Following Tom Gayner Into His Two Biggest Positions

Anh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Tom Gayner, Chief Investment Officer of Markel Corporation, has managed to beat the general market in the long period of time. In the period of 2002-2011, he delivered an annualized return of 6%, beating the S&P 500’s annualized gain of only 3%. As of June 2013, his two biggest positions were CarMax (NYSE: KMX) and Berkshire Hathaway (NYSE: BRK-A).

Should investors follow Tom Gayner into those two stocks? Let’s take a look.

Berkshire Hathaway will have a decent return in the long run

Berkshire Hathaway is the biggest position in Tom Gayer’s portfolio. He owns 1,099 class A shares and more than 1.55 million B shares of Berkshire Hathaway, accounting for 12.8% of his total portfolio. Berkshire Hathaway has been considered one of the best stocks of all time, with a great long-term share price appreciation. Since 1965, Berkshire Hathaway has advanced from only $15 to share to around $175,100 per share.

Recently, Berkshire Hathaway experienced a 46% year-over-year growth in second quarter earnings. The spectacular second quarter earnings growth was due to a significant improvement in the company’s derivative positions, from a loss of more than $1 billion last year to a profit of $461 million this year. The significant gain in the derivative positions was mainly due to the increase in European equity index put options, written on four major global equity indexes, expired in the range of June 2018 to Jan 2026.

Interestingly, Buffett wrote European put options with long maturities, which allows him to take a lot of premium in cash for investing in a long run, as he does not have to pay his counter party until maturity. He said that “only the price on the final day that counts.” The increase in value of four big indexes in the past five years has been the main reason for the significant improvement in the equity index put option value.

Moreover, there are improvements in nearly all businesses in Berkshire Hathaway. The highest gain belongs to BNSF business, climbing from $1.28 billion last year to nearly $1.4 billion this year. Berkshire Hathaway is trading at $175,100 per share, with the total market cap of $287.7 billion. The market values Berkshire Hathaway at 1.44 times its book value. Looking forward, under Warren Buffett’s leadership, Berkshire Hathaway could continue to grow in the future, delivering decent long-term results to shareholders.

CarMax – high leverage, expensive valuation and growth acceleration

On June 2013, Tom Gayner held more than 5.1 million shares of CarMax, accounting for around 8.4% of his total portfolio. CarMax, incorporated in 1996, is the nation’s biggest retailer of used cars, operating around 118 used car superstores in 58 metropolitan markets. It's also one of the biggest wholesale vehicle auction operators in the U.S., selling nearly 324,800 vehicles through its on-site auctions in fiscal 2013. Most of its revenue, $8.75 billion, were generated from the used vehicle sales while the wholesale vehicle sales came in at around $1.76 billion. What I like about CarMax is its consistent positive growth in comparable store used vehicle unit sales in the period of 2010 – 2013. In 2013, its comparable store used vehicle unit sales growth was 5%.

What I do not like about CarMax is its high level of leverage. As of May 2013, it had more than $3 billion in equity, $725 million in cash, $208 million in short-term debt and as much as $6.2 billion in long-term debt. The net debt/EBITDA (earnings before interest, taxes, depreciation and amortization) was as high as 6.5.

Despite the high financial leverage level, CarMax intends to accelerate store growth in the next several years. The company expects to increase new store count by 50% to 60% in the next five years, with the growth rate of 15% - 20% for many years. Within this current fiscal year, CarMax targets to add 13 stores and 10 more in each of the next two years. Afterwards, the total store count might reach 150, operating in 30 states. CarMax is trading at $49.40 per share, with the total market cap of around $11.10 billion. The market values CarMax quite expensive, at 19.6 times its trailing EBITDA.

AutoNation – the highest profitability with a reasonable valuation

Let's have a look at one of CarMax's competitors to determine its relative strength and weaknesses. It is AutoNation (NYSE: AN) Compared to AutoNation, CarMax has a much higher valuation. AutoNation is trading at $48.40 per share, with the total market cap of $5.80 billion. The market values AutoNation at a much lower EBITDA multiple, at 13.3. AutoNation is considered the biggest automotive retailer, offering both new and used vehicles in the U.S. Interestingly, AutoNation seems to be a better pick than CarMax, due to its higher profitability. In the past twelve months, while CarMax delivered only 4.95% in return on invested capital (ROIC), AutoNation has a higher ROIC, at 6.85%. Moreover, AutoNation seems to be safer with a lower leverage level at only 2.4 times its net debt/EBITDA.

In the second quarter 2013, the company has completed the acquisitions of Don Davis Toyota Scion in Dallas and SanTan Honda Superstore and Hyundai of Tempe in Phoenix. The acquisition allows the company to enhance its brand mix in Dallas and Phoenix market. It also completed the re-branding of more than 200 franchises under a unified AutoNation brand name. The rebranding investment amount was quite high. Excluding the rebranding expenses, its EPS growth could nearly double. However, the rebranding is a right decision, which will benefit the company in a long run. The company focuses on adding new brand representation in its existing market by looking for acquisitions and new store opportunities.

My Foolish take

I like Berkshire Hathaway a lot. Under Buffett’s leadership and more than 70 diversified great operating businesses with outstanding and talented management, Berkshire Hathaway would keep growing its book value in the long run, effectively driving its share price on the market. I also like AutoNation, due to its highest profitability and a reasonable valuation. AutoNation is also a good stock for investors with its potential business growth and the long-term benefits from the rebranding initiatives.

Anh HOANG has no position in any stocks mentioned. The Motley Fool recommends CarMax. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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