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Crush the Market and Sleep Soundly With This Stock

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

Recently a friend of mine told me with a smile, "Berkshire Hathaway (NYSE: BRK-A)(NYSE: BRK-B) is my favorite mutual fund."

While he was obviously kidding about the "mutual fund" part, Berkshire arguably remains the world's most successful holding company and represents one of the most compelling investments the world has to offer.  With a compounded annual gain from 1965 through 2011 of 19.8% (and up nearly 20% so far this year) anyone who put $5,000 into Berkshire in 1964 would be sitting on nearly $30 million today. That's a 6000-bagger, folks.  Now I feel a little sheepish for being so excited when my shares of Under Armour (NYSE: UA) quadrupled in two years.

That said, while I believe Berkshire will continue to outperform the market going forward, I favor another smaller, similar company even more: Markel Corporation (NYSE: MKL).

Bigger Isn't Aways Better

While Markel's $4.6 billion market cap is nothing to sneeze at, it's easy to underestimate just how much room it has to grow.  By comparison, Berkshire's capitalization is nearly fifty times as large at $225 billion.  

On one hand, being small certainly creates some disadvantages for Markel.  For one, while Berkshire's massive balance sheet and larger base of equity allows it to invest both its float and shareholder equity in stocks, Markel can only prudently invest shareholder equity.  Markel management has stated, however, they "[...] should be able to move in the same direction as Berkshire (as Markel continues to grow). "

On the other hand, being the little guy affords Markel one huge advantage: A much larger investment universe. Even Warren Buffet has conceded the best opportunities for high returns exist for those who have less money to invest, telling Business Week in 1999, "[...] it's a huge structural advantage not to have a lot of money.  I think I could make you 50% a year on $1 million.  No, I know I could.  I guarantee that.

For Markel, this is where its President and Chief Investment Officer Tom Gayner comes into the picture. Interestingly, Gayner has never owned a "hot" stock (unless, of course, you count stocks which only became "hot" after he purchased them).  Instead, he focuses on buying stocks of profitable, undervalued businesses and waits for the price to reflect the value.  If this sounds boring (or if you haven't heard of some other investors who found success with this methodology), you should note Gayner's value-oriented approach has helped Markel become a 20-bagger (!) since he took the helm in 1990.

In addition, a quick glance at Markel's news feed over the past two years shows no less than seven headlines reading something to the effect of "Markel announces acquisition of (insert random obscure company name)." These headlines are largely thanks to the work of Markel Ventures, of which Gayner is also President.

Markel Ventures operates separately from Markel's core insurance and investment operations, and perhaps its website describes it best when it writes Markel Ventures' purpose is to "[...] make strategic and generally controlling investments in businesses that operate outside of the specialty insurance marketplace."

Currently, Markel Ventures is comprised of a number of businesses that serve niche markets like bakery equipment, food processing, dredging equipment (don't feel bad; I had to look it up, too), laminated wood flooring for truck trailers, behavioral health programs, retail analysis services, and elevator wall panels.  

I don't know about you, but I literally yawned as I reread that list.  However dull they may seem, though, all Markel Ventures companies have met the following criteria as described on its site:

  • Small, profitable businesses with good returns on capital.  More specifically:
    • Revenue – $25 million to $250 million
    • EBITDA – $5 million minimum to $50 million
    • Enterprise value – $25 million to $300 million
  • Talented management teams (to remain in place post-closing) and a culture of integrity
  • Ownership – Majority control; prefer at least 80%
  • Reinvestment opportunities and capital discipline
  • Fair prices 
So Markel's looking for small, efficient, money-making businesses with disciplined management and high insider ownership.  Additionally, Markel buys these businesses using little or no debt and with "no plans for an exit in the future."  I know, I know....where's the fun in that?  After all, I did just pen a couple posts about two of the most volatile, speculative stocks out there (see here and here).  Well, it turns out some of us don't like to speculate and still want to diversify (note sarcasm), so if you want to put some of your investment dollars to work and still want to get some sleep, Markel's tame beta of 0.62 should provide some comfort.
In all seriousness, in today's world of speculative investments and high frequency trading, it's refreshing to watch Markel methodically exude patience and discipline.  As the economy continues to ebb and flow while the rest of the investing world goes crazy, Markel will undoubtedly continue to quietly build its empire.  As Gayner said just a few months ago, "Things are always getting better or worse.  It's no different this time."
Since going public in 1986 at just over $8 per share to today's price in the high $400's, Markel shows no signs of slowing down.  Don't let the "high" share price fool you (with a lower-case 'f'); Markel's current price to earnings ratio of 19 shows its trading at only a slight premium to the S&P 500's current P/E of 16.  Because Markel is...well...Markel, this premium is well-deserved.  As always, there's no guarantee there won't be bumps in the road.  By owning shares of Markel, you can help ensure those bumps will be much less painful.  
In fact, I challenge you to read and absorb any of Markel's annual and quarterly reports.  In doing so, I'm confident you'll see what I see: A prudent, growing company whose returns will undoubtedly mop the floor with the market indexes over the long run...and let you sleep sound all the while.

symie5 owns shares of Under Armour and Markel. The Motley Fool owns shares of Berkshire Hathaway, Markel, and Under Armour. Motley Fool newsletter services recommend Berkshire Hathaway, Markel, and Under Armour. 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.If you have questions about this post or the Fool’s blog network, click here for information.

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