Markel: Book Value Growth and Capital Allocation

Markel Corporation Annual Report 2014

MKL2Markel’s annual report for 2014 has been released and can be downloaded here.

Here is our annual report to you for the year 2014. If you are reading this, it’s probably because you already own Markel. This is your company. You own it and we work for you. In the course of this report we’ll attempt to answer two major questions that we think you would want to know as owners of the business, namely, “How are we doing, and, what’s next?” (Source: Annual Report, 2014)

Also, the letters to shareholders dating back to 1986 is also found at Merkel’s homepage (see link above).


We are a diverse financial holding company serving a variety of niche markets. Our principal business markets and underwrites specialty insurance products. We believe that our specialty product focus and niche market strategy enable us to develop expertise and specialized market knowledge. We seek to differentiate ourselves from competitors by our expertise, service, continuity and other value-based considerations. We also own interests in various industrial and service businesses that operate outside of the specialty insurance marketplace. Our financial goals are to earn consistent underwriting and operating profits and superior investment returns to build shareholder value. On May 1, 2013, we completed the acquisition of Alterra Capital Holdings Limited (Alterra), a Bermuda-headquartered global enterprise providing diversified specialty property and casualty insurance and reinsurance products to corporations, public entities and other property and casualty insurers. (Source: Annual Report, 2014)

Book Value per Share

Compounded annual growth rate in book value per share during the last twenty years has been 16% (see image below taken from the 2014 annual report).

I have also put together a simple diagram showing book value per share from 1996 to 2014. During this time period book value grew from $25.71 to $543.96.




Capital Allocation

In the shareholder letter Markel lays out a detailed description of its capital allocation policy (emphasis added).

First, we look to support organic growth in our existing insurance and Markel Ventures operations. We have a team of proven, successful operators within the walls of Markel. Our first choice is to give them more resources when they have the opportunity to put money to work effectively.

Second, we can pursue acquisitions in the realm of insurance or non-insurance businesses (that should cover it). We have experience and a proven track record of being able to successfully acquire and operate businesses all around the world. In the short-term, we can do math and count money. We can, with reasonable precision, know what things cost and what returns we can earn when we own them. We’ve done that.

More importantly, in the longer term, we see that our values and our culture work all around the globe. Talented people want to be part of this company. With talented and honest people we can accomplish anything. As such, in the long run we expect the businesses we buy to grow far beyond our initial estimates of size and profitability and to eventually exceed our wildest expectations. We do more of what works, and we give more resources to the talented associates who make good things happen. We do less of what doesn’t work, and we reallocate those resources to others.

This works. It is what matters over time.

We ask for an unusual degree of trust and flexibility from our owners and we try our best to be explicit in communicating how we are proceeding with our plan to build one of the world’s great businesses. The good news is that you have decades of evidence demonstrating that we deserve this trust and will carry on in building the value of your company. We intend to keep going.

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. The great news to report is that our investments did what they are supposed to do. They supported the insurance operations AND they produced excellent returns on our capital.

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.

As to our fixed income operations, we look for the highest quality fixed income securities that we can find to match up against our insurance liabilities. In large measure, we match the expected duration and currencies of our insurance liabilities to fixed income securities with similar durations and currencies. We do not attempt to forecast or profit from interest rate or currency movements. While we remain humble about our ability to earn returns from forecasting the future, we do remain responsible for protecting our balance sheet against big changes in those factors. As such, we continue to own a portfolio of fixed income securities which mature faster than what we expect from incoming insurance claims. We will continue to maintain this modest override from our normal design until such time as interest rates are higher than current levels. We just don’t think we are being paid appropriately to take the risks of owning long-term bonds so we won’t do it. It is the same decision any underwriter at Markel would make when they don’t think the rewards justify the risk.

We manage practically all of our investments in house at an extraordinarily low cost. At year end the total investment portfolio stood at $18.6 billion. Our total in house management costs remain a single digit number of basis points of that number and can’t even be measured until you get to hundredths of a percent. Additionally, we tend to be incredibly tax efficient in managing our investments given our long-term ability to buy and hold quality equity investments. This is a massive addition to the long-term returns you earn as shareholders. We continue to use our four lenses to find and select investments and we often ignore investment fashions and conventional wisdom while doing so. Currently, two features of today’s marketplace strike us as good examples of ways in which we behave differently than most institutions.

One example is the current move to passive and indexed investments. One goal of indexers is to reduce investment costs. Count us in for that part. As we cited earlier, we operate at very low investment management cost levels. The problem with indexing, and when it cycles in and out of favor, is that it is a relatively brainless activity. Certain behaviors and practices get reinforced by money gushing in or out of indexes, and prices of real companies get distorted in the process. We’ve been around long enough to have witnessed the dreadful returns experienced by indexers in the late 90’s and early 2000’s. We’ll try to use brains and common sense to avoid the excesses of index strategies while at the same time competing toe to toe with them on costs. Our record of now being in our third decade of outperforming the S&P 500 should give you some confidence in our approach.

A second example of how markets periodically become unhinged from long-term reality can be seen in the current action of the oil market. Arguably, oil is the most liquid, important and globally traded commodity on the face of the earth. Hundreds if not thousands of companies participate in the energy business. Hundreds of thousands if not millions of people work in, and study this field. The fact that oil could sell for over $100 per barrel, and for less than half that price within a few short months, should be about all of the evidence you need to dismiss those who believe in efficient markets, or forecasting just about anything.

Our investment record has not and will not be based on our ability to forecast the future of geopolitical changes, interest rates, currency moves, technological change or any other factor that occupies the minds and hours of countless investment professionals. We simply accept that all of those things will continue to fluctuate and change, and that our four part process does the best job we know of finding the people and financial circumstances who will make the best of whatever happens.

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. We’ve only purchased modest amounts of our stock over the years and we believe that you are better served when we can reinvest capital into businesses which create attractive recurring returns. (Source: Annual Report, 2014)

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. This article is informational and is in my own personal opinion. Always do your own due diligence and contact a financial professional before executing any trades or investments.


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