Tom Gayner Entrusts a Quarter of Markel's Equity Portfolio to 3 Brilliant Capital Allocators

by: Devon Shire
Like many equity investors I have a little black book of professional money managers that I follow for ideas. In my opinion there are no points for style when it comes for investing. The only objective I have is to compound money as fast as I can, with as little risk of permanent capital loss as possible. So I have no reservations about borrowing good ideas from others rather than trying to use only original ideas I find myself. I know I’m not the sharpest knife in the drawer, so why not use the best knife I can find.
One thing that I have concluded from studying successful investors is that generally you do not have to take big risks and invest in dodgy companies in order to outperform the stock market. You can make outsized returns buying the best companies when everyone else is ignoring the intrinsic value of the underlying business. But while risky companies can be avoided, what these successful investors that I follow generally all do is concentrate their capital in a few of their best ideas.
I don’t equate concentration (within reason) with risk. I equate investing in poorly capitalized companies with risk.
A perfect example of a low risk yet concentrated approach to successful equity investing is practiced by Tom Gayner of Markel. You have likely heard of Markel which is essentially a mini-Berkshire Hathaway. Markel is a specialty insurer and Tom Gayner is in charge of investing the premiums Markel collects (the float) from customers as well as the retained earnings and shareholder capital of Markel itself. The “float” Gayner invests goes into fixed income securities. The shareholder equity capital goes into equities.
Over the past 10 years Gayner has produced a 7.6% annual return on the Markel equity portfolio which currently stands at just over $1.8 billion.
At the end of June 30, 2011 the Markel equity portfolio was pretty heavily concentrated 51.5% invested in just nine names:
Click to enlarge
$ Holdings
% of Portfolio
Berkshire Hathaway
Brookfield Asset Management
Diageo PLC
United Parcel Service
Nine Largest Holdings
Total Equity Portfolio
Click to enlarge
Gayner is clearly concentrating on his best ideas with almost 28% of the equity portfolio in just Berkshire, Carmax and Fairfax and almost 40% in the top five positions.
Here is a link to the recent Markel SEC filing which details all equity holdings at quarter end: (Markel Holdings).
What stands out to me about all of these holdings is that they are all extremely well run companies that would be suitable for the investing dollars of widows and orphans. Gayner is focusing his equity portfolio on his few best ideas, but not taking on much risk of permanent capital impairment because these are dominant companies with sound balance sheets.
In the last Annual report Markel lays out the strategy behind the selection of equities:

“The balance, comprised of shareholder funds, is available to be invested in equity securities, which over the long run, have produced higher returns relative to fixed maturity investments. When purchasing equity securities, we seek to invest in profitable companies, with honest and talented management, that exhibit reinvestment opportunities and capital discipline, at reasonable prices.We intend to hold these investments over the long term.”

If know Markel you should be struck that the above excerpt reads as though Markel is basically looking to invest in companies that are just like itself ! And that is basically what Gayner has done with a full quarter of the equity portfolio detailed above. I’m referring to the capital that is invested in Berkshire Hathaway, Fairfax Financial and Brookfield Asset Management. These three companies and Markel could be siblings they are so alike in core beliefs.
Gayner’s checklist when considering an investment is “we seek to invest in profitable companies, with honest and talented management, that exhibit reinvestment opportunities and capital discipline, at reasonable prices.”
I’d like to consider how Berkshire, Fairfax and Brookfield stack up against that checklist.
Are Berkshire, Fairfax and Brookfield profitable companies? Clearly yes, check to that one.
Are Berkshire, Fairfax and Brookfield run by honest and talented management? Again a resounding yes as Warren Buffett (Berkshire), Prem Watsa (Fairfax) and Bruce Flatt (Brookfield) are on a short list of most respected CEOs.
Are Berkshire, Fairfax and Brookfield companies that offer reinvestment opportunities and capital discipline? I’d say that allocation of capital in a disciplined manner is at the very core of each of these three. Buffett and Watsa are two of the most revered investors in the world and Bruce Flatt while not as well known understands value investing as well as anyone.
And finally are Berkshire, Fairfax and Brookfield available at a reasonable price ?
Valuation of a business is of course always subjective. But I am willing to offer an opinion on each of these three as I know them fairly well.
Berkshire Hathaway today at under $110,000 per class A share is in my opinion a no-brainer table pounding buy. I wrote about the attractiveness of Berkshire recently for Seeking Alpha here (Berkshire), with the point of my article being that the group of world class operating businesses that Berkshire owns are being priced like dying video rental stores. I think Berkshire’s intrinsic value is easily 50% higher than the current stock price. And that kind of discount is utterly ridiculous for a diversified collection of businesses with Berkshire’s incredible financial clout behind them.
Fairfax Financial under $400 per share represents better than a reasonable valuation. In my recent article I detailed how conservatively positioned Fairfax currently is with a billion dollar cash hoard and a hedged equity portfolio. With a current valuation just over book value and a master investor in Prem Watsa at the helm I’d say reasonable is a pessimistic view of the current stock price.
Brookfield Asset Management currently trades around $30 per share. In his most recent (Shareholder letter) Bruce Flatt of Brookfield lays out what he thinks the fair valuation of Brookfield is:

We attempt to provide you with our Value, which we refer to in our materials as Intrinsic Value.

This is a combination of our book values, adjusted for some assets and operations which are not reflected at their fair values under IFRS accounting. The current number is approximately $39.31 and as shown in the following table, we believe that based on one’s view of the discount rates and market assumptions, this number could reasonably be higher or lower by $7.50 per share. We view this as the liquidation value on the low end and business value on the high end.

On a liquidation basis, you may take the view that realized values would be less than the underlying values, as we own a lot of assets and liquidating them all at once might be difficult.

Alternatively, if you believe that a company should be valued as a going concern at the value willing buyers and sellers would pay for assets or businesses in a normal market, then you might conclude that achievable sales prices are above their appraised values, in particular when the current cash flows are still at low points as many operations recover from the recession.”

According to Mr. Flatt the valuation range of Brookfield would be roughly $32 to $46. With a current share price of $30 Brookfield seems to also meet Tom Gayner’s reasonable requirement.
The more I read the more I think that today the stock market presents us with a unique opportunity. Not that the stock market as a whole is materially undervalued. But rather that high class companies like those discussed above are buying undervalued. And that presents the best of both worlds: Attractive returns, and very little risk of permanently losing money.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.