A Look At Berkshire Hathaway And Its Best Clones
Summary
- Berkshire Hathaway is not the only choice for long-term investors who want to enjoy the power of compounding.
- Alleghany and Markel, despite their relatively small size, can compete well with Warren Buffett's gigantic holding.
- How well have these excellent companies performed during the last five years?
Even at the risk of shocking the investment community a bit, my thesis is that for a long-term shareholder, it makes more sense to invest in a Berkshire Hathaway's (BRK.A) (BRK.B) clone like Alleghany (Y) or Markel (MKL). I will argue why Y is the best choice right now.
Although I am a passionate follower of Warren Buffett's investment philosophy, it's also my personal belief that the best days of his renowned holding, Berkshire Hathaway are gone. The value mindset dictates to place few but big bets, and if you are already a whale, a few fish will hardly be able to satisfy your appetite. In my view, its dry powder at record levels shows how increasingly difficult it is for the company to find acquisition targets that can fit its requirements: big, available for sale, and at a reasonable price.
This problem will not be solved anytime soon. Instead, it may worsen as Buffett and Munger approach the end of their extraordinary career.
Luckily, there are a few interesting options in the market that are likely to replicate Berkshire's outstanding results in the years to come and are better positioned to take advantage of its unique business model, which can be defined as compounding power on steroids! Their size is still small in comparison with BRK (more than thirty times smaller!), so they will skip easily BRK's dilemma and don't have to worry about their size for the next 2 or 3 decades! On top of that, you don't have to pay an extra price for them as their P/B numbers are in line with their bigger counterpart.
Berkshire's alternatives
As mentioned, my favorite ones are two Berkshire copycats: Markel and Alleghany. Now that the FY2019 results are all out, I have the opportunity to compare the recent results of the three firms.
The following is the five-year stock price performance comparison:
Source: Yahoo finance
None of them pay dividends, even though Y started to pay a small dividend last year. Therefore, overall, the performance is not biased by cash distributions, at least so far.
Probably, the best operating ratio to first consider is the book value per share CAGR:
BV per share at 12/31/2014 | BV per share at 12/31/2019 | 5 Y CAGR | Shares' count increase (decrease) | |
BRK | $146,186 | $261,417 | 12% | (1.1%) |
MKL | $544 | $803 | 8% | (1.2%) |
Y | $465 | $611 | 6% | (14%) |
Source: Author's elaboration
It's worth mentioning that the share issuance/buy-back activity affects the book value performance. If the price-to-book value is constantly over the 1.0 level (as it's always been the case here), issuing shares will artificially increase the book value per share growth, in the short-term, while buying back shares will have the opposite effect.
Another important aspect to consider is the price-to-book value. While BRK has a P/B figure of 1.35, MKL is, currently, recording a higher number (1.55), while Y has the smallest one: 1.15.
In our view, the smallest P/B value for Mr. Buffett's holding (in comparison with its counterparts) could be justified by BRK's much bigger size, which is hundreds of times bigger than MKL or Y. As I previously discussed, the mini-Berkshires have the opportunity to compound their gains for a much longer time in the years to come. Therefore, Y appears undervalued, considering it has the smallest size and the smallest P/B value too.
Additionally, since insurance is an important part of the firms' operations, I should mention the combined ratios of the three firms in the last 5 years.
Berkshire | Markel | Alleghany | |
2015 | 96% | 89% | 89% |
2016 | 95.8% | 92% | 83% |
2017 | 105.3% | 105% | 106% |
2018 | 96.5% | 98% | 103% |
2019 | 99.3% | 94% | 99.4% |
Average | 98.6% | 95.6% | 96.1% |
Combined Ratios Compared - Source: Company reports (Author's elaboration)
Indeed, insurance operations are much less significant for BRK, given the size of their non-insurance holdings (23% of the total assets). In comparison, the assets for Alleghany's Capital*, for example, represent less than 10% of the total (see the picture below).
Source: Company's report
That is a key reason for investors to favor the Berkshire copycats in their portfolios: their private equity business is still in its early years!
*Alleghany's Capital is a wholly-owned subsidiary of Alleghany Corporation that owns and manages the venture business of its parent company.
ILS considerations
The involvement the companies under consideration have for the insurance-linked securities business deserves particular mention, given that one of them (Markel) has a significant exposure to the sector, another one (Alleghany) a moderate take, while Buffett doesn't like this business (and, in any case, at the moment, it is objectively too small for Berkshire to significantly jump in).
Markel established, as I mentioned, a significant position in the ILS space when a few years ago, it acquired the ILS manager CatCo, a story that didn't end well. Later, it bought a fronting business (State National) and, in November 2018, Nephila, a big fund manager of insurance-related products.
The management clearly sees a lot of interesting synergies between ILS and its insurance and fronting businesses, as underlined in the last conference call:
Mark Hughes
You talked about the synergies or your ability to have your Markel operations working with Nephila to help investors get exposure to the property market, if I heard that correctly. Could you talk a little more about that? How meaningful, l kind of what does that look like as if that's emerging?
Tom Gayner
Sure. As I said, what we're doing is basically working as distribution for Nephila in this case to commercial wholesale and retail property business. So, that deal was negotiated at arm's length between our Markel folks and the Nephila folks. And we're hoping, over the course of the year, that could send $50 million to $60 million of property premium over to the Nephila.
