Friday File: Earnings Season heats up in our portfolio, dealing with Animal Spirits and Mr. Market

Animal spirits are heating up, which is always fun in the market, sparking some adrenaline and making us all feel smart as our stocks go up… but should also make us at least a little bit nervous. Especially when we see a resurgence of the kinds of things that only seem to happen in really speculative markets, like the wild meme stock frenzy recently starting to heat up and look a little bit like 2021 again, or the big wave of new SPAC offerings hitting the market to try to take advantage of investor optimism.

I obviously don’t know if the market is going to top out anytime soon, or what will happen in the second half of this year as the tariffs get finalized, the real economy absorbs the impact, and the market decides where longer-term interest rates will go, that macro stuff is essentially unknowable (and, of course, something completely different and surprising can always happen)… but I do know two things: The stock market is unusually expensive, particularly for the large cap S&P 500; and most indications are that we’re in a greed-driven “risk on” market. That doesn’t necessarily mean anything for next week or next month, or even next year — expensive and optimistically valued market runs can come to an abrupt end, or can last for years — but unless you’re focused on short-term trading, these are times when we really have to focus on knowing what we own, and why we own it, and what risks we think we’re taking. When markets are volatile and crazy stuff seems to be happening, try to hone in on what you want to own, why you want to own it, and what, if anything, would make you change your mind.

You’re probably sick of me offering up these types of lectures, so I’ll just try to quickly summarize three concepts I’ve written about before that might help us keep our heads, even if those around us might be losing theirs: Mr. Market, Trading Sardines, and those aforementioned Animal Spirits.

Mr. Market

I’m not a strict “Graham and Dodd” value investor in all things I do, but the very notion of determining the value of a company before you buy it is the then-revolutionary core of Ben Graham’s wisdom, as it has percolated down through generations of people who think of themselves as “value investors” — you decide what the value is, let the market decide what the price is on any given day, and buy when the value is higher than the price. When the market offers to sell to you at a price you know is below the company’s rational value, you buy… when the whole world loves the stock, and only offers to sell it to you at a high price, you wait. Or if it’s really crazy high, you might sell, too… but mostly, if it’s a good company I want to own for the long term, I wait.

Here’s how Ben Graham’s most famous student, Warren Buffett, put it in his Annual Letter to Berkshire Hathaway shareholders, back in 1988:

“Ben Graham, my friend and teacher, long ago described the mental attitude toward market fluctuations that I believe to be most conducive to investment success. He said that you should imagine market quotations as coming from a remarkably accommodating fellow named Mr. Market who is your partner in a private business. Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his.

“Even though the business that the two of you own may have economic characteristics that are stable, Mr. Market’s quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions he will name a very low price, since he is terrified that you will unload your interest on him.

“Mr. Market has another endearing characteristic: He doesn’t mind being ignored. If his quotation is uninteresting to you today, he will be back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic-depressive his behavior, the better for you.

“But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence. Indeed, if you aren’t certain that you understand and can value your business far better than Mr. Market, you don’t belong in the game. As they say in poker, “If you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy.”

“Ben’s Mr. Market allegory may seem out-of-date in today’s investment world, in which most professionals and academicians talk of efficient markets, dynamic hedging and betas. Their interest in such matters is understandable, since techniques shrouded in mystery clearly have value to the purveyor of investment advice. After all, what witch doctor has ever achieved fame and fortune by simply advising “Take two aspirins”?

“The value of market esoterica to the consumer of investment advice is a different story. In my opinion, investment success will not be produced by arcane formulae, computer programs or signals flashed by the price behavior of stocks and markets. Rather an investor will succeed by coupling good business judgment with an ability to insulate his thoughts and behavior from the super-contagious emotions that swirl about the marketplace. In my own efforts to stay insulated, I have found it highly useful to keep Ben’s Mr. Market concept firmly in mind.”

An admirable goal that I often fail to fully reach… but it’s good to have goals. That’s why I put my “buy under” prices in print and update them regularly on the Real Money Portfolio, because I want to decide what to pay to own companies I like, based on some rational assessment of their business and their future potential. I might be wrong, of course, and that happens with some regularity, but I don’t want the market deciding for me… and if my mood about how much something is worth shifts every time the price changes, then that means I’m falling into the trap of relying on Mr. Market’s wisdom.

