For some people, their perfect lunch is a steak at The Palm. Me, I prefer a Jimmy John's sandwich in a conference room.
That is, as long as Tom Gayner is in that conference room.
Tom Gayner is the President and Chief Investment Officer of Markel, a specialty insurer located 102 miles south of Motley Fool HQ. Mr. Gayner kindly invited me and three other Fools to have lunch with him this past Tuesday.
Markel is regularly mentioned in speculative discussions around which company could be the "next Berkshire Hathaway." Gayner is always one of the main arguing points to support the case of Markel's destiny for greatness. As Chief Investment Officer, Gayner manages the company's equity portfolio which has generated returns of 12.4% per year over the past decade – handily beating the S&P 500.
In addition to that sterling performance, Gayner is one of the most quotable investors out there. Needless to say, I kept my notebook and pen ready as I munched on my club sandwich. Here are five things I learned during our lunch.
Bigger isn't always better
Markel is a $9 billion company. It must have dozens of investment analysts scouring the world for hidden opportunity via complex models, right? Wrong. Markel's formal investing team is comprised of two people. Two. Gayner and his investing partner run the whole investing show.
I asked Tom why he chooses to keep the team so small. He explained since the stock portfolio's annual turnover rate is typically between 5-10% and long-term ownership is so important to their philosophy, they do not want to buy stocks for the sake of buying stocks.
He presented the hypothetical scenario of an investment analyst being asked to pitch a stock to the rest of the team every week, and week after week, the analyst said, "I don't have anything." Eventually, he is going to start feeling the pressure to come up with something to make it look like he's "doing something" and will pitch a potentially bad idea. By keeping the investing team small at Markel, Gayner is able to control the process and avoid making poor decisions.
I'm a better investor because I'm a businessman (and vice versa)
So if Gayner doesn't have a large team of analysts checking every number and building complex models, how does he make sure he is getting proper feedback and vetting of his ideas? You need to know what mistakes you are potentially going to make so you can correct them or avoid them altogether. Charlie Munger once said, "Tell me where I'm going to die, so I won't go there."
I discovered how Gayner checks his blind spots when I asked how he distinctly divides his time between being a full-time investor and a full-time insurance executive. His answer was that he does not see them as two distinct buckets. The meetings he has with the insurance team or the chief actuarial colors his analysis when evaluating a new stock to buy. It's a virtuous cycle. Gayner described it as a venn diagram.
The stocks Tom Gayner buys are just like the ones you and I own – they often soar in value and regularly plummet in value. The rollercoaster ride operated by Mr. Market can keep many investors awake at night; for Gayner, he just shrugs and calls it "Statement Volatility."
The term came up when we asked him why more insurance companies don't invest in equities. Unlike some investments, stocks are "marked to market" – meaning every quarter when you close the books, a company has to report the latest value of those stocks. Even if they never plan on selling those shares at that price, many investors and companies fear the backlash from outside investors and the risk of losing their jobs – even if investing in equities is the right thing to do long-term.
Markel is able to avoid this backlash because of its years devoted to being a good steward of shareholder capital. Every annual report is prefaced with a letter that starts "To our business partners." Markel has forged a long-term oriented culture that gives Gayner and team the ability to ignore "volatility."
Sugar, Money, and Dirt
Whether they admit it or not, every investor has a circle of competence – no one is good at everything. Even Gayner will readily acknowledge that investing in banks has not been good to him. But when asked what he considers his circle of competence, he described it in three words "sugar, money, and dirt."
Sugar: As humans become wealthier (a trend that has continued... well, forvever), their thirst for sugar only grows. Gayner likes to invest in these businesses – food, alcohol, candy, etc.
Money: Financial intermediaries and handlers have also been around for generations. Brokers and payment facilitators like Visa and MasterCard get Gayner excited.
Dirt: Businesses on the ground, like the corner gas station, are cash flow businesses – the earnings and cash flows are predictable, making the valuation process less prone to calculation errors.
Understanding your circle of competence is more important than just knowing what stocks to buy. It allows you to react more logically when the stock prices may be irrationally high or low.
Gayner also stress that these three things are his circle but do not necessarily need to be everyone's. He noted that just because Rory McIlroy's ability to smack a golf ball is his circle of competence doesn't mean it should be everyone's.
The most important thing
In the annual letter to Markel shareholders, Gayner details his four-part investing approach. He looks for:
1. Profitable businesses with good returns on total capital that don't use too much leverage
2. Management teams with equal measures of talent and integrity
3. Businesses that can reinvest their earnings and compound their value or that practice sound capital management techniques such as good acquisitions, dividends, and share repurchases
4. Fair and reasonable prices
But if he could only pick one, Gayner said he's going with #3 and it's not even close. When buying shares of a company with high rates of reinvestment, valuation almost becomes a footnote in the decision process.
Gayner cited the common Buffett-story of when the Oracle of Omaha took a big stake in American Express shortly after the "Salad Oil" scandal in 1963 after shares of AmEx fell from $65 to $37 in the course of a few months. But what is almost never mentioned is that even if Buffett would have bought the stock at its pre-crisis highs, his returns as of 2014 barely would have budged. Sure, Buffett is glad he was able to scoop up shares after the crisis had hammered the stock, but American Express's ability to reinvest earnings at a healthy clip for decades made Buffett's entry point essentially arbitrary.
If you find an incredible business, don't spend endless nights perfecting your five-year discounted cash flow valuation model because if it's actually an incredible business, it probably won't matter that much.
Time for dessert?
I'm not sure if Markel will be the "next Berkshire Hathaway." Nor am I sure that we'll ultimately hold Tom Gayner in the same regard we do Lynch, Buffett, or Graham. Those investors surely had some good fortune thrown their way that boosted them to the next level of greatness – but they also all had a consistent process and an addiction to long-term thinking. I'm a fan of long-term thinking too, but I just wish I had more time to pick Tom Gayner's brain.