Alleghany's take is surely more conservative. They own 50% of a fund manager (Pillar) that is much smaller than Nephila and manage Pangaea and Bowline, which recently completed a $250 million issuance of cat bonds.
This is how CEO Weston Hicks summarized his company's involvement in ILS:
TransRe's approach to the alternative capital market has been to utilize a combination of aligned capacity (through its sidecar, Pangaea), market-facing capacity (through Pillar, its 50%-owned alternative capital manager), and strategic capital relationships (through its unique exclusive agency relationship with Gen Re for North American business). We are working with TransRe to develop additional strategic capital relationships, which give TransRe the ability to "punch above its weight" in the reinsurance marketplace.
Our view is that, although investors seeking differentiation may appreciate certain ILS products, in the long run, the risk-reward may not be acceptable.
At the moment, Assets Under Management of ILS funds is about $90B (trap money included), which is roughly one-sixth of the whole reinsurance capacity available. It's hard to imagine this small portion being ceded at cheap prices by first insurers. Then, ILS managers invest their clients' money in short-term, safe bonds, collect premiums for them and pay claims in exchange for fees. It's unlikely that, over a long period, the pro-forma, combined ratio of these policies will fall under the average 100% threshold. Therefore, all the long-term investors will get in the end will be a short-term bond yield in exchange for a fee and a long-term commitment: that is not a great deal!
Latest developments
The three companies have been beaten hard by Mr. Market year to date.
Source: Yahoo finance
Most of the stock price loss is, of course, due to the recent fears the Covid-19 outbreak spread throughout the investment community.
Our opinion is those fears are way exaggerated: the outbreak should have reached already its peak as the chart below shows.
Source: Johns Hopkins CSSE
The new confirmed cases have been constantly fewer than the people recovered since 18th February 2020!
Anyway, among BRK, MKL, and Y, the last one has the smallest exposure to possible negative outcomes driving from a larger spread of the epidemic.
Alleghany's insurance/reinsurance operations, in fact, are practically 100% involved in P&C and specialty, with little or no exposure to life or health insurance business. Moreover, its private equity sector is the smallest one in relative terms, as already seen, so that it will probably be hurt less by the eventuality of an economic downturn.
Also, a closer look at the balance sheets of the three companies reveals how Alleghany's pile of cash + triple A bonds (the sum of them I called "safe assets" in the table below) puts the firm in an enviable position: Berkshire, on the contrary, has a lot of cash on hand but also a lot of equity securities.
| Safe Assets/Total Assets | |
| MKL | 39% |
| BRK | 18% |
| Y | 63% |
Source: Author's elaboration
Conclusions
The end of the 2019 financial year gave me the opportunity to assess a brief comparison between three wonderful companies: Berkshire Hathaway and its main copycats: Markel and Alleghany.
Overall, I believe Berkshire has reached a challenging size when it comes to effectively keep on executing its business model. That is why its smallest copycats are better positioned to take a significant reward from their compounding power in the long run.
Between Markel and Alleghany, the former is more expensive due to the fact that MKL's total cap exceeds its equity value by around 60%, while Alleghany does it by just around 15%. That is partially offset by MKL's better performance in terms of P/B value growth over the last 5 years. However, I am skeptical about the company's recent overexposure to the ILS business, which has already caused considerable losses to MKL's shareholders.
Alleghany is also in a better position, according to our view, to get advantage from an economic downturn (or to be hurt less!). At the present low valuation, the company could start to buy back its shares aggressively, as it's already authorized to buy back more than $600M of its common stock under the current program (roughly 6% of the total cap).
That's why I consider Alleghany to be the best choice for a long-term oriented investor right now.
This article was written by
Analyst’s Disclosure: I am/we are long Y. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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Comments (23)
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Best Regards
there is also a difference in buy-back activity.
Speaking in general terms Y has a much more conservative approach than BRK or MKL and in the last 5 years that has not worked out well.
Congratulations.
I think luckiness plays a big role in our successful or unsuccessful stories.
My mum persuaded my father to buy roughly the same amount of shares of a local bank here where I live: they lost the whole sum.
And my mum is much wiser than my father!
It's important to act logically, learning from mistakes and always improving.
It is a mistake buying a stock without knowing how to read a balance sheet, even if the outcome is positive in the end.
Averaging Combined Ratios does not represent the true picture of net income after 5 years.
There is a reason Allegheny Capital is trading so close to book. Author has not uncovered.
WHEN not IF the shit hits the fan, opportunities will come knocking on BRK door , much like thee 10% interest with Option BRK got from Goldman in late 2000s. That wont happen with Y.
The Book Value CAGR speaks for itself over the lat 5 years. Y lags both BRK and MKL by significant amount , especially if you compound BV growth 5 more years at constant rates.Nice attempt, yet weak support and thin analysis.
I didn't argue that combined ratios give a picture of real net income, just a picture of the insurance performance. Again BRK insurance operations are much bigger so it is hard to have compelling performance.
When the shit hits the fan, opportunities arise everywhere, for Y much more opportunities than BRK given the smaller size.
thanks for commenting and remember: simplex sigillum veri!