Trading Sardines

This story comes to mind because now, with meme stocks and SPACs having a comeback of sorts, is the time to be honest with yourself about whether your portfolio is full of “trading sardines” or “eating sardines.”

That comes from an investing parable that has been around the markets for a long time, but was probably popularized mostly by Seth Klarman in his book Margin of Safety, which was published about 25 years ago. Klarman related a tale about the sardine merchants in Monterey, California, who were buying and selling canned sardines with increasing speculaative fervor as the fishing dried up (also the setting for Steinbeck’s Cannery Row, just FYI), and that turned into a bit of a trading mania as people couldn’t find sardines and the prices skyrocketed. One buyer was so pleased with himself after getting a high-priced tin of sardines that he got ready to have a nice meal, sitting down to enjoy his prize… and found the sardines had turned and tasted horrible. He went back to the trader who sold them to him and complained, and that trading partner was astonished that he would have tried to eat them — with his admonishment being something along the lines of, “those are trading sardines, not eating sardines.”

So it goes — every experienced investor knows that some of the stocks they hold are trades that they hope to sell to someone else, hopefully someone dumber or more misguided than them… and some are stocks they’re willing to “eat,” positions they can live with holding for a long time because of the fundamentals of the underlying business (“fundamentals” meaning the actual revenue and earnings and sustainable margins, not just the “story” that excites investors).

We all get some wrong sometimes, but it’s important to know whether you own a stock because you want to own a piece of that company’s profits for a long time, which is always eventually what causes value to surface and be appreciated by the world, or just because you hope it’s going to get more popular. If you give it enough time, it’s a lot easier to be right about an eating sardine than a trading sardine.

Animal Spirits

Warren Buffett has famously said, “If you understand chapters 8 and 20 of The Intelligent Investor and chapter 12 of The General Theory, you don’t need to read anything else and you can turn off your TV.” Those chapters from Graham’s Intelligent Investor are mostly about using “Mr. Market” to your advantage (ch.8) and investing with a “margin of safety” (ch. 20), and Chapter 12 of John Maynard Keynes’ General Theory is mostly about long-term expectations and how they color investor psychology… a lot of wisdom about human behavior today comes from these books written in 1949 and 1935, respectively — the world changes, but people don’t change too much.

Here’s a little excerpt from that Keynes work:

“Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than on a mathematical expectation, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits — of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of the quantitative benefits multiplied by quantitative probabilities. Enterprise only pretends to itself to be mainly actuated by the statements in its own prospectus, however candid and sincere. Only a little more than an expedition to the South Pole, is it based on an exact calculation of benefits to come.”

And, of course, the sadder part, which has to do with what happens when speculative optimism, in the form of “animal spirits,” fades away… say, if the story becomes less popular, or the bull market is dashed on the rocks of some crisis….

“Thus if the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade off and die; — though fears of loss may have a basis no more reasonable than hopes of profit had before.

“It is safe to say that enterprise which depends on hopes stretching far into the future benefits the community as a whole. But individual initiative will only be adequate when reasonable calculation is supplemented and supported by animal spirits, so that the thought of ultimate loss which often overtakes pioneers, as experience undoubtedly tells us and them, is put aside as a healthy man puts aside the expectation of death.”

As Keynes later says, “it is our innate urge to activity which makes the wheels go round.”

There’s nothing wrong with that, and without animal spirits there would be no new discoveries, no entrepreneurs, and no leaps forward for the world… but you won’t want to spin all your wheels, all the time. The long-term investor has to invest with some optimism, otherwise you’ll never make enough money to beat inflation to a meaningful degree and hope to accumulate some wealth… but being super-optimistic when the rest of the market is already on an optimistic high can certainly create some painful moments during the next market downturn or the next violent shift that favors some entirely different kind of investments, whatever that may be.

It doesn’t really matter which metaphor we want to use to think about how the markets work, fueled by human nature, whether that’s “trading sardines” or the “Mr. Market” parable from Ben Graham or the “animal spirits” described by Keynes — the point is that most of us who are long-term investors need to stay focused on companies and what we think they should rationally be worth, based on how much profit those companies can generate over time… not on how the market is subtly urging us to feel on any given day. And you don’t have to do something every day.

