My 1 Reason for Owning Markel

The following article is exclusive content from The Motley Fool. While this is typically paid content, we are bringing it to you free because we think it is especially pertinent to your ability to invest wisely. Specialty insurer Markel (NYSE: MKL) has been discussed at length on our newsletter discussion boards, but the key to investing is often found in examining the details. Below you will hear from one of our newsletter analysts about how shareholder-aligned incentives are yet another reason why Markel excels.

On this board, and many other Fool boards, we've discussed Markel in depth. We've highlighted its niche-business model, its combined ratio, historical growth in BVPS, the culture and great people, the Alterra acquisition (pros and cons), but we've given one thing short shift -- management's incentives. For me, that's a hugely important issue, and it's the No. 1 reason I chose to invest in the company.

Incentives are important
As an undergrad and as a business school student, I studied economics. At its heart, the discipline is all about incentives. Many of the models are flawed, but there is a fundamental truth: People act in their own interest. Of course, the field opened itself up to lots of criticism by defining interest too narrowly, forgetting cultural, behavioral, emotional, and evolutionary issues. But the field has recently adapted its models to be more broad and practical. In the end, though, there is truth to the fact that people act to better their own situation, however you define it. I believed that as a student.

And I saw it in my career as a corporate consultant. I did more than a few projects that involved sales force incentives for major corporations. In every case, I saw that the salespeople would optimize their behavior around their incentives. If they received better incentives to sell a particular product or service, that's what they sold. If they weren't charged for giving free samples or trial services, they'd give them out like mad. If it was charged against their account, they'd be very careful. If they were rewarded on selling high-margin products, they'd sell high-margin products. If they were rewarded on total sales, they'd sell low-margin products. And they weren't bad or dishonest people. They just played the game set before them.

My point is, whether you look to economic theory or real-life corporate examples, you'll find that incentives matter. Charlie Munger has made this point many times. And it matters to corporate executives. So, when I make an investment, I make a point of reading management's compensation and incentive policy, which isn't disclosed in the 10-Q or 10-K filings, but is available in corporate proxy statements.

Markel is the gold standard for corporate incentives
So, I've told you why I care about incentives, and, hopefully, you agree they are important. As you'd imagine, I've read Markel's proxy statement, along with many other companies. And in the end, Markel stands out among all the companies that I've ever studied for the quality of its incentives.

Markel's named executives are primarily rewarded based on a single measure -- compound annual growth in book value per share (BVPS) over a five-year rolling period. The system is simple, it's easily understood, it's honest, and, most importantly it's aligned with shareholders.

It is long term. As a reasonable shareholder, I have a long-term outlook. I don't care about this quarter or the next, but I do care about the company's performance over five years. I'm happy to see that Markel rewards its executives for having the same outlook. They don't have to worry about manipulating this quarter's numbers to get a bonus, but they do need to generate value over the long term to get paid.

It is also based on a metric that aligns with shareholder results. BVPS is a key proxy for intrinsic value in insurance (that's what Warren Buffett uses). And it is a key determinant in the value of the stock over a long period. In other words, Markel management only gets paid for driving the key metric that also drives shareholder value. I like that.

In short, I think Markel has the best incentive system in the corporate world (if you know of a better one, tell me so I can research the company). It is long term and aligned with shareholders. And just having such a system indicates to me that Markel's management is honest. It wants to win or lose along with shareholders -- a rare and old-fashioned notion, but a good one.

Foolish bottom line
There's many reasons to invest in Markel -- it's a great company with a terrific team. But I'd argue the best ones are their shareholder-aligned incentives. Incentives are important! Luckily, Markel has gotten it right. So that's my No. 1 reason for owning Markel shares.

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  • Report this Comment On November 23, 2013, at 12:01 PM, crca99 wrote:

    "...make a point of reading management's compensation and incentive policy, which isn't disclosed in the 10-Q or 10-K filings, but is available in corporate proxy statements."

    Thanks for this info.

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