Odds of a Double 'Very High" for Mini Berkshire-Hathaway, Markel

Berkshire Hathaway has been one of the most successful companies over the past 43 1/2 years. They have grown book value per share at about 20% per year with stock performance of a similar amount. Given their $286 billion market cap, growth going forward most likely will be only a few percentage points above the stock market. I expect the stock market to return no more than seven percent over the next decade. I think the highest rate of growth in book value per share you can hope for Berkshire Hathaway over the next decade is 10 percent.

As a holding company, Markel operates in a very similar manner as Berkshire Hathaway. They write insurance and invest the float. First, they have grown book value per share at a 20 percent annualized rate since going public in December 1986. Markel has a huge advantage over Berkshire in that it is much smaller. The current market cap of Markel is $7.3 billion - one fortieth the size of Berkshire. Markel has a good chance of growing book value per share above 10 percent per year. There is a slight possibility they could grow it as high as 15 percent per year.

Like Berkshire, Markel generates its returns based upon underwriting profitable insurance and investing the float. Markel is an extremely well managed company. First, over the past decade, their stock portfolio has beaten the S&P 500 Index by two percent per year. Second, Market underwriting success is one of the best in the insurance industry. Since going public in 1986 they have generated an underwriting profit in about two-thirds of the years. This compares very favorably to the industry which has generated an underwriting profit in only 12 percent of the years since 1986. Markel has generated superior underwriting results in every 10 year rolling period since 1986. Over the past decade they have a combined ratio that is 5.5 points higher than the industry. The weakest 10 year relative combined ratio occurred during the 10 year period ending in 2006 when their underwriting profit was 2.9 percentage points than the industry.

With Markel you have an outstanding company with great management. What is most compelling about Markel is its valuation.Since 1986 Markel has sold at an average price to book value ratio of 1.84. Peaks in their valuation occurred in March 1987 (P/BV of 3.95), September 1997 (P/BV of 2.75) and January 2007 (P/BV of 2.44). Troughs in their valuation occurred in December 1990 (P/BV of 1.11), January 2009 (P/BV of 1.15), August 2010 (P/BV of 1.13) and September 2011 (1.06). The current P/BV valuation of Markel is 1.15. (See attached PDF for a historical valuation chart.)

Holding companies such as Berkshire Hathaway, Leucadia, and Brookfield Asset Management typically sell at a trough valuation of 1.0 times book value to as high as 2.5 to 3.0 times book. Fair value for these conglomerates tends to run about two times book value. Assuming a trough valuation for Markel of one times book, estimated downside risk from its current 1.15 P/BV ratio is 13 percent. At two times book value the company would have upside appreciation potential of 74 percent. This is a very favorable upside return potential of 5.7 times estimated downside risk.

The odds of a double digit return for Markel over the next decade is very high. Assuming a terminal P/BV ratio of 1.75 and growth in book value per share of 10 percent per year, the total return for Markel would be 14.7 percent per year. A terminal price/book value ratio in 10 years of 1.5 implies a 13.0 percent annualized return. With Markel, at its current price you get an outstanding management and the potential for an attractive return over the next decade.