Above The Fray

As you probably know, we have a significant portion of our capital allocated to Berkshire Hathaway, Fairfax Financial and Markel Corporation. While the three companies do have some important differences, they are all also remarkably similar. Berkshire, Fairfax and Markel are all holding companies with worldwide property and casualty insurance at their core. They also feature excellent capital allocators at the top. There are no better investors than Warren Buffett, Prem Watsa and Tom Gayner. Warren is assisted in capital allocation by Charlie Munger, Todd Combs and Ted Weschler. Prem’s investment team includes Roger Lace, Brian Bradstreet, Wade Burton and others while Tom relies on Mike Heaton, Saurabh Madaan, and Dan Gertner for capital allocation help. The float that is generated from insurance is invested in either marketable equities and fixed income instruments or, increasingly, in large or controlling interests in private or public non-insurance businesses.

While the big picture is relatively simple, all three companies have many moving parts and when you dig into the details, they are analytically challenging. We have owned all three of these companies for a long time and one of the most enjoyable parts of my job has been discussing and debating the finer points of the investment merits for these companies with investment manager friends and our investor partners over the years. I attended the Berkshire Hathaway annual meeting in Omaha for 28 consecutive years before the coronavirus pandemic forced all shareholders, including me, to attend remotely this year. I have attended the Fairfax annual meeting every year since 1990 and was honoured to be asked by Prem Watsa to moderate the Q&A at the Fairfax virtual annual meeting this year after attendance was also rendered impossible by the needs of physical distancing. I have been to Richmond, Virginia for the Markel annual meeting fewer times over the years but I have known Tom Gayner well for over 25 years. I was a very early attendee (number 12) at an event that Markel hosts in Omaha each year that has grown to over 2,000 people. Before we go any further, I want to make it clear that I will not be disclosing which one of these three companies I like best as it will make me feel a little like a parent being asked which one of their children they like best! They are all phenomenal companies and we continue to be excited to be shareholders in all three.

Let’s compare the long term track record for all three companies:

I find it interesting that, through all the ups and downs of business and markets, these three companies have produced very similar and very outstanding track records. Of course, Warren Buffett has been at it much longer and continues to hit the cover off the ball despite the challenges of deploying $818 billion in assets as of the end of 2019! The path of the market price over time for all three companies has been lumpy, with each company experiencing share price drops of 50% on several occasions, but certainly very rewarding for long term shareholders.

Tom Gayner, Prem Watsa and Warren Buffett have all commented at various times about the declining utility of book value per share as a measure of intrinsic value given that all three companies have deployed more of their assets to wholly owned or controlled private businesses and these assets are not carried at fair value in the book value calculation. To provide one very simple example, See’s Candies, 100% owned by Berkshire Hathaway, is likely worth more than ten times the approximately $85 million value at which it is carried on the books.

While I agree with their view on this, I do believe that book value per share can be used as a rough proxy or a starting point in determining intrinsic value. Analytically, you can quite easily think of book value as a floor and add on to this number any adjustments you wish to make to reflect the fair value of the private businesses in any intrinsic value calculation. If you accept the premise, as I do, that intrinsic value for all three companies is significantly higher than book value, then you can comfortably compare book value per share to the market price to determine whether or not you are getting a margin of safety with your investment.

So, what does the current situation look like? I will compare the current market price with the stated book value per share as of the end of the first quarter. Book value per share for all three companies declined in the first quarter in the range of 11.1% to 12.1% owing to the mark to market losses, but only minimal realized or permanent losses, in their equity investment portfolios. To be fair, there are some basic tweaks that need to be understood about these book value per share values. I have added back the $10 per share dividend paid by Fairfax in the first quarter in calculating the first quarter decline in book value per share but I have not adjusted its book value per share downward for the difference between equity cost and fair market value of associates. I did not adjust Berkshire’s investment in associate Kraft Heinz downward either. Based on the published first quarter results, book value per share for Fairfax declined the least and Markel declined the most. The share prices also declined in the range of 23.2% to 46.9%. Hmm? Doesn’t that seem a little extreme relative to what actually happened? Berkshire declined the least and Fairfax declined the most! Bear in mind that book value per share has likely increased for all three companies since quarter end as the market prices for the equities in their investment portfolio have almost certainly improved. The comparison, with all figures shown in U.S. Dollars, follows:

What does all this tell me? First, all three companies are attractively priced and carry a huge margin of safety. Second, the outlier of the three is Fairfax.  Despite all three having similar long term track records, Fairfax trades at half the current valuation of Berkshire and Markel. Is this justified? While you can make your own assessment, my answer is no. In fact, I agree with Prem Watsa who described the share price at the virtual annual meeting in April as “ridiculously cheap”.  While it is true that price and value can diverge for what can seem to be a painfully long period of time, it is also true that this divergence cannot last forever. Patience, while certainly being a virtue, can also be very profitable.