Published: December 7, 2009

Ask any 10 U.S. investors to name the most-admired American financial figure and it’s a pretty good bet at least nine of them will answer Warren Buffett.

Thus, it should come as no surprise that other firms would want to emulate the business strategies of Buffett’s company, Berkshire Hathaway Inc. (NYSE: BRK.B) -- which is exactly how Markel Corp. (NYSE: MKL) is making its name on Wall Street.

Like Berkshire, Markel Corp. lists its primary business as insurance -- but it’s no State Farm Insurance or Allstate. Rather than selling auto or homeowners policies directly to consumers, Markel and its subsidiaries (listed below) sell specialty insurance products and programs in an assortment of niche markets.

Its Excess and Surplus Lines segment provides coverage for commercial properties in potential catastrophe zones (those put at risk by hurricanes, earthquakes and other disasters), product liability, and assorted other commercial and business risks, even losses from terrorism.

Other highly focused coverage areas include life insurance for race and show horses, property and liability for high-value motorcycles, personal watercraft and airplanes and liability for energy-production activities. Markel’s London-based international insurance arm offers maritime insurance and reinsurance policies for major shipping companies, and its financing division provides capital for the much-better-known British marine insurer Lloyd’s.

When is the last time you saw a story about a new insurance policy written by Warren Buffett? The answer’s probably “never” because virtually all of the interest in Berkshire Hathaway is focused on Buffett’s investments -- and the same applies to Markel, albeit on a considerably smaller scale.

In other words, if you’re considering becoming a Markel stockholder, your analysis should probably be on which stocks it’s buying, not the companies it insures.

Taking a Page Out of Buffett’s Playbook
On its corporate Web site, Markel says it seeks “to earn consistent underwriting profits.” But it goes on to add that such profits are only one component of the company’s overall business strategy. While the site doesn’t precisely spell out the details of Markel’s business strategy, its true nature becomes apparent if you look at the company’s most recent 10-Q filing.

For its third quarter, ended Sept. 30, 2009, Markel reported an underwriting profit of $17.98 million, with a nine-month profit of $42.65 million. Both those numbers are a marked improvement over the same 2008 periods, when $115.1 million in Gulf Coast losses tied to Hurricanes Gustav and Ike produced respective underwriting losses of $126.31 million and $60.88 million. The 2009 numbers certainly aren’t bad from a pure business standpoint -- lots of insurers would love to have them -- but they pale when you look at the next line at the company’s operating statement.

It shows the company’s net investment income, which totaled $66.66 million for the third quarter of 2009 (down just over $1 million from 2008) and $200.76 million for the first nine months, matching the 2008 numbers. In other words, the company had 3.7 times as much investment income in the third quarter as it made selling insurance -- and 4.7 times as much for the first nine months.

Now, admittedly, there’s some cherry picking here because Markel did report substantial realized investment losses from stock sales, particularly in 2008 when the financial world was crumbling around us all. Still, when you add up all the pluses and minuses, Markel’s 2009 investment activities enabled the company to post three- and nine-month net income figures of $59.12 million and $108.28 million, respectively.

So how does Markel manage to do so well on its investments? For the answer, you again have to look at Berkshire and Buffett. Richmond, Va.-based Markel is headed by Chairman and Chief Executive Officer Alan Kirshner, but the company’s investment program is directed by Chief Investment Officer Thomas Gayner -- and Gayner’s philosophy is pretty much a carbon copy of Buffett’s. He’s a conservative, long-term, value investor and he focuses on companies with a high return on equity, a low stock price relative to cash flow, and a low price-to-book value ratio.

According to a Markel regulatory filing with the U.S. Securities and Exchange Commission, Gayner has found a total of 77 different companies that meet his criteria, and the shares he holds in those companies are worth roughly $1.37 billion. The roster of firms includes such household names as 3M, Abbott Laboratories, Campbell Soup, Disney, General Electric, International Business Machines, PepsiCo, Procter & Gamble, and Wal-Mart. And Markel’s largest holding may be Buffett’s own Berkshire Hathaway (898 Class A shares valued at about $91 million and 31,418 Class B shares, worth about $106 million).

Markel’s third largest position is in Fairfax Financial Holdings -- 279,459 shares valued at $97.6 million or so -- and it also has large positions in Leucadia National and Brookfield Asset Management, all three being insurance/investment combines that also follow the Buffett/Berkshire model.

Markel’s Gayner also seems to be following Buffett’s tracks when it comes to betting on the future health of the U.S. economy. Whereas Buffett recently made headlines by offering to buy up the 77.4% of Burlington Northern Santa Fe Corp. he didn’t already own, wagering the country will ride railroads into the future, Gayner is apparently betting Americans aren’t likely to give up their cars either. His second-largest holding is in CarMax, the nation’s leader in used-car sales, with subsidiaries also selling new cars and providing financing to auto buyers. Markel has 5.3 million shares of CarMax worth about $106.7 million.

Gayner is also predicting an eventual recovery in the housing market with major stakes in Home Depot, Plum Creek Timber and Pool Corp., a leading maker of swimming pools -- a frequent addition sought by home buyers and re-modelers.

If you’re wondering how Markel can afford such a massive investment portfolio, just consider company’s basic business -- insurance. Though the net underwriting profit for the first nine months of 2009 was just $42.65 million, the company’s net receipts in the form of premiums totaled $1.325 billion. A big chunk of that has to be held in reserve for future claims, though many of those won’t come for years -- and some will never be filed. (A unique aspect of the insurance business is that the customers really don’t want to get their money back because it means they have to suffer some kind of disaster.)

That leaves a massive amount of cash available to fund investments. In its latest quarterly SEC filing, Markel had $1.7 billion in cash on hand at the end of the third quarter -- and, with that kind of reserve, Gayner can buy only when he thinks the time is perfect, plus he’s never forced to sell when he doesn’t want to. Thus, his annual return on investment of just over +14% for the past 10 years -- hardly the market’s most shining decade, as evidenced by the Standard & Poor’s 500 Index’s 10-year average return of -0.64%.

-- Larry D. Spears
Contributor
Money Morning