So… what’s up with our portfolio this week?

A lot of the recent optimism has been over progress and some potential clarity on trade deals, heading into next week’s August 1 tariff “deadline.” The news about a trade deal with Japan helped our ETF position in small Japanese stocks (WisdomTree Japan SmallCap Dividend Fund (DFJ)), so that’s now up a good 10% or so from when we started buying it in March… but it’s still pretty cheap, and pretty easy to own for some non-US “value” exposure (the average position in that ETF has a PE of about 12, and a ~4% dividend yield, and should ride any improvement in the Japanese economy).

The news also gave Stellantis (STLA) a boost, at least for a brief moment, since people started thinking that maybe the car companies in Europe that export to the US will end up with a similar deal to Japan, so that helped Exor (EXO.AS, EXXRF) a little bit… though Stellantis has been so weak, for so long, that it’s down to being only about 10% of the net asset value (NAV) for Exor these days, a similar weight to CNH (CNH) or Philips (PHG). Ferrari (RACE) is still the big driver for that family-controlled investing conglomerate, accounting for more than 40% of NAV (no big move in the “discount” of late, Exor still trades at about a 45% discount to the net value of their investments — and I still think any discount greater than 40% is likely to be a good buy point for long-term investors, that’s where my “preferred buy” level resets each week).

We also got a bunch of quarterly earnings reports to cover this week, so let’s start with one of the biggest companies I own, and one of my longest-term holdings:

Alphabet (GOOGL, GOOG) continues to say and do all the right things, essentially meeting market expectations (plus a hair) and offering some optimism about their future. The one big-picture concern is capital spending, since that is eating up more and more of their cash flow, and they did raise their Capex guidance for this year to now $85 billion (up $10 billion from what they said last quarter), which is a crazy amount of money, even for a giant like Alphabet. Still, that’s in response to more demand from Alphabet’s customers for their Google Cloud services and their AI platform and products, and that’s what the market wants — they want AI leadership, and you can’t get there right now unless you spend gazillions of dollars on new data centers and AI chips and all the other goodies.

I’ve written before about how this could unspool badly sometime in the future, with all the mega-cap tech companies spending so much that it’s almost inevitable that they’ll overspend and overbuild, as has happened with every “race” in the past, whether that’s building out the internet and fiber-optic networks, or the early power grid, or even the railroads. And we of course know that Alphabet faces lots of antitrust and regulatory challenges around the world, much like Apple (AAPL), so there’s always at least a little something to worry about.

Still, the spending is working, it’s building up the Google Cloud business nicely (which grew its backlog dramatically again), and they don’t really have a choice unless they want to just surrender that business to Microsoft (MSFT) and Amazon (AMZN) and others, all of whom are also going “all out.” It’s not a high margin business today, it’s not nearly as attractive as Google Search or advertising, the businesses that have gushed cash for Alphabet for almost 20 years… but that doesn’t mean it cant be, someday. YouTube was a silly dalliance when Google bought them in 2006, and was still a trivial part of the business when it started generating a profit, in 2010, but now it’s by far the most valuable video platform in the world, likely to generate $35-40 billion in ad revenue this year.

As long as Alphabet remains the AI/infrastructure/search/cloud leader that’s most attractively valued, either because of fears of AI eroding search advertising or because of antitrust remedies (like maybe having to sell Chrome), I’ll just keep holding on. So far, the fears are much more prominent in investors’ minds than they are on the Alphabet income statement, and I think that’s likely to remain true into at least the near future. The worries are there, but the business is doing very well.

Here’s what I wrote about Alphabet following their last quarterly update, at which time the stock was also at about $190 (though that was after falling 10% on the news that CapEx was rising to $75 billion).

Google does not have much of a choice with its capital spending, and we don’t know if that capital spending will bear fruit in the future, but we do know that Alphabet does not have a history of being careful with spending or optimizing capital spending — they haven’t had to, because they’ve had such a waterfall of cash gushing over their heads from the advertising business. So to de-risk that a little, I’m going to be more aggressive with depreciation, and say that in addition to the GAAP requirements for depreciation, a third of that total CapEx is really better thought of as a required operating cost for the business.

