By Jack Fuller
“Investment is most intelligent when it is most business-like.” The famous words uttered by Benjamin Graham are some of the most important in the history of investing, and influenced a legion of followers who include William J. Ruane, Irving Kahn and Warren Buffett. We took a look at five stocks which have leaders who believe in the value investment mantra, and who would make Benjamin Graham proud.
We think these names have a good possibility of strong returns for investors as well:
Leucadia (LUK) was the first to pop up on our radar. The investment company manages more than $9 billion in assets and has holdings in a variety of firms, including iron and copper mines, plastics manufacturers, hotels and casinos, wineries, and energy facilities among many more. The “mini Berkshire Hathaway” (BRK.A) has a simple goal – invest in undervalued companies to create value for investors.
Leucadia has done just that in the past few years as shown in its 10K, with large stakes in the investment bank Jefferies (JEF), whose shares have tripled in just a few years. LUK was also an early believer in beaten-down auto lender AmeriCredit (ACF), which was bought out by General Motors (GM) a few months ago for $3.5 billion.
Our bullishness on Leucadia can be distilled to the following: a) the firm’s management can identify undervalued assets and turn them around; b) Ian Cumming and Joseph Steinberg are a team that consistently makes great investment decisions and acts transparently; and c) Warren Buffett's Berkshire partnered with Leucadia multiple times in the past (Berkadia), which demonstrates that Berkshire, too, is confident in LUK.
However, while the firm has many positives, we also have a few concerns. We are concerned with how heavily dependent on Cumming and Steinberg the firm is; without them, we believe Leucadia’s valuation would severely weaken. Still, we think Leucadia has made some great bets with heavy early investments in energy and biotech, and we think that they may pay off and raise Leucadia’s value significantly. LUK, with a $34 share price and $8.3 billion market cap, would certainly make Graham proud with its shrewd acquisition history.
Markel Corporation (MKL) is also worthy of Graham’s keen eye. This specialty insurance firm has come a long way since its IPO of $8.33 per share in 1986; the firm currently trades around $410 per share and commands a market cap of $4 billion. Markel takes on policies dedicated toward items that are relatively obscure and infrequently priced. The strategy leaves Markel with fewer competitors going after the same dollars, and gives it the room to gain added profits, albeit with a greater chance of risk considering its high amount of investment in common stock. Markel was doing well until the recent natural disasters in Australia (floods), New Zealand (earthquake) and Japan (Tsunami). The damages cost Markel about $70 million, hurting Markel's first quarter profits. Despite this blip, we are confident in Markel’s niche position.
Markel hit a year high of $430.26 in April, and we expect that number to be exceeded by the end of the year. We only remained concerned with the risk associated with Markel’s heavy investment in equity as an insurer, but we believe it shouldn’t be too much of a problem as we expect markets to rebound.
We think Markel's bets in Carmax (KMX), Home Depot (HD) and Diageo PLC (DEO) show that Markel's chief investor, Tom Gayner, has the discipline to allocate capital to wide and emerging moat companies at the right price.
For more conservative stakeholders, Graham would likely approve of Alleghany Corp. (Y). Alleghany has found its comfort zone in property/casualty insurance with real estate mixed into the formula, and its goal is to create stockholder value through ownership and management of a small group of operating businesses and investments. Alleghany’s subsidiaries include Capitol Transamerica (CATA) and RSUI Group. Alleghany Corporation has had an average earning growth of 1.9% over the past 10 years. As of the end of February, Alleghany held $825 million in cash for use in future investments and no debt to note.
Alleghany focuses on purchasing positions in companies that it plans to hold and improve for long periods of time. That business model allows Alleghany to invest in firms that others would typically avoid, and makes it a more reliable investment similar to Berkshire. We remain bullish on Alleghany, and eagerly await its next move with its large cash reserves. Shares trade at $327.
Alleghany's investment team was prescient with early positions in railroad stocks. Years after Alleghany initiated positions in Burlington (BNSF), Berkshire eventually bought the railroad. As a Seeking Alpha story pointed out back in 2007, Y is another "mini-Berkshire." Y still owns parts of HomeSite and ORX exploration, an E&P.
The fourth firm on our list is Wesco Financial Corp. (WSC). The diversified financial corporation chaired by Charlie Munger is based in Pasadena, California, and does business in insurance, furniture rental and steel service. In February, Berkshire Hathaway agreed to acquire the remaining 19.9% of Wesco it did not already own. Wesco shows some strong financials: according to SmarTrend, Wesco commands the highest free cash flow per share in the property and casualty Insurance business at 18.89x, and also ranked fourth in terms of sales per share in the property and casualty industry with a sales per share of 104.6x.
We also think Berkshire’s purchase of remaining shares shows great confidence in the firm’s ability to generate further value for investors. However, we would have to hold on Wesco based on a heavy year-over-year loss in net income. Based on its most recent quarter, Wesco’s net income decreased 533.9% year over year, and return on equity has also dropped. Of all the firms on our list, Wesco offers the least potential on a standalone basis because its shares will be exchanged for Berkshire shares. Wesco trades around $385.
We finally arrive at Berkshire Hathaway (BRK.A) (BRK.B), Warren Buffett's baby, which owns over 70 firms and has stakes in more than a dozen others. If there is one Graham disciple who stands above all others, it is Buffett with his focus on providing value to investors. Berkshire’s book value per share has increased an average of 20% per year over the last 40-plus years, but we do see slowing in that growth rate due to Berkshire's large size.
The company’s fourth quarter earnings were up year over year, helped significantly by the recent acquisition of railroad company Burlington Northern Santa Fe. The firm also sat on a mountain of cash at the turn of the new year (about $35 billion), and that doesn’t include the cash it received from Swiss Re (SWCEY.PK) and Goldman Sachs (GS) for investments during the financial crisis. The crises in Australia, New Zealand and Japan hit Berkshire hard, but we expect the firm to recover as soon as next quarter.
The firm’s largest concern remains with the acquisition of Lubrizol (LZ). Bershire’s valuation could drop short-term as a cloud surrounding trades made by one of Berkshire's executives, David Sokol, envelopes the company. We remain bullish on the Berkshire's long-term prospects, and recommend that investors take advantage of short-term dips. BRK.A currently trades around $110,000 while BRK.B trades at $75. We remain bullish on the firm’s bright prospects as long as the greatest inheritor of Graham’s legacy remains at its head.
Compared to a $2M-plus lunch with Buffett, as we highlight in a recent article, Berkshire shares look very cheap.