Lessons From Markel's Tom Gayner

Merry Christmas from Eagle Point Capital! Dan and I are thankful for all of our readers. We wish you the happiest of holidays, and good health and more wealth in the new year.

The year's end is a natural time for reflection. At the moment, I am reading a new translation of Marcus Aurelius's Meditations. It's a series of personal reflections written by the most powerful man in the world - the emperor of Rome.

Marcus Aurelius wrote between 172 and 180 while waging a war on Rome's frontier. Meanwhile, the Antonine plague ravaged Rome. Despite the turmoil, Marcus devotes his first journal to gratitude. One by one, he acknowledges and thanks the people who influenced him most.

Most regard Marcus Aurelius as the last good emperor or Rome. Indeed, Gibbons begins The History Of The Decline And Fall Of Rome with Aurelius's son Commodus.

What made Marcus Aurelius great? I'm no scholar, but I'd argue it was his humility. He knew that he didn't have all the answers, and he didn't try to think them all up himself. Instead he studied philosophy, surrounded himself with capable advisors, and tried to go to bed a little smarter every night.

Almost 1,500 years later Sir Isaac Newton said, "If I have seen further it is by standing on the shoulders of giants." It could have just as easily come out of Marcus Aurelius's mouth.

Dan and I often quote Newton because it's as true of us as anyone. It's impossible to overstate how much we've learned from studying the triumphs and tragedies of other investors. It's critical to learn from your own mistakes, but it's a lot faster (and cheaper) to learn from other people's.

One of the people I’ve learned the most from is Markel and its CEO Tom Gayner. Though Gayner isn’t nearly as well know outside of value investing circles as investors like Warren Buffett, he has just as enviable a record. When Gayner joined Markel, book value per share was $8. Now it’s $800.

Every investor can learn something from him. As Jason Zweig put it:

Every investor can learn something from him — Instead of trying to mimic the inimitable brilliance of Mr. Buffett, maybe more investors should emulate the common sense and patience of Mr. Gayner.

Borrow Other People’s Best Ideas

Investors often call Markel a “baby Berkshire.” It’s an insurance company with a long track record of profitable underwriting. It reinvests its profits into public and private businesses. The company has three growth engines: insurance, investments, and ventures (wholly owned companies).

Pairing insurance with investing produces a symbiotic relationship where the whole is greater than the sum of the parts. In fact, any free cash flow generative business paired with any rational investment policy will produce extraordinary results.

Connor Leonard and IMC has done with using the profits from the Golden Corral franchise. AutoZone and Verisign have done it with an aggressive stock repurchase program. Individual investors can do it too: spend less than you earn and dollar-cost-average into stocks. There are no points for difficulty or uniqueness in investing.

Markel didn't dreamed up this structure. They observed that it worked for Berkshire Hathaway and adopted it as their own. Like Marcus Aurelius and Sir Isaac Newton, Tom Gayner knows to borrow the best ideas other people have already figured out.

Think Long-term

Markel doesn’t think in quarters. Gayner says:

We want to be doing a good enough job for customers and delivering enough value and delighting them in such a way that they want to keep doing business with us. Cutting that into quarterly time frames and setting expectations that are tied to that, that just seems like a bad idea.

Markel doesn’t hold investor days or quarterly conference calls. Instead, they host a Q&A in Omaha the morning after the Berkshire meeting. It’s a natural fit considering their overlapping investor base with Berkshire. Markel even copies Berkshire’s format, simply taking questions from the crowd.

Gayner’s experience as an operator has made him a better long-term investor. He’s learned that even the best businesses under the most capable managers have temporary setbacks. Having experienced setbacks himself, he can empathize.

Gayner has learned to stick with proven managers through thick and thin. He cuts them slack so they have room to improvise and fix the problem without cutting corners. He says:

Get the right people in the room and give them a long enough leash to make some potentially sub-optimal decisions. Leave a little slack in the system. Allow time and space, and muscle, and rest, and energy to create things that you — you couldn’t have thought of beforehand that happened somewhat through serendipity.

This reminds me of what psychologist Amos Tversky said:

The secret to doing good research is always to be a little underemployed. You waste years by not being able to waste hours.

As they say, jazz is the space between the notes.

Avoid Investment By Committee

Sam Markel founded Markel in 1930. When he passed away, Sam’s four sons (two sets of twins) assumed management. The sons only took action when they agreed unanimously. Though the company survived their reign, it didn’t grow. There were too many cooks in the kitchen.

Extraordinary results require contrarian thinking. The best opportunities lie where others aren’t looking. The larger a committee, the more inertia it has and the harder it becomes to deviate from the consensus.

Today Markel has two CEOs. Gayner manages investments and ventures while Richard “Ritchie” Whitt manages insurance. The two make major capital allocation decisions together, but execute day-to-day matters independently.

Two seems to be the magic number for an investment team. It’s useful to talk things through with someone. Buffett has Munger, Greenblatt had Goldstein, and Pabri has Spier. It’s no accident EPC has precisely two of us running it.

Avoid Competition

Peter Thiel says “competition is for losers.” He classifies companies as either monopolies or non-monopolies. Monopolies are where the real money’s made. Gayner uses game selection to avoid competition. He seeks monopolies in over-looked niches.

Markel Ventures competes with private equity for acquisitions. Markel can offer cash, a quick closing, and a permanent home for the business.