That’s probably too conservative, assuming the bull market keeps roaring along… and I have no idea whether investors will have the same concerns as I do about Alphabet’s business getting a little worse as it grows into this CapEx. It may be worth more than that, it’s a uniquely powerful company right now with a fantastic business, but I want to be mindful of the risk that the cash-generating part of the business is growing a lot more slowly than the cash-spending part of the business..

Since then, the market multiple has dropped a hair (to ~23X forward earnings), and earnings for Alphabet have jumped up a little bit, in part because AI so far is helping, not hurting… but CapEx has also bumped up by another $10 billion, so my adjustment to earnings (essentially just saying that a third of the CapEx is really necessary spending on operations, which is almost twice as much as really gets reported as depreciation) would bring that adjusted level of profit down. The current forecast for the next four quarters is about $120 billion in earnings for Alphabet, which includes roughly $20 billion in depreciation impact, but we’ll bump that up to $30 billion, so our new expected “profit” is $110 billion for the next four quarters… 23X that, to keep a premium valuation for a dominant growth company, even if it’s not as capital efficient as it was before this AI spending took off, would give us a new “max buy” level for Alphabet of $2.53 trillion… which is about $209 (that’s a little higher than it was a quarter ago, since in retrospect I now think I wasn’t giving them enough credit for what they’re already accounting for in increased depreciation). If you want to be more conservative, like I was back in February, putting even more of that new CapEx spending into operating costs, you cold reasonably bump that down — each $10 billion cut to your adjusted earnings expectation, in that model, would reduce the “fair” share price by about $19.

I’m still comfortable with Alphabet at this price, and it’s a lot cheaper than Apple, Microsoft, Amazon, or Meta, with similar or better growth prospects than all of those, at least in my expectation, so I think it gives us even a little bit of a margin of safety… which is perhaps sensible for a company that is in the middle of an arms race for AI infrastructure buildout, and could be meaningfully impacted by antitrust remedies or other regulatory pressure. I did sell a chunk of my Alphabet holdings when it hit a stop loss during the tariff challenges earlier this year, mostly because I’ve taken no profits on that stock in the 20 years I’ve owned it, but I expect that they will be at least a survivor of this wave of AI mania, even if they might not turn out to be the most dramatic “winner.”

But to be clear, it’s still not cheap, given the real risks. For more of a margin of safety, I’m pretty confident that Alphabet should have at least $9.75 in GAAP earnings over the next four quarters. The S&P 500 earnings multiple over the past 25 years has been a bit over 16, so my “preferred buy” level, just to value Alphabet as an “average” company, would now be 16X expected earnings, or roughly $156. We’ve certainly seen the stock trade below that level recently, so it’s not out of reach.

*****

Speaking of artificial intelligence, Vistra (VST) and the other power producers who feed the PJM grid didn’t report earnings this week… but they did get a “the party keeps rolling” update from the latest capacity auction. PJM is the electrical grid operator that manages much of the mid-Atlantic region of the East Coast and big chunks of the Midwest, touching parts of 13 states in an area that includes “data center alley” in Northern Virginia, the most concentrated and power-hungry data center complex in the world (reports are probably a bit hyperbolic, but indicate that as much as 3/4 of global internet traffic passes through Virginia in some way). That grid management company holds auctions to help make certain that they’ll have a flow of electricity in the future that meets their projected peak demand, with a margin of safety, essentially having power producers bid to guarantee a level of production during future years and be paid for that commitment (consumers can also bid to reduce their demand at peak times, but that’s a much less interesting part of the auctions for investors).

Those auctions are supposed to happen three years out, in order to incentivize producers to build extra capacity to meet future demand (it theoretically takes a few years to build a new natural gas power plant, for example), but they’re a bit off schedule in recent years, so this month’s auction was for capacity beginning only a year from now, for the year from mid-2026-2027 (they’re catching up, so there will be an auction for 2027-2028 in December of this year). Still, the construction of new generation capacity is being incentivized, as intended, since the AI market has provided growth “signals” to the power market for a couple years now, even if it sometimes takes longer than three years to bring it online.

