Mr. Gayner started with quoting from his most recent quarterly memo to board: “Over the years, we've consistently discussed the core parts of our investment process, our searching for profitable businesses with good return on capital, run by honest and intelligent management teams with great reinvestment opportunities with capital allocation discipline, at fair prices.”
Mr. Gayner said that these notions are all tied together. But if you have to ask him which of these criteria is the most important, he would say it’s the reinvestment opportunities and capital discipline. The idea of reinvestment opportunity and capital discipline embed the other ideas. If the business is not profitable, there is no money to reinvest, if the management team is not honest, they will steal money from shareholder. Finally fair price may be a lot more than you think it would be, if profitability and reinvestment opportunity can really take place.
Mr.Gayner then pointed out that we will agree with him that profitability, management integrity are important. But the reinvestment opt and capital discipline are less frequently discussed. Therefore, he want also touch on what fair might mean.
Consider the case for BRK. Back in 1965, Berkshire was trading at $19 per share. It was a high cost producer in a declining business. It’s hard to think of any financial number that would suggest buying BRK at $19 per share is a financially shrewd move. Buffett himself said it's a mistake and a partially emotional act. But Buffett realized his error and embarked on the task of reinvesting whatever the funds BRK generated into more economically productive assets,he did that relentlessly and continuously. Today we call that capital allocation.
It took Mr.Gayner until 1990 to realize his mistake of not buying BRK’s stock. But better late than never. Since 1965, BRK's compounded about 20% per year. This is the greatest example of great capital allocation. Here is when the idea of fair value comes into play. If you invested earlier say in 1965, the 19 price tag may not be justified at that time. If you analyze the prospect of the BRK at that time, it's probably more like a value trap. However, if you had paid 10 times and price, or $190 share later, you are buying a much better business at an attractive price. So $190 is really a fair price whereas $19, although much cheaper, is arguably not a fair price.
Today, most fund managers talk about the impact of Interest rates, Ukraine, the Fed and etc.These are all important factors but they pale when compared to the task of finding managers, who can consistently and successfully produce earnings for the business, and reinvest those earnings over a very long period of time. As BRK shows, there is no more important factors.
Markel’s holdings illustrate this point. Mr.Gayner said they would be lucky to find 2 or 3 businesses run by great capital allocators every year. You may ask, what happens if something horrible happens to the business you invest in. The example of American Express can answer that question. By 1963, American Express has already been a successful business for more than a century. You could buy its stock in any single day during its history and do very well over the long run. The scandal in 1963 tanked the stock. It was an incredibly stupid mistake. American Express was perceived to be going for bankruptcy. We all know Buffett purchased as many American Express shares as possible and made a lot of money.
But here is an interesting question. What would happen, if you had purchased American Express' stock the day before the scandal broke out and therefore, paid a lot more than Mr. Buffett? You would think that you would not do very well. But If you have bought AMEX at a much higher price than Buffett, the return difference would have gotten closer and closer with each passing day. Today, you and Buffett would compound the American Express investment at nice double digit rates with almost negligible difference.
That's why Markel’s investment team spends most of time finding profitable businesses that can reinvest their earnings. And they will continue to keep searching. They need to pay a lot of attention to qualitative factors just as much as those quantified. They've done this in the past and They'll continue to do so in the future.
At the same time, Markel will continue to build a strong culture, value its people and focus on creating long term shareholders value. These qualities are rare but once you have them and work hard at it, they are sustainable competitive advantages.