Although the stock market is near all-time highs, and its cyclically adjusted price-to-earnings (P/E) ratio is close to the dot-com peak, it is still possible to find attractive value stocks. Since it's nearly impossible to time the market, buying a consistent compounder at a fair valuation is a better strategy than waiting for a crash.
That's where Markel (MKL 7.83%) comes in. The specialty insurer has been compared to Berkshire Hathaway (BRK.A 0.37%)(BRK.B 0.59%) because it uses insurance premiums to invest in stocks and acquire businesses.
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It's been a winning formula over the long term. The stock has returned about 700% since 2000. That's double the S&P 500 index. For investors with a long time horizon, waiting for a market crash is likely to cost more money than just buying and holding the shares. That's especially true given the reasonable valuation right now.
The baby Berkshire nickname
Markel consists of three business units that create a cycle of cash, investments, and returns. Its insurance segment isn't typical. Unlike life or health insurance, or even traditional property insurance, the company writes policies in underserved areas where it feels it has expertise. This reduces competition and lets it succeed based on policy availability and service rather than price.
Insuring specialized professions, earthquake-exposed commercial properties, and equine-related risks are just a few of the oddball niches the company has carved out for itself. If it feels like the portfolio is out of balance, it will sometimes collateralize these risks and sell them to other investors to generate income. It's a small part of the business but a useful one to constantly maintain the desired risk profile.
The premiums its customers pay generate float -- money for a service (insurance claims) the company doesn't yet need to provide. That float is tantamount to an interest-free loan. Management uses some of this money to invest in equities.
Those investments represent the second segment of the business. The industry is highly regulated, and Markel has to invest a significant portion of the premiums in ultra-safe bonds. However, what it has been able to invest in stocks has consistently outperformed the broader index over the past two decades.
| Period | Markel Annual Equity Returns | S&P 500 Annual Returns | Annual Outperformance |
|---|---|---|---|
| 2016 to 2020 | 15.5 | 15.2% | 3 bps |
| 2011 to 2015 | 13.7% | 12.6% | 11 bps |
| 2006 to 2010 | 6.2% | 2.3% | 390 bps |
| 2001 to 2005 | 10% | 0.5% | 950 bos |
Data sources: Markel, YCharts; bps=basis points.
The third business unit is called Markel Ventures. It's through this segment that Markel owns controlling interests in businesses outside of speciality insurance. Similar to Berkshire Hathaway, Markel lets local management teams run these independently once acquired. The portfolio of companies reported $2.8 billion in revenue last year and is split about evenly between physical products and services.
A fair value and potential inflation hedge
Warren Buffett has said it is better to buy a great business at a fair price than a fair business at a great price. In evaluating the price of his own stock, he has historically used book value as a measuring stick. Book value is simply a company's assets minus its liabilities.
Like Berkshire, Markel management uses the rate book value compounds to assess their own performance. That makes it a useful way to analyze valuation over time. Outside of the pandemic, the stock has traded between 1.35 and 1.75 times its book value over the past five years. Right now, it sits at the bottom of that range. In that respect, investors don't need a market crash to get a fair price on the stock.
MKL Price to Book Value data by YCharts
An interesting correlation also exists between that price-to-book ratio and the 10 year U.S. Treasury yield. It makes sense. Insurance companies tend to hold a lot of their assets in bonds. Therefore, a portion of Markel's profits will rise and fall with interest rates.
MKL Price to Book Value (3y Median) data by YCharts
Investors worried about potential inflation might see this as a hedge against rates rising. It's just another way diversification helps stabilize profits.
In an expensive stock market, it's understandable if investors are nervous. With so many companies priced for years of hyper-growth, some are bound to disappoint. However, Markel offers investors a solid business, with proven management, at a valuation that has historically produced solid returns.
The stock may not fit the wild daily swings that day traders love, but its consistent compounding has produced market-beating returns over decades. That's why now is a great time to pick up shares rather than waiting for a crash that could still be years away.