And as I imagine most people would have expected, the auction cleared at the price cap, meaning as high as it’s allowed to go under the current regulations. That means most of the region has a higher clearing price for this portion, though a good chunk of Maryland and Virginia (areas covered by Dominion Energy and BG&D) is actually lower, since they cleared at a higher price last year, before there was a cap for the whole grid.

Mostly, this was just a bit of reassurance for investors that future electricity demand remains high and growing, and that this big grid, at least, is probably going to see prices continue to rise. That may or may not cause retail electricity prices to jump, the estimate from PJM is that the average customer might see a 1-5% increase a year or so from now, as a result of this auction, but growth and bidding interest in this auction reinforces what we already knew: Demand is high and rising, and that’s good for the companies that own power generation assets.

And though everyone already pretty much knew that, thanks to the constant flow of stories about urgent demand for more power generation to feed more data centers (including, just this week, that extra $10 billion Alphabet is planning to spend on AI capacity), that auction was enough to give a boost to the power producers who supply PJM — including our Vistra (VST), as well as Constellation Energy (CEG), Talen (TLN), NRG Energy (NRG) and others, with the stocks jumping up 5-10% on Wednesday after the auction.

Though it also served as a reminder that the more regulated utilities, companies who are steadier and may own some generation assets, but primarily deliver electricity to customers and work with regulated retail pricing, are less directly boosted by wholesale electricity prices, which you can see in the stock market reaction of the large utilities in the PJM region that actually operate and are expanding a lot of the grid this week. The stock price of companies like Dominion Energy (D) and Duke Energy (DUK) and Exelon (EXC) didn’t really react at all to the auction results — that’s generally because the electric utility business has separated over the years, dividing the steady power delivery companies from the more volatile power generation companies. Regulated retail utilities are still the steady eddie, reliable stocks that typically pay a decent dividend and have relatively steady share prices — power generators are more volatile, dependent on shifts in demand and on the cost of fuel, and they’ve enjoyed a huge surge from the surprising increase in electricity demand brought on by the AI infrastructure buildout (well, surprising to an investor in 2022, at least).

It’s also true that most of the big utility holding companies own some of both kinds of business — Vistra owns regulated utilities in Texas in addition to its many power generating plants that consume coal, natural gas and uranium, for example, and Dominion Energy is mostly a huge utility but also owns some of its own generation assets. There’s plenty of middle ground, but probably the best demonstration of this difference between utilities and power generators (or independent power producers (IPPs), as they’re often called) is in the chart of Constellation Energy compared to its former parent, Exelon.

Exelon was a huge diversified utility company, and they spun out their generation assets into a new company called Constellation Energy in 2022, sadly timed just before we had this shift to thinking about electricity demand growing in the US, for the first time in decades. That means Exelon, which until 2022 was the biggest owner of nuclear power plants in the US, spun those plants off after that industry had been in decline for decades, and had pushed some operators and service companies into bankruptcy and a lot of early nuclear plant closures… but it turns out that the spinoff was completed just a year or so before everyone realized that nuclear power plants might become some of the most valuable assets in the world, supplying steady carbon-free power to all those hyperscale data centers. This is how the two stocks have done since:

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So that’s also a reminder of how the common-sense understanding of what’s going on in the economy can change pretty quickly. Closing down or spinning out nuclear power plants didn’t seem at all silly in 2022, 11 years after the Fukushima disaster and five years after Westhinghouse declared bankruptcy (in part because Plant Vogtle in Georgia, the most recent new reactor built, was massively delayed and way over budget, and other planned plants were scrapped), and just two years after major nuclear plant owner First Energy declared bankruptcy, in part because of the massive costs of maintaining those plants and the extremely low price for competing natural gas.

But that “abandon nuclear” strategy seemed short-sighted by 2023, and laughable by 2024, when Vistra bought those First Energy (by then called Energy Harbor) plants out of bankruptcy and soared as one of the more nuclear-exposed independent power producers in the US. Sometimes logic comes over the whole market in a wash, and we wake up dizzy afterwards, barely realizing how much the ground had shifted under our feet.

