One stock that's made its way on my radar recently is Markel (MKL -0.78%). Last year, Warren Buffett and his team at Berkshire Hathaway bought a lot of stocks. One stock they purchased was specialty insurer Markel, spending about $600 million for more than 467,000 shares.
Markel underwrites insurance policies, but it's so much more than that. It has a vast investment portfolio spread across publicly traded companies and private businesses. Its investing style has earned it the nickname "Baby Berkshire" because its business model mirrors that of Berkshire Hathaway.
Given the similarities, it wasn't surprising to see Berkshire begin building a position in the insurer. Is what's good for Buffett good for your portfolio? Read on and decide for yourself.
Image source: Getty Images.
Markel's insurance niche can be highly profitable
First and foremost, Markel is a specialty insurance company that operates in a niche market called excess and surplus (E&S) insurance. E&S insurance is a small portion of the total property and casualty (P&C) insurance industry, representing just 10% of this market.
E&S, or specialty, insurance differs from standard insurance. Specialty insurance covers hard-to-place risks and follows different rules from standard insurance policies. With traditional insurance, rates and forms are highly regulated. As a result, insurance products are highly uniform, and companies end up competing mostly on price.
Specialty insurers write unique policies that limit their exposure and don't face regulations limiting the premiums they are allowed to charge. As a result, insurer such as Markel compete by writing unique policies on things they have expertise in covering that other insurers won't touch. This specialized market knowledge and fewer regulations can make specialty insurance a highly profitable business when times are good.
Its industry-beating performance
If you want to judge the quality of an insurance company, one great metric to use is the combined ratio. This ratio is foundational for how management evaluates an insurer's underwriting performance.
The ratio takes the sum of losses and expenses divided by premiums earned. A ratio of less than 100% is good, and the lower, the better.
Over the past decade, the P&C industry average combined ratio was 99%. Markel's combined ratio is a solid 95% in comparison. This figure shows Markel is doing an excellent job balancing risks and beating out most competitors.
Why it's earned the nickname "Baby Berkshire"
Markel's investment portfolio, which includes numerous publicly traded companies, sets it apart from other insurers. Last year, Markel had more than $22 billion in investments, spread across fixed-maturity investments such as government bonds, equities, and short-term investments. Nearly 35% of its investments are in stocks, including large investments in Berkshire Hathaway, Deere, Home Depot, Brookfield, and Google parent Alphabet, rounding out the top five.
Data source: Markel regulatory filing. Chart by author.
Markel's investment portfolio is very diversified. It holds investments across 138 stocks, whereas Berkshire Hathaway has investments in 49 stocks. Markel's top 10 holdings make up 39% of its holdings, while Berkshire's top 10 stocks are 89% of its portfolio.
The company's investment performance has been solid, but not spectacular. Markel's equities have returned 13.2% annually over the past decade, while its total portfolio return, which includes bonds, returned 4.8% annually during that period.
Is it a buy?
Markel has been a solid long-term performer. Over the past two decades, the stock has had an annual return of 9.5%, not all that far from Berkshire's 10.6%.
Markel has done a solid job of underwriting insurance policies and investing in stocks and other private businesses, giving it good cash flows. Its comparison to Berkshire is well deserved, although it isn't as aggressively concentrated in a few companies.
MKL Total Return Level. Data source: YCharts
E&S insurance can be a stable source of cash flows, but like many businesses, insurance is cyclical. Insurers have faced pressures on their profitability and rising catastrophe costs in recent years. This has created a favorable underwriting environment where insurers can raise premiums and face less competition. With inflation high and continuing losses from environmental catastrophes, this "hard" insurance environment will likely persist.
Although Markel isn't going to have eye-opening returns, it's a well-run insurance business with a solid investment portfolio that will hold up for the long haul. It's well positioned to take advantage of rising interest rates, and worth considering for a buy the dip on any stock market sell-offs.
