I still like to read the old-fashioned printed and bound annual reports that show up on my doorstep -- it's old news by the time it gets there, certainly, and I knew months ago all the pertinent 2005 information from the latest Markel (NYSE:MKL) report that I just received. But I still like to read them -- I like to review the letters to the shareholders especially, and I even like the purty pictures that give an idea of the image the company is trying to project.
So I was looking through the 2005 Markel letter to shareholders, and thought I'd share a few of the things that I really like about this specialty insurer, things that I may not have gone into detail on when I noted that I bought shares back in March.
Part of an earlier Markel post of mine was retitled "Markel looks like Berkshire Hathaway Junior" when it was republished on Seeking Alpha a little while back, so while that wasn't the central crux of my argument for investing in MKL it was in front of my mind when reading the annual report. It's a comparison that has been made before, so I'm not exactly reinventing the wheel now, but the sport of imagining what it would be like if you were one of those lucky few who bought Berkshire thirty years ago is an addictive one.
And the Markels are starting to sound quite a bit like the Oracle of Omaha in some ways. Read these quotes -- if you squint a little, they could be Nebraskan:
"Should we find the market unwilling to allow us to achieve our profitability targets on this basis, we may find it necessary to withdraw" "We strive to manage the business so that each product will earn good returns in five=year blocks of time and so that our varied product mix will produce underwriting profits every year." "We would expect that if the weather were the same in 2006 as 2005 our results would be much improved, should it get worse, we will remain financially secure and adjust accordingly, and with good weather, our results should be very pleasing." On missing out on hot markets in energy and technology: "Energy and energy sources, like technology, change over time. For investors, this change is both exciting and dangerous. It is exciting because change creates dramatic positive outcomes for certain companies in the energy markets. It is negative because the long-term trend in energy and technology pricing is down. This creates a headwind for businesses in those fields and we p refer to avoid investing in companeis with decreasing pricing power ... We remain investors focused on long term, durable-compounding businesses with easier to understand franchises or business dynamics ... over long periods of time this approach has proven sound." On the surge in hedge fund popularity: "After the 'swarm' phase, we believe that returns become disappointing, if not dreadful, and opportunities begin to be created as sellers get out and prices drop to more economically attractive levels. We expect this to occur over the next several years and we look forward to participating in these markets as opportunities present themselves."
What else comes to mind when reading the report? Compensation is also done right at Markel -- they pay very generous bonuses to their top performers, to the extent that more than 30 of their associates earned larger cash bonuses than the Markel executives. This year, only about 2% of the bonuses given out went to the executives, which is pretty impressive in today's environment of insane executive compensation.
And they base the bonuses for the executives on something important, too: It's not the share price, since the executives can't do much (at least, not much that's good for long term investors) to boost the share price in any given month. No, Markel executives get bonuses based on the increase in book value of the firm.
But what I find most intriguing is the way in which the investing arm of Markel is starting to behave a little bit more like Berkshire Hathaway. Not the focus on large companies that are undervalued, and that they want to hold forever (Markel's unrealized taxable gain on investments is now over $400 million) ... that's been the case at Markel for a long time.
No, what I find interesting is the fact that Markel is starting to branch out into operating businesses and private transactions. Just as Buffett has several times said he would prefer to buy a company outright, so Markel has dipped a toe into the water of outright business ownership.
Their investment criteria are the same for private transactions as they are for stock purchases: profitable businesses with good return on capital, management teams with talent and integrity, reinvestment opportunities and capital discipline, and reasonable prices.
The two companies that caught their eye this past year, as they decided to delve into private "alternative" investments, were, appropriately enough, right in their own back yard in Virginia -- AMF Bakery Systems, a baking equipment producer, and First Market Bank in Richmond, which they acquired a partial share in together with the Ukrop supermarket-owning family.
Boring businesses. Easily understood. Unsexy generators of good cash flow. Salt-of-the-earth management in place who can continue running the businesses. Not anything the hedge fund managers would be competing for, or driving up the prices on.
Sound like anyone else you know?
In Markel's words, "In both these instances, we were able to find and negotiate these transactions principal to principal ... We believe similar additional opportunities will develop over time and we look forward to expanding this part of our investment portfolio."