Hidden inflation is an insidious devourer of profit. Forget what the Consumer Price Index is telling us — higher costs don’t always get passed on to the consumer. Sometimes quality is reduced instead.
Whether it’s the bag of potato chips that’s half-filled with air, the controversy of “pink slime,” or the shrinking amounts of cake mix in packages that used to hold more — whether we admit it or not, the inflation we’ve been worried about is already here.
It’s the kind of environment where we see “Forever Stocks” shine. These are companies that have businesses built to last through bear markets, rising interest rates and, yes, inflation.
This “Forever Stock” has an operating margin of 44%, which gives it plenty of wiggle room to withstand economic hardships. Expected earnings growth is 11.8%, and its business model has started to turn the heads of some of the biggest players on Wall Street. The company has been referred to as a “Baby Berkshire” since it’s an insurer with a large investment arm similar to Berkshire Hathaway Inc. (NYSE:BRK.A).
But why buy the baby version instead of Warren Buffett’s eponymous brain child? As Buffett explains: “Our future rates of gain will fall far short of those achieved in the past. Berkshire Hathaway Inc. (NYSE:BRK.A)’s capital base is now simply too large to allow us to earn truly outsized returns.” Berkshire Hathaway Inc. (NYSE:BRK.A) is too big to generate the enormous returns it did when it was smaller and more agile.
The “Forever Stock” I’m talking about is insurer Markel Corporation (NYSE:MKL). Markel Corporation (NYSE:MKL) specializes in insuring niche markets such as summer camps, antique motorcycles, auto races and amusement parks. It faces little competition in these markets, which gives Markel Corporation (NYSE:MKL) the ability to adjust rates as economic conditions change without losing its client base.
The specialty insurance company recently reported mixed results on second-quarter earnings, mainly due to its $3.3 billion buyout of competitor Alterra. But that should hardly be taken as bad news. The acquisition increased Markel Corporation (NYSE:MKL)’s book value by 12% to $452 per share, giving the stock a very attractive 1.17 price-to-book (P/B) ratio. Compare that with Berkshire Hathaway Inc. (NYSE:BRK.A)’s 1.45, and we start to see how Markel is the better value.
The size difference between the two companies reveals why Markel Corporation (NYSE:MKL) has the ability to invest in ways Berkshire Hathaway Inc. (NYSE:BRK.A) cannot. Markel Corporation (NYSE:MKL)’s market cap is just over $5 billion, less than 2% of the massive Berkshire Hathaway Inc. (NYSE:BRK.A).