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Compounder Growth Propspects


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How do you estimate compounder growth prospects and incorporate valuation into when to buy?  For example if you take a look at MKL.  The appear to be growing in high single digit/low double digit growth rates.  Does paying 1.26 times book value make sense when the S&P 500 returns will be 5 to 6% at there current price.  This implies a 5.8 year breakeven point (.26/(10% - 5.5%)).  Also in cases like BNL there is no advantage as you can get 10.5% return buying at BV or for KMP 10% return (7.3% yield plus 7% growth in BV/(P/BV)) buying at 2.46x BV.

 

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The CAGR for 2013 is 17% but over the past 5-years the 5-yr GAGR it has ranged for 8 to 12% so I look at 17% as a high point.  As going to BV I am not sure that is going to happen but relative so BNL who has grown @ 12% per year since YE 2007 and is expecting that going forward and can be purchased at book it does not look as favorable.

 

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I do this for certain banks/insurers that I think will compound at rates higher than their costs of capital.  I usually do a 5-10 year adjustment period, and allow TBV to compound then apply multiple then discount it back.  Adjust for payout ratio & stock repurchases.  It is a large significant part of some valuations performed. 

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The CAGR for 2013 is 17% but over the past 5-years the 5-yr GAGR it has ranged for 8 to 12% so I look at 17% as a high point. 

 

Well, if you go back 20 years the CAGR in BVPS is 15% (see page 2 of 2013AL).

 

In many years the 5-year CAGR in BVPS has exeeded 20%... As reacently as 2007 it was 18%...

 

The whole letter is a fantastic read imo! Find it in attachment! ;)

 

Gio

MKL2013AL.pdf

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I agree BV growth is great historically but as these firms grow there BV growth declines (look at BH as an example).  So I am looking at Markel and given there size saying that low teens is good starting point.  With BNL is get low teens growth but a cheaper price.  The question in my mind is the premium above BV worth paying for in the case of MKL vs. BNL or even KMI.

 

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The question in my mind is the premium above BV worth paying for in the case of MKL vs. BNL or even KMI.

 

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I don't know BNL and KMI, but to me MKL gets a management quality premium. I know they won't do stupid things, will be shareholder friendly, and will allocate capital well. That's subjective of course, but it still matters a lot, especially if you intend to hold for a long time.

 

I also think that soon because of Ventures, book value won't be as clearly linked with IV as before, kind of like BRK, so historical comparisons of valuations aren't apples to apples.

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I agree BV growth is great historically but as these firms grow there BV growth declines (look at BH as an example). 

 

The reason why BVPS at BH has not shined until recently has nothing to do with size… Of course, how could it?! BH is still a very small company with huge room for growth!

The reason instead is that you cannot grow BVPS at high CAGRs when all your assets are in a relatively low return business (unless you make use of a lot of leverage!)… In fact, at the beginning investments were almost negligible… now that investments have grown large enough, BVPS in the last 2 years has increased 20%+: BVPS growth at BH actually has accelerated! And I think it will keep increasing very fast for a very long time!

MKL, of course, is already much larger than BH… But imo is not TOO large to keep compounding at high rates.

 

Gio

 

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the chuck akre interview posted here a few days back had his thoughts on valuing MKL. he said he thinks it earns 70$. that makes it less than 10 times true economic earnings.

 

i have no idea what number it is, but it's something he uses :D. didn't look into it any more than that.

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Which company is BNL?

 

I don't think the fair value for Markel in 5 years time will be BV. Being able to underwrite profitably on a consistent basis is worth more than book value and if they are still doing this in 5 years time, it will still be the case. As time moves on and Markel acquires more companies under Markel Ventures, then those companies may become worth substantially more than BV, just as Geico has become for Berkshire.

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Is it the same question as asking what is the fair value for Berkshire?  Whatever we think it should be, market has priced it at 1.7 - 2.7 x book back in mid 90's, 1.5-2x book back in early 2000's, 1.2-1.5x since the crisis.  And in each case, as long as you have sort of avoided the couple of years where the valuation range took a jump to a different range, the return has all been quite satisfactory.

 

The big piece of it, of course, is also the insurance cycle in the background, and Markel valuation range is influenced by it much more than Berkshire.

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The Berkshire performance collapse is my concern.  Over the past 10-years it has approached the performance of the S&P 500 as its P/BV has declined and BV growth has slowed.  You have the best capital allocator in the world whose performance is approaching the S&P 500.  I like the Markel team and approach my only concern is if size has reduced the best capital allocator in the worlds returns, why would it not do more so for others?

 

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I like the Markel team and approach my only concern is if size has reduced the best capital allocator in the worlds returns, why would it not do more so for others?

 

Of course it would! But MKL might grow 10 folds and still be much smaller than BRK…

 

Gio

 

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the chuck akre interview posted here a few days back had his thoughts on valuing MKL. he said he thinks it earns 70$. that makes it less than 10 times true economic earnings.

 

i have no idea what number it is, but it's something he uses :D. didn't look into it any more than that.

