Buffett’s #1 Most Undervalued Stock

It’s no secret that Berkshire Hathaway’s largest equity holding is Apple (NASDAQ:AAPL), representing 50% of its entire stock portfolio. What is less well-known is his investment in Markel (NYSE:MKL), which represents just 0.1% of his portfolio, and yet which is his most undervalued position using a cash flows analysis.

Even though the stock commands a relatively small overall stake in the Berkshire equity stack, it’s still large in absolute dollar terms with a $233 million market value.

So, what does Buffett see in Markel to warrant investing almost a quarter of a billion dollars in it?

Famously, one of the great drivers of economic success at Berkshire Hathaway over the past half century has been its insurance business, which for much of the time has been headed by Ajit Jain. So, it’s not a big surprise to discover Buffett’s penchant for specialty insurers extends beyond his own re-insurance business and into his equity portfolio.

Markel markets and underwrites specialty insurance in the UK, Bermuda, US, Canada and Asia Pacific regions. That wide geographic scope has translated to a big market capitalization that was just shy of $19 billion at last count.

What makes the firm attractive to Buffett and his investment team are the standout financials but exactly which ones leap off the page?

Why Did Buffett Buy Markel Insurance?

Most likely, Buffett bought Markel stock because of its low price-to-earnings ratio of 9.8x and its wide economic moat. The PE ratio under 10x is a rarity among such large companies and offers the potential for a handsome return over the coming years, handily beating those offered by the bond market.

So too the economic moat can be identified by looking no further than the return on invested capital that sits at 12.8%, suggesting Markel has a sustainable competitive advantage.

For shareholders, there is lots to like as you dig into the Markel numbers. For instance, the return on equity comes in at 15.0% on the button, a figure that no doubt impressed Buffett.

And the company has a very strong history of delivering quality earnings. Over the past ten years, each annual earnings report was accompanied by a profit. That’s indicative of a robust business model that can withstand the booms and busts of economic fortune and still produce a bottom line in the black.

A further check in the plus column for Markel is its history of revenue growth, which has been stunning over the past five quarters. In Q2 2022, revenues were reported at $1.7 billion while in the last quarter they came in at $3.3 billion.

The balance sheet looks sturdy too with $4.3 billion in cash contrasted against long-term debt of $3.7 billion.

Perhaps what stunned Buffett most of all was how strong the all-important cash flows have been. For 12 straight quarters, they have been in the black with the lowest quarterly report showing $247 million in levered FCF and the highest coming in at $880 million last quarter.

So, is it time to follow in Buffett’s footsteps?

Is Markel a Buy?

According to the 7 analysts covering Markel, the stock has 3.8% upside to fair value with a price target of $1,460 per share. That doesn’t seem too intriguing to capture Buffett’s attention so is it possible the analysts are underestimating the potential of the stock?

When we look deeper into a valuation analysis and pay close attention to cash flows in particular, it’s more evident what Buffett and his investment team may be spotting. A discounted cash flow forecast analysis reveals the intrinsic value of Markel is closer to $1,629 per share, which would correspond to an upside of 17%.

So, while the small group of analysts are modestly bullish, the reality may well be that Markel has substantially more gas in the tank to power higher over time. At the very least, the low PE ratio would suggest that any long-term investors will earn a handsome yield over time, absent some catastrophic tail event that would hurt the insurer.

All that boils down to a Buy, though not necessarily for dividend investors who won’t be thrilled to learn that Markel offers no yield presently, in spite of the hefty cash flows.

Final Thoughts

Trading at 1.4x book value and 1.2x the last twelve months sales, Markel appears to be trading cheaply, which is no doubt a factor that sparked Buffett’s interest in the stock.

Another key metric that suggests the stock is trading at bargain basement prices is its price-to-earnings ratio of 9.8x.

For value investors, the most compelling analysis stems from a scrutiny of cash flows that points to around 17% upside opportunity if fair value is realized.

With $15.3 billion of revenue and $52.7 billion in assets, Markel presents a really interesting opportunity to buy a large cap stock at a low multiple. It’s no wonder that Buffett, who actively hunts for deals like these, was excited enough to bet almost $250 million on the position.

Even though that large stake only represents 0.1% of his overall portfolio, it would be a big position in most any other hedge fund or billionaire portfolios.

The firm’s combination of steady and diverse revenues across the globe alongside its strong history of profitability are compelling for any investor looking for a relatively safe haven during periods of upcoming economic turbulence.

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The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.