging your returns by using other people s money. Insurance companies also enjoy huge tax advantages. After all, insurance companies don t have to pay taxes on the premiums you pay them, because they haven t yet earned any of that money. So unlike most companies that have to pay taxes on revenue and profits before investing, insurance companies get to invest all of the money they receive first. Think of the float as a massive taxfree loan that bears no interest and doesn t have to be paid back. Markel and Its Float Markel s core specialty insurance business is profitable, and much like Berkshire s, it generates a significant float. As you ve seen, the float is effectively free money for Markel to invest for the sole benefit of shareholders.

6 Yet, few insurance companies actually invest a large percentage of their portfolio in stocks. Most stick to fixed income instruments to make sure they can always pay claims. In contrast, Markel invests a much larger portion of its float into stocks. This means higher returns for the investment portfolio over time although this comes at the price of higher volatility. In this way, Markel s philosophy again echoes that of Berkshire Hathaway. Markel invests its shareholder equity with a long-term view, with the conviction that stocks of quality companies at fair prices will outperform bonds over long periods of time. Markel s Buffett Disciple, Tom Gayner Tom Gayner, Markel s long-time Chief Investment Officer, runs Markel s investment portfolio. Not surprisingly, Gayner is a very public disciple of Warren Buffett, and his philosophy sounds a lot like that of the Oracle of Omaha himself. Gayner invests in equities using a simple four-point filtering process based on the principles of value investing. Gayner has said he looks 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 Markel s $3 billion stock portfolio is much less concentrated than Buffett s, Gayner s commitment to Buffett s principles have delivered similar results. Under Gayner, Markel s book value per share compounded at 15.3% per year for 20 years, and its equity portfolio has grown 12.8% per year over the last 10 years. In the August 2014 issue of The Alpha Investor Letter are the average annual returns that Markel s investment portfolio has produced with a comparison of the steadily rising per-share book value and stock price. Over the past 20 years, Markel shares have risen from $39 to $800. With Gayner himself holding 39,000 shares of Markel stock, worth more than $31 million, Gayner has got a lot of skin in the game. A Note on Markel s Management Markel s shareholder-friendly management is one of those intangible assets that does not show up on a balance sheet. Markel management has always focused on the importance of creating an ownership culture and trust. Employee turnover at Markel is very low. Compensation is highly tied to long-term incentives, such as five-year compound annual growth rate of book value. And 50% of employees bonuses are in stock. Management strives to create an ownership culture where employees think like owners and they operate with long-term mindset.

7 Markel: Historically Cheap You might think that you d need to pay a premium for a stock like Markel. But you d be wrong. Markel s current Price to Book (P/B) ratio stands at 1.4, while its long-term, 28-year average P/B Ratio is With Markel you get a consistently profitable insurance company with one of the best investment management teams around and a shareholder-friendly long-term management at a cheap price. And you get a company on a roll, as the one-year chart below reflects: Source: StockCharts.com 3/26/15 So buy Markel Corporation (MKL) today, and check the latest monthly issue or Hotline for the current stop price on this place. Disclosure: I own Markel in my personal portfolio and on behalf of my clients at Global Guru Capital.

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