Yet, private equity firms are often willing to pay more. They’re using other people’s money, lots of debt, and have to either deploy their money and earn a fee… or give it back. Guess what they choose?

Some owners prefer a permanent home for their business over a high price, but most don’t. So private equity usually has an edge. Markel compensates by hunting in niches too small, too boring, or too cyclical for private equity.

Markel’s Cottrell subsidiary is a good example. The company dominates the market for the car carries auto dealers get deliveries on. When cars sales rise, it’s a profitable. But when car sales drop, there’s no price reduction that will spur incremental demand. When no one that needs to move cars, the business loses money.

Cottrell’s cyclicality makes lenders wary of lending to it. And without leverage, private equity won’t buy it. Gayner’s logic for buying it was simple:

My math was if I buy that today, I’m pretty sure that within the course of the next five years I’m going to get out all my money and — and then still own the business, which is probably better and bigger in five years especially with the culture they have and the people that are running it…

I’m indifferent to the path — whether I make zero in year one and 40 percent of it in year two, and 10 percent of it in year three, and zero again in year four and whatever the residual is in year five. That — that pattern doesn’t matter to me because I’m not trying to hit quarterly — quarterly goals.

Markel’s permanent capital allows Gayner to avoid path dependence. He doesn’t care if the good years come before the bad ones. He only cares that there will good years on balance. Deciding if a business will produce profits over time is much easier than predicting when it will produce profits.

Let Your Winners Run

Tom Gayner’s grandma was his most important investment teacher. He said:

After my grandfather died, grandma didn’t make any substantive decisions. The 12, 13, 14 stocks that my grandfather had when he died, my grandmother held those until she died.

Fortunately, her portfolio included Lockheed Martin and Pepsi. The rest could have gone to zero and it wouldn’t have mattered. She still would have had excellent returns. Compounding is like an evolutionary process where the winners inevitably dominate the losers. It naturally produces power laws.

Gayner learned that when you’re right about something, stay with it. Stay on the train as long as it keeps rolling. Peter Lynch said the same:

Selling your winners and holding your losers is like cutting the flowers and watering the weeds.

The benefit of a buy-and-hold coffee can approach is that the winners naturally compound and dominate portfolio. Meanwhile, the losers become a smaller percentage of the total. They both take care of themselves.

Avoid Unforced Errors

Mike Heaton, President of Markel Ventures, once asked Tom Gayner, “What does it feel like when you’re making a mistake.” Heaton says, “It feels great! Because if it didn’t feel good, you wouldn’t do it.”

Investment mistakes are inevitable, even for the best. They’re impossible to avoid. How should investors proceed knowing that some of their “best” ideas will prove to be mistakes?

First, Gayner thinks investors need humility. Admitting that you could be wrong is an important first step. We try to embrace this at EPC by focusing on avoiding stupidity rather than seeking brilliance.

Second, investors need to embrace feedback loops. Feedback can come from anywhere - listening to other people, market prices, or news. It’s easy to lock yourself in an echo chamber and surround yourself with yes-men, but that doesn’t do you any good.

Finally, Gayner never prices his investments for perfection. He demands a margin of safety such that even if he’s wrong he’s unlikely to lose money. Dan and I try to do the same. We prefer to buy businesses we’re virtually certain to grow, but at a price that implies they won’t. If we’re wrong and they don’t grow, we haven’t overpaid.

As Ben Graham said, "The purpose of the margin of safety is to render the forecast unnecessary."

Dollar Cost Average

Gayner divides errors of commission into two categories: business and valuation. Either the business isn’t as good as expected, or the business was as expected but the price was too high. Value investors are more likely to make a business mistake than a valuation mistake.

Dollar cost averaging helps smooth out valuation mistakes. Markel has underwrote profitably in 116 of the 120 quarters Gayner’s been there. That produces consistent cash flows he can use to dollar-cost average into his favorite businesses.

Though this model is hard for hedge funds to replicate, it’s easy for individual investors.

Dollar cost averaging is powerful because it forces investors to focus on compounders, not special situations. Dollar-cost averaging isn’t as effective when an investment thesis hinges on a multiple re-rating higher. It works best on businesses that are increasing their intrinsic value over time.

Focus On The Best Businesses

The best businesses tend to make the best investments. Gayner likes to quote Munger, who says “Time is the friend of the wonderful business.” Since Markel was built to generate durable free cash flows, it’s natural for Gayner to prefer wonderful businesses with a long runway ahead.

But this wasn’t always the case. Gayner started, like many do (including myself) as a quant. He tried to buy statistically cheap securities, even if that meant compromising business quality. While this worked decades ago in Ben Graham’s era, it’s much tougher today. The low-hanging fruit has been picked.

Now Gayner focuses as much on a business’s intangible qualities as its quantitative metrics. As Einstein said, “Not everything that can be counted counts and not everything that counts can be counted.” It’s not that quantitative metrics aren’t important, it’s just that they’re not the whole story.

When Gayner was younger, he found ideas on the WSJ’s “New 52-Week Lows List.” Now, he finds more ideas on the “New 52-Week Highs” list. When a stock is consistently making new highs, he asks himself what the market believes that he’s missing. Is this actually a wonderful business? This is a powerful mindset rooted in humility.

If you would like to invest with Eagle Point Capital or connect with us, please email info@eaglepointcap.com. Thank you for reading!

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