Nov 3, 2021

Searching for the Next Berkshire

Andrew D. Ellis avatar
Andrew D. Ellis
backtothefuture.jpg

“If you want to beat the S&P 500, start thinking of the index as a filter and not a benchmark. It’s the starting line; not the finish line.” Andrew D. Ellis, Founder, ThinkingLonger, LLC

As a data driven investor, I ache to find the next Berkshire Hathaway. With the mountains of financial information that is available to today’s investor, you might think it would be possible. But that’s not as easy as one might think. Diamonds in the rough are hard to find and financial diamonds often look like ordinary stones for years on end. Berkshire Hathaway is a good example.

In fact, as John Rekenthaler has written (in Morningstar Report), you would not think that Berkshire Hathaway was so great after the first ten years of Buffett’s management of the company.

[After] 10 years of Buffett’s management, BRK’s stock-market performance suggested few hints of his genius. Yes, BRK had twice surged by more than 70% in a calendar year, but its best result among the eight remaining years was a 13% gain, and it had lost money on five of those occasions.

But Rekenthaler also points out that Berkshire’s share price over that period did not reflect its growth in book value over the same period. Over the ten year period from 1965-1975, Berkshire book value increase was explosive, comparable only to the rise in oil prices during the same period. Of course, investors cannot buy book value but the expectation is that share price eventually reflects book value and consistently rising increases in book value suggest a strong company.

In February 1981, Buffett again took pen to paper and wrote his sixteenth annual shareholders letter. In it, having run the business for sixteen years, he wrote:

In the sixteen years since present management assumed responsibility for Berkshire, book value per share . . . has increased from $19.46 to $400.80, or 20.5% compounded annually.

At that time, Berkshire’s share price was $430 per share. Would you have bought it? Remember, the price was five dollars below the book value. If you had bought 50 shares for $21,500, those shares would be worth approximately $212 million today. But – and it’s a huge “but” – would you have been willing to wait forty years for that investment to achieve its current value? Are you prepared to “think longer” about your investments and play out your investment thesis over a lifetime? Would you have the discipline to do nothing?

I’m the first to admit that I came to the Berkshire Hathaway party late in the game. I bought a few shares in 1998 and, at the time, book value and all, I thought that I was out of mind to do it. How could a stock rise about the ridiculous 1998 price of Berkshire? But, to me, the price was not the issue. I could see the Berkshire formula: expand the insurance business (and the available float) but don’t chase premium income by offering insurance policies that weren’t profitable, use the profits to buy other companies that sustainably “gushed” cash, keep successful management in place, don’t pay dividends, keep debt low, reinvest continuously, repeat.

So, I bit my lip and bought a few shares. Berkshire is still in my portfolio; I’m never going to sell it and when Mr. Buffett passes away, I’ll buy more (of the B class of Berkshire Hathaway – its “baby” trailing stock) as I expect some shareholders to panic and sell, thereby reducing the price. I’ll buy more if the stock ever gets close to its book value per share. Mr. Buffett has spent years teaching his colleagues how to think about investing and I’m confident that they will carry on.

My baby steps in 1998 made me think long and hard about what I had failed to see that was right in front of me. When I think about that, I wish that I could have been an investing combination of Marty McFly and Indiana Jones. I want to get in my DeLorean (which I don’t own), put on my Stetson (which I do own) and go back to 1981 and buy a lot more BRK-A. Of course, this wasn’t going to happen. But, does history repeat itself? Is there a company that is trying to repeat the Berkshire formula?

All of which brings me to 2010 – and my apologies for how long it took me get here. I found Markel Insurance (NYSE:MKL) an insurance company with great management, with premium income that consistently exceeded expenses, and with target markets not attracting “big boy” competition. But, most importantly, it was following the Berkshire formula:

expand the insurance business (and the available float) but don’t chase premium income by offering insurance policies that weren’t profitable, use the profits to buy other companies that sustainably “gushed” cash, keep successful management in place, don’t pay dividends, keep debt low, reinvest continuously, repeat.

In 2005, seventy-five years after its founding, Markel had created a subsidiary called Markel Ventures for the express purpose of buying interests in non-insurance enterprises. But, coward that I was, I sat on the sidelines until 2010, at which point I bought the stock at $335 per share (which had fallen to $200’s during the Great Recession). Today, the stock trades at $1,317 per share – and like BRK, I’ll buy more when there’s a dip in the book value per share.

Below is a price chart for BRK (in blue) and MKL (in green) (from Yahoo Finance). The commonality of the trends is striking and, to my way of thinking, comforting.

I don’t expect MKL to approach BRK’s price but, if my MKL stock increases in price by four every ten years, I’m thrilled. I’m prepared to play out the hand for twenty years or more.

All of which brings me to today. Sometimes, being a data-driven investor means doing nothing for a very long period of time. I’m reminded of a famous quote from Charlie Munger: “Waiting helps you as an investor and a lot of people just can’t stand to wait.” I’m not recommending that anyone go out and buy MKL. I am suggesting that sometimes it pays to be patient. The choice is yours.