 

That was a good interview about his thoughts on com pounders & especially MKL

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The Berkshire performance collapse is my concern.  Over the past 10-years it has approached the performance of the S&P 500 as its P/BV has declined and BV growth has slowed.  You have the best capital allocator in the world whose performance is approaching the S&P 500.  I like the Markel team and approach my only concern is if size has reduced the best capital allocator in the worlds returns, why would it not do more so for others?

 

Packer

 

I actually think Berkshire performance will improve under the Ts

America has had slow growth for the last decade. But we are about to witness a change, just my gut feeling.  And looking at the stuff t and t buy I feel the co is in very capable hands. No wonder the company is buying at 1.2 x book. 

 

No position.

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The Berkshire performance collapse is my concern.  Over the past 10-years it has approached the performance of the S&P 500 as its P/BV has declined and BV growth has slowed.  You have the best capital allocator in the world whose performance is approaching the S&P 500.  I like the Markel team and approach my only concern is if size has reduced the best capital allocator in the worlds returns, why would it not do more so for others?

 

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Yeah.  I certainly agree with that sentiment. 

 

One thing about looking at insurance companies is that it's really hard to look through the filings to get a feel for what's going on in each of the underlying business.  Even the regulatory filings doesn't really go to that degree of granularity, and these guys are going in and out of lines all the time.  So you just sort of have to go with some level of trusting the management.  In a way it makes the job easy, just go with a P/B ratio.  But it certainly doesn't satisfy the intellectual curiosity.

 

 

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Guest longinvestor

Is it the same question as asking what is the fair value for Berkshire?  Whatever we think it should be, market has priced it at 1.7 - 2.7 x book back in mid 90's, 1.5-2x book back in early 2000's, 1.2-1.5x since the crisis.  And in each case, as long as you have sort of avoided the couple of years where the valuation range took a jump to a different range, the return has all been quite satisfactory.

 

The big piece of it, of course, is also the insurance cycle in the background, and Markel valuation range is influenced by it much more than Berkshire.

 

Fair value has been always higher than market price, has been the case for several years now. Market has been unable to keep pace with IV growth. Should work out well for patient investors.

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The Berkshire performance collapse is my concern.  Over the past 10-years it has approached the performance of the S&P 500 as its P/BV has declined and BV growth has slowed.  You have the best capital allocator in the world whose performance is approaching the S&P 500.  I like the Markel team and approach my only concern is if size has reduced the best capital allocator in the worlds returns, why would it not do more so for others?

 

Packer

 

I think the reasons to pay more than bookvalue are the insurance operations and the outperformance of the manager which is partly discounted. Insurance operations have become more competetive and the outperformance in the past 5 years was mediocre for most managers, so thats probably the reason they are worth lower multiples these days. Most people in this forum have probably a different view on this than me, but i think insurances are a commodity business where more companies in this business will lower the returns for all. So this is not going to change. After all i calculate with a fair value of 1.5x bookvalue for most insurance companies to calculate my forward rate of return. LRE.L is the only one where i go lower to 1.3-1.4xbv, because they have a bad capital allocation. ( my opinion :) )

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Guest longinvestor

The Berkshire performance collapse is my concern.  Over the past 10-years it has approached the performance of the S&P 500 as its P/BV has declined and BV growth has slowed.  You have the best capital allocator in the world whose performance is approaching the S&P 500.  I like the Markel team and approach my only concern is if size has reduced the best capital allocator in the worlds returns, why would it not do more so for others?

 

Packer

 

BRK has been and continues to be in a no-man's territory. The market has been in the wait-for-Warren-to-pass-away mode for a long time now while WEB is handing over the capital allocation to others at a hectic pace,  BRK's model transition from partial to whole ownership of businesses is in plain sight now, the capital intensive businesses are soaking up billions in capital and will continue this as far as the eye can see, the insurance float which even WEB thought would slow down is growing again with new lines of business, the housing bets BRK made pre-and during-crash times have barely started to pay off etc. etc. More birds are being put into the BRK bush than ever before.

 

They say past performance does not guarantee future results and in an oblique way, BRK finds itself in this position. My bet is that the next 10 to 15 years is likely to be far different for BRK than the previous 10-15. Time will tell

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I really like the BRK approach but how can fair value always be higher than market price?  At some point in the past fair value has to be have been reached or is there not a problem with fair value?

 

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I think one of the most difficult thing for the market to do, and therefore one of the areas where the largest discrepancies between prices and values can be found, is to assess correctly a business which will compound capital for many years into the future.

And that is so difficult for the market to do, because it is the job of the entrepreneur… while only a very tiny percentage of market participants are entrepreneurs.

Therefore, yes! I guess price can lag iv for many many years… Until that business finally ceases to be a compounding machine (if BRK risks that fate, nothing really lasts forever! ;)).

This, of course, doesn’t mean you cannot make a lot of money: if iv is 2xbv, and a business sells for 1.5xbv 10 years in a row, but increases bv at 15% annual, your capital in that business grows 4 times, even if the business in year 10 is still undervalued…

 

Gio

 

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