Since we’re on the topic, we also got a minor update from our favorite nuclear stock, BWX Technologies (BWXT) — they have been working on the Pele microreactor for the department of defense for a few years now, and there have been plenty of delays along the way, but they have now started to build the reactor core, so that’s encouraging, and they’ve already made the TRISO HALEU fuel (Lockheed and Rolls Royce are also building parts of this transportable 1.5GW microreactor, which is now expected to start producing electricity in 2028 — as with many nuclear test projects, it will be assembled at the Idaho National Laboratory). That’s not going to have a big short-term impact on BWXT’s earnings, but it’s good to see progress (particularly given how few civilian SMR projects have actually made any progress toward reactor construction). BWXT’s reactor work has been picking up on both the military and civilian side, including this Pele project as well as the reactor vessel for the BWXR-300 being built in Ontario, and we’ll be watching to see what they say about the commercial nuclear outlook when they report — that should be in about ten days, so we’ll hear more before too long.

Reports from our P&C Insurance stocks begin to roll in…

W.R. Berkley (WRB) didn’t offer up any surprises this quarter, the most notable news from the conference call was that CEO W.R. Berkley, Jr. (son of the founder and Chair) reset expectations a little bit — they’ve been talking for a long time about an expectation of 10-15% growth, and this is what he said in the Q&A:

“Look, I think we had come out with that band if you will, probably, I don’t know, call it, 18 months ago, maybe 24 months ago, if you’re asking my best guesstimate at this stage in spite of the number that we saw in this quarter, my view is that it’s probably somewhere between 8% and 12% would be my guess as opposed to 10% to 15%.”

That’s a reset in the growth thinking which we see reflected across most of the industry, and it seems to maybe be beginning to hit the stocks after some real boom years, but the impact has so far been quite gradual — growth in net written premiums this quarter was about 7%, down from 9-10% over the past couple years.  There’s no big change on the balance sheet from a quarter ago, so W.R. Berkley is still at a similar valuation on that front — great company, I’m confident it will do well over the next 10-20 years, but there are meaningful “down” cycles in the insurance business, too, when things go poorly for years at a time (not just slowing growth, but shrinking premiums and income), so I’m also hoping it comes back down a bit to a valuation that gives us a little bit of a margin of safety.

That could easily come over the next few quarters if we see interest rates come down a bit as the property insurance rates continue to moderate from the crazy growth of the past few years, as always happens (high rates bring in more competition, most recently from a lot of underwriting startups, often fueled by hedge funds and private equity, and usually the new entrants make big underwriting mistakes, leading to losses after a few years and then another reset for the market as the new money flees). The market is softening to at least some degree, with reinsurers loosening their standards a little, though there’s still plenty of concern about casualty insurance (that’s the liability side, as opposed to physical property coverage). WRB management is still saying all the right things about managing risk, and they always have some good big-picture commentary about the market and the investing environment (for bonds), but my “buy under” prices won’t change very much as a result of this quarter… still a great company, still fully priced.

And still with a pretty good handle on the state of the insurance industry and the state of the world, I think — this is the intro from the conference call, summing all of that up:

“… it is very much an interesting moment in the property and casualty space. We are reminded of the complications of this industry, an industry where you make a sale before you ultimately truly know your cost of goods sold. We have been grappling with this reality as an industry forever.

“But there are moments in time when it comes into sharper focus than others. We certainly, over the past several years, have had to grapple with financial or economic inflation and that was combined with social inflation, which we have talked about, and I suspect we’ll continue to talk about. But while on the heels of COVID, financial or economic inflation seems to be brought far more under control, there are some real threats to that. Certainly, tariffs are top of mind for all of us.

“In addition to that, one should not lose sight of what’s going on in the labor market and what that may mean for wage inflation over time, particularly around some of the administration policies that they are in the process of putting into place. And finally, there is the big question around deficits and what that will ultimately mean for the economy. And lastly, to what extent can we expect the U.S. consumers continue to be the driver and allow the economy to remain as resilient as it’s been. These are amongst some of the macro questions that we are grappling with.

“Obviously, there’s applicability to both our underwriting activities and how we think about selecting and pricing risk. And furthermore, I think it goes without saying there’s meaningful applicability to the investment portfolio and how we think about positioning that. So as always, lots of moving pieces trying to not just interpret what they all mean for today, but also how we think about positioning the business going forward.”

