Investing lessons from a mini-Berkshire Hathaway

IT WAS the luck of the draw. In 1986, a young analyst, Tom Gayner, was tasked with covering Markel’s initial public offering. While researching Markel, Gayner was struck by its similarities to Berkshire Hathaway, led by renowned investor Warren Buffett.

For a start, both companies had a large insurance operation. Insurance firms have two sources of revenue: charging premiums for coverage and investing those premiums into interest-bearing assets, typically bonds. Most insurers would take a loss in the insurance operations and make up the difference through investment gains.

Markel, a specialty insurance firm, stood out by making an underwriting profit, a rare feat in the sector. Instead of investing solely in bonds, Markel would invest the profit into stocks, taking a long-term approach. Intrigued by Markel’s unique strategy, Gayner joined the company in 1990.

His perseverance eventually led him to become Markel’s co-CEO in 2016 and finally, its sole CEO in 2023. Gayner has undoubtedly played a crucial role in increasing Markel’s value to over US$20 billion today.

Since 1990, Markel shares have soared from around US$22.25 to nearly US$1,560, an astounding gain that turns every dollar invested into almost US$70. Over time, Markel became known as a mini-Berkshire while Gayner earned the nickname “mini-Buffett”.

Given his reputation, it was a privilege to hear Gayner speak at a Singapore Markel Group Brunch held earlier in October. As a Markel and Berkshire Hathaway shareholder for more than a decade, these are a few lessons I picked up during this session.

Mistakes of commission and omission

If you had the chance to go back in time, what would you do differently? Gayner believes there are two types of investment mistakes: mistakes of commission and mistakes of omission.

Mistakes of commission occur when you take an incorrect action, such as buying the wrong stock or selling a winner too early. Mistakes of omission happen when you fail to act when you should.

Interestingly, most investors are fixated on mistakes of commission. There’s a good reason for this behaviour. These errors are vivid and embarrassing. They often linger in your mind long after you make them. Simply said, the pain of monetary losses due to your own actions is not easily forgotten.

Here’s the rub. Gayner believes mistakes of omission are far more costly than mistakes of commission.

He shared a personal example of passing on investing in Berkshire Hathaway (A shares) in 1984 when he first discovered the company. At the start of 1984, shares were trading at around US$1,300. By the time he got around to buying some shares, the stock price had risen to US$5,750. Hence, he missed out on a gain of over 340 per cent.

I’ll add a second lesson to his point. Shares of Berkshire Hathaway (A shares) closed at nearly US$694,000 per share last Friday (Oct 11). In other words, even though Gayner did not invest earlier, his shares are worth about 120 times more than what he paid.

While his returns could have been over 530 times if he invested earlier, I don’t think anyone would lose a smile with a 120-fold return.

So, here’s my take: if you find a great company with a promising future, it may not be too late to invest, even if the stock has already appreciated. In my view, finding a great company is much harder than finding a cheap stock which may not perform in the future.

Gayner’s criteria for buying stocks

Markel invests in both bonds (fixed income) and equities. For a start, the insurer tries to match the level of fixed-income investments with the insurance coverage that is likely to result in claims.

When selecting stocks to invest, Gayner looks for four key factors. The first is about finding a profitable business with minimal to no debt and a good return on capital. The reason is clear: starting with this pool of stocks increases your chances of finding a winner.

Second, he wants a talented management team with integrity. Gayner may have taken a leaf out of Buffett’s playbook here. As Buffett once said, without integrity, the other positive management qualities will work against you.

Interestingly, Gayner also connected the use of debt with management’s character. For him, debt is a character marker.

In a podcast recorded earlier this year, Gayner recalled the advice of Shelby Davis, another legendary investor and mentor. Davis pointed out that in the absence of knowledge about a new business, the use of debt can be a telltale sign. Simply said, if a business is entirely equity-financed, the management team will have no incentive to steal from their own funds.

To be sure, this does not mean that a debt-laden company is fraudulent. However, Gayner argued that leverage creates conditions for a dishonest management team to exploit since the money does not belong to them.

My take? It’s a broad-based method that can be effective when you are starting to learn about new companies.

Gayner’s third criterion is reinvestment opportunities. In our view, his first two criteria focus on finding a well-run company with a strong track record, while the third assesses whether the business has the opportunity to continue earning similar returns in the future.

The fourth and final factor is a reasonable stock valuation, which is self-explanatory.

Get smart: Master investing and your guts to take action

What if you have found the right stock to invest in, and are ready to take action? Before you dive in, consider this: Gayner attributes his success to a consistent influx of investment funds.

In fact, in the 400 months at the company, he’s had fresh funds to invest in 393 of them. He credits the constant availability of cash to his ability to keep a level head and make better decisions. Not all of us have the luxury of consistent cash flow, a key factor to consider.

Finally, Gayner acknowledges his own limitations. Although he admires Warren Buffett, Gayner diverges from Buffett’s strategy by diversifying more. Why does he do so? He readily admits that he is not as smart as Buffett.

In my view, Gayner’s admission may be the most important lesson for investors. We should always adapt our investment strategy to our own circumstances. If you don’t have a reliable source of investment funds, consider holding cash as part of your portfolio or investing in dividend stocks to generate income.

Above all, keep your feet on the ground and don’t be greedy, says Gayner.

The writer owns shares of Berkshire Hathaway (B shares) and Markel. The writer is co-founder of The Smart Investor, a website that aims to help people invest smartly by providing investor education, stock commentary and market coverage