This article is part of our Real-Money Stock Picks series.
The logic is simple: If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly ... you are hurt when stocks rise. You benefit when stocks swoon.
For that reason, the always-up market we seem to be in at the current moment doesn't make me terribly happy. Year to date, the S&P 500 (SNPINDEX:^GSPC) is up nearly 17%. In July alone, the index tacked on more than 4%.
But while I prefer to have a market that's falling -- and thereby discounting a wide variety of stocks -- I also know that even in a bull market, it's still possible to find attractively (or at least fairly) valued stocks that are worth buying. Today, I'm ready to buy two of them.
Special(ty) is good
Markel (NYSE:MKL) is a specialty insurer. That means the company underwrites risks that many well-known, larger insurers don't. For example, Markel provides insurance coverage for:
- Tourist railroads
- Environmental consultants' professional liability
- Warehousemans' legal liability
- Horse theft
- Small fishing ventures
- Mortality risks at zoos
- Classic cars
Specialty reinsurance creates both opportunity and risk for the companies that go after the business. On the opportunity side, because there may be less competition in some under-served areas, there's the possibility of receiving higher rates for the coverage. And to the extent that a level of expertise can be built in a niche area, one specialty insurer can dominate a smaller risk category the way they couldn't in, say, standard retail auto insurance.
At the same time though, because these are smaller risk categories, there may not be as much data available to base underwriting on, and unforeseen risks could crop up. There's also a smaller overall market opportunity, so any specialty insurer that hopes to grow and expand will have to build expertise in a lot of these small, focused areas.
Markel has done a truly superb job leveraging the opportunity in specialty insurance while avoiding the risk pitfalls. The company has a commendable underwriting track record and a conservative approach to the business that has led to the kind of results shareholders can appreciate. Over the past decade, Markel's tangible book value per share has grown at an average annual rate of roughly 12%.
If you're wondering what tangible actions the company takes to drive these business results, consider the following from its 2012 annual report:
Inherent in the Company's reserving practices is the desire to establish loss reserves that are more likely redundant than deficient. As such, the Company seeks to establish loss reserves that will ultimately prove to be adequate. Furthermore, the Company's philosophy is to price its insurance products to make an underwriting profit.
There are two things worth highlighting, here. First, that Markel's management would rather take larger reserves up front to make sure they're prepared for large losses -- that's conservative to an extent that you just don't see at most insurers. Second, Markel is more focused on writing insurance policies that will be profitable rather than simply writing any policy that will grow the revenue line. Day traders may not care about details like this, but these are practices that long-term shareholders should stand up and cheer about.
If the first half of the Markel investment thesis is the solid insurance business and underwriting, the other half is the company's stellar investment results. Often known as "Baby Berkshire," Markel's investment operations mimic Berkshire in that the company invests excess liquidity in the stock market in order to earn additional returns for its shareholders. Piloted by the highly respected Tom Gayner, Markel's investment arm has excelled. Overall, the insurer's portfolio returned 6.2% per year for the decade ending in 2012. Its equity portfolio by itself averaged a 9.2% annual return over that period. For comparison, the S&P gave investors a paltry 2% per year over that 10-year stretch.
Finally, in another nod to its Berkshire-esque ambitions, Markel is growing an arm that it calls Markel Ventures. This part of the business buys smaller companies in their entirety, giving Gayner another way to redeploy shareholder capital and providing another profit source for investors. Currently, Markel Ventures is a relatively small contributor to Markel's overall bottom line, but it's a huge opportunity for the future.
Another Platinum insurer
The story behind Platinum Underwriters Holdings (UNKNOWN:PTP.DL) is similar to Markel's in that it's a very conservative and high-quality insurer with a great management team. The specifics of the opportunity diverge from there, though.
While Markel is a primary insurer, offering insurance coverage directly to end users, Platinum is a reinsurer, offering insurance for insurers. If that sounds odd, it's really not -- primary insurers, Markel included, often decide that they only want to take a certain, defined amount of risk on some policies or groups of policies. In those case, they can work with a reinsurer to offload some of the excess risk they don't want to hold onto.
And if a key selling point for Markel is the fact that it has outstanding investment operations, at Platinum Underwriters, it's a more broad capital allocation skill. Under the leadership of CEO Michael D. Price, Platinum deftly chooses where to allocate shareholder capital based on where it can achieve the best returns. When the reinsurance market cycle is attractive, the company obviously looks at that market as a prime place to commit capital. But when that's less attractive, it has the option to choose other investments, buying back stock, and delivering special dividends. The bottom line is that the focus is always on where long-term, risk-adjusted returns look best.
That focus has worked out well for investors. Between 2003 and June of 2013, Platinum's tangible book value per share has more than doubled, delivering near-10% annual growth. And that's even as the company paid a modest annual dividend.
The price is right
While I think both Markel and Platinum are admirable, well-run companies, I wouldn't be inclined to buy their stocks at any price. But with the two trading at respective tangible-book-value multiples of 1.6 and 0.97, I think now is a good time to buy, and I will be making these two insurers the first two additions to my Real-Money Stock Picks portfolio.