Finding undervalued companies can be very difficult in a bull market like the one we're currently experiencing. Even with the market cooling off over the past two weeks, many stocks look overvalued. However, it's when the market is up that Foolish investors should remember Charlie Munger's words: "A great business at a fair price is superior to a fair business at a great price."
Let's take a look at three companies in the financial services business, looking for both value and opportunity.
Back from the dead
CEO Robert Benmosche has led American International Group (NYSE:AIG) back from its "too big to fail" days as a bloated giant in the center of the financial collapse, to a lean organization that is focused on its core insurance businesses. The latest quarterly results emphasize this, as key earnings numbers continue to show positive results. Add in the announced $1.5 billion in share buybacks and a reinstituted dividend, and there is a lot to like about what's happening at AIG.
However, it's not clear who will replace Benmosche, 69, when he steps down. He came out of retirement to run AIG, and at some point in the next few years, he will leave. It's important that whoever replaces him maintain the culture of responsible, conservative underwriting and capital management, and keep the company from betting on financial instruments that create too much risk, like the Credit Default Swaps that nearly crippled the company and destroyed decades of wealth for many shareholders.
The aforementioned Charlie Munger and Warren Buffett have steadily guided Berkshire Hathaway (NYSE:BRK-A) (NYSE:BRK-B) through decades of growth in both the core insurance businesses like GEICO and General Re, and through the process of allocating the excess capital generated, or "float," to build an incredible stable of wholly or partially owned companies (more than 50) like Fruit of the Loom, MidAmerican Energy, and Heinz, as well as significant positions in a handful of publicly traded companies like IBM, Coca-Cola, and American Express.
The consistent income generated by these businesses is a testament to Buffett's process of investing in companies that have a solid competitive advantage, talented managers, and predictable profitability. This simple process had led to decades of outsized returns.
The concern over Buffett's mortality is important, but overblown. At nearly 83, the Oracle will step away from the business at some point in the not-so-distant future. However, if there's one thing that's been central to the company's success, it's the culture. Fifty-five different companies operate under the Berkshire umbrella, and all are led by talented, driven leaders that aren't micro-managed by the parent company. This should aid an easier transition to whomever assumes the mantle of CEO, as will the likely expansion in responsibility for Todd Combs and Ted Weschler as managers of Berkshire's investment portfolio.
An upstart a quarter-century in the making
Founded in the 1920s, and a public company since 1986, it may seem like a stretch to call Markel (NYSE:MKL) an upstart. However, the company's Markel Ventures business unit is less than a decade old, preceded by Markel-Gayner Asset Management Corp. And much like how Buffett has spent decades investing the float into a diversified range of businesses, both wholly owned and in positions in public companies, Chief Investment Officer Thomas Gayner uses what the company calls its "permanent" capital in much the same manner.
And while it's unfair to expect the 50-year old Gayner to be the next Buffett, there are certainly comparisons to draw between investing in Markel today, and Berkshire Hathaway in 1980. Without reaching too far, here are two characteristics that make Markel such a compelling investment.
- The company has a powerful dedication to writing profitable insurance business, one of the hallmarks of Berkshire's insurance subsidiaries. This means a willingness to walk away from business it doesn't see as profitable, resulting in an underwriting profit in 14 of the last 20 years.
- Markel Ventures has grown 51%, 52%, and 54% over the past three fiscal years, and at only $489 million in annual revenues, there is tremendous future growth potential.
So where to invest?
By most measures, AIG still looks to be undervalued. Its price-to-book ratio is 0.7, well below that of most of its peers. However, the company must demonstrate sustained ability to write profitable business. So far, the evidence suggests that it will, and that its traditional customer base wasn't scared away in the same manner investors were. Berkshire, however, is a little tougher to value in terms of upside.
But Buffett himself has given us two helpful pieces of information. First, the company won't likely grow at the same rate as the past. Second, 1.2 times book is the magic number for the company to buy back shares. Today's multiple is closer to 1.4, which would indicate that a little patience would net a better entry point. With that said, it could be worth opening at least a small position even at this price to start, and add more shares over time as Mr. Market's volatility presents better values.
Lastly, Markel is a tremendous opportunity to get in on a long-term growth powerhouse. Again, it's not only unfair, it's also unreasonable to expect Markel to be the next Berkshire. However, this is still an incredibly well-run company with top management and what appears to be a solid capital allocation strategy, and that's a great recipe for sustained returns for many years.
These are three solid companies that will all likely perform well for years to come. But if you're looking to buy just one today, and hold for years, Markel gets the nod in my eyes.
Jason Hall owns shares of Berkshire Hathaway, American International Group, and Markel. The Motley Fool recommends American International Group, Berkshire Hathaway, and Markel. The Motley Fool owns shares of American International Group, Berkshire Hathaway, and Markel and has the following options: long January 2014 $25 calls on American International Group. Try any of our Foolish newsletter services free for 30 days.
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