And after going into some detail on the bifurcation of the market, with some product lines going into a down cycle and others still seeing rate improving:

“We remain very focused on making good risk- adjusted returns, the decoupling of product lines and how they make their way through the cycle, combined with the breadth of our offering allows us to continue to grow when others perhaps are experiencing more of a headwind. In our opinion, you certainly are seeing different product lines at different points of transition. We have historically and continue to be more of a liability market, and we think that much of the liability market is where the opportunity will likely be over the next 12 to 36 months. So again, we think we’re well positioned on the underwriting side.

WRB management paid out another meaningful special dividend this past quarter, and did not buy back any stock — I think that’s a pretty reasonable stance at current valuations, 20% or so above my “max buy” price, though I did let those dividends reinvest.

And there has not yet been any big movement from Mitsui in their effort to buy 15% of the company. That Japanese firm is “buying in” with permission from the Berkley family but not really any close cooperation, and will vote with them, but they’re buying the shares in the open market, not creating any new equity for WRB — and so far, Mitsui hasn’t yet hit any of the SEC reporting thresholds where they have to report their stake officially, so it’s presumably still under 5%. That could support the shares in the near future, because it probably has and might continue to exert some buying pressure anytime the shares are otherwise a little bit weak, and the stock is down 10% or so from the June highs.

The longer-term risk in the insurance cycle, generally speaking, is that with interest rates now pretty steady at a higher level, and most insurance companies earning 5% or so on new money these days (even with an average duration of less than three years, as is the case with WRB), some underwriters will loosen their standards and start taking more of a chance of losing money on policies in order to take market share and accumulate more “float” on which they can earn good investment returns, which has been how cycles have mostly played out in the past. This is what Berkley said about that:

“… clearly, there is an economic model here and there is a relationship between investment income and underwriting profit and how it all comes together to deliver an outcome. That having been said, let’s understand that perhaps the most competitive part of the market is in some of the shorter tail lines, i.e., property, where investment income is making the most modest contribution. So do I think that there is an impact? Yes. Do I think that, that is going to take us fast to the world of cash flow underwriting? No, sir, I do not.”

I’ve bumped up my buy levels for WRB by a little bit to incorporate some growth in their book value and their float — “max buy” is a 25% discount to book + float, and I calculate that at about $61 now, and “preferred buy” is just a bottom-fishing level of 1.5X book value, which would come in at about $37.  I don’t expect we’ll see that lower value anytime soon, not with the company powered by a $30+ billion investment portfolio that ought to be earning about $1.5 billion/year, but we might see that during the next downturn in the insurance business, whenever that comes — like most insurers, even high-quality underwriters with a consistent record of operating profitability, WRB has occasionally been thrown out with the bathwater and pushed down to trade near book value (and it has sometimes even seemed to deserve that for relatively brief periods of time, when they’ve had large losses or a big mistake in the investment portfolio — both of those things happen to pretty much all insurance companies, the way we distinguish the best of them is that it happens much more rarely).

Chubb (CB), on the other hand, while much larger, is still drifting into a reasonable “buy” range, seeming to trade based on faltering sentiment for the insurance industry as a whole (probably because they’re a large, global leader).  They reported a very solid quarter, with book value per share now topping $174 on the back of another quarter of very good operating results, with a combined ratio around 86%, and excellent investment returns (driven by higher interest rates, which are still helping because it has taken some time to trickle through to the bond portfolios of most insurance companies).  Chubb really benefits from their global business, which means that even when they pull back a bit in the property insurance business, because of lower premiums and competition, they can push more into growing on the casualty side, or even in life insurance, or in overseas markets where property insurance is not currently declining in price. They have options, and one of the best CEOs in the insurance world to steer them into the best strategic direction.

So like many companies, Chubb had insured losses in the first quarter which were big enough to have a meaningful impact on earnings, but has bounced back after a much quieter quarter (the big impact in Q1 was from the Los Angeles wildfires, with Chubb one of the major underwriters for high-value home insurance in the US). But the earnings numbers were slightly worse than analysts were expecting, so the stock has drifted down a bit, not unlike W.R. Berkley, and is now back almost to where it was when the Los Angeles wildfires news brought them down to about $260/share in early January.

And as coincidence would have it, that $260/share level is now my “preferred buy” price, so if we drop below that it will be very compelling — I should note that I use 1.5X book value as that “preferred” level, because I think that’s a very fair valuation given the improved interest rate environment and Chubb’s strong and consistently profitable global business, but it’s not necessarily a “bottom fishing” level, especially if interest rates crater at some point — in the years since Chubb merged with ACE to create this global giant, in 2016, CB has a few times drifted down to 1.2-1.3X book value (no surprise, it drifted even lower than that during the brief COVID reset period in 2020, when everyone panicked about everything)… but back when they traded at 1.3X book pre-COVID, for example, they were keeping the vast majority of their capital in cash and short-term investments, which earned almost nothing — today, they’ve ramped up their long-term investments, since bonds are offering a rational yield again, and they’re making MUCH more money from the investment side. As they hold on to business and continue to underwrite profitably, something they’ve done consistently for decades, those higher rates continue to let that much larger investment portfolio compound much faster. If you want to be more opportunistic and wait for more of a historic discount, then 1.3X book value would be about $226 — which is roughly 15% below where the stock is right now, and would get CB back to where it was trading 18 months ago, so it’s obviously within the realm of possibility.

And when it comes to the “max buy” price, we take that float into account — we look for a 25%+ discount to the total of their book value plus the insurance float (money they get to invest, but don’t “own” because it’s reserved to settle expected future claims). Calculating float is more art than science, I think Berkshire Hathaway (BRK-B) is the only company that actually reports its own estimate of float each year, in part because it was really Warren Buffett who opened the world’s eyes to the value of that float, but I estimate that number at about $145 billion for Chubb these days… which means that a 25% discount would put it at just under $109 billion, and divided among a little more than 400 million shares outstanding, we get a “max buy” price of $272, which is actually uncomfortably close to our “preferred buy” price. That tight range is a little bit silly, which I think highlights how reasonable the Chubb valuation is right now, but we’ll stick with it for consistency, at least until I come up with a more reasonable argument for something else. Earnings expectations for Chubb are pretty tepid right now, with most analysts expecting earnings to stick around the current $22/share level going forward, maybe growing to $25/share over the next year or two, so the stock is at roughly 12X earnings, also quite reasonable (and similar to a lot of other insurance companies who are known for consistently strong underwriting).

It would be easy to let Chubb drift up to become a much larger holding, given my confidence in management and their history of excellent operating results, but I’m not in a hurry, it looks like the insurers might be losing a little bit of shine because of the declining property tax rates in much of the US, even though property is really only about a third of the P&C business overall (casualty/liability is a larger market), and that could continue to put some mild pressure on the stock prices… so I think buying Chubb is entirely reasonable here, but there’s no obvious positive catalyst on the horizon after several years of a great insurance market for most insurance companies, so perhaps we’ll get lucky and see some real bargains emerge. Or we can just quietly enjoy the compounding, either way.

And our third P&C Insurance company to update investors this week was our most aggressive outlier, the Excess & Surplus (E&S) lines specialist Kinsale Capital (KNSL).  Kinsale has been a wild growth story for the past decade, during which it has usually been the most richly valued insurance underwriter in the stock market, and it has earned a premium valuation (at least relative to book value).

This is one of my favorite insurance companies, mostly just because of how unique it is and what an excellent job they’ve done of managing their operating expenses and shifting their business into new lines of excess & surplus lines insurance to find profitable niches, with a valuable advantage over competitors that comes from their very technology-boosted and efficient underwriting process in this tricky market, particularly for smaller customers (like small businesses, or high-net-worth homeowners).

But it was interesting to see just how much Porter Stansberry apparently loves the stock, too — we’ve written about his past teases of the company at Porter & Co. in recent years, but this week he specifically tweeted it out (X’ed it?  That sounds wrong) as a stock that he thought would probably fall 20% on earnings, but then jump much higher over the coming year.  To be fair, that’s in part just a repeat of a pattern Kinsale has shown a few times in the past, it’s often very volatile around earnings updates as growth expectations reset, but I was curious to see whether he was right this time around, particularly because I knew that although I’m not likely to buy a lot more Kinsale (I’m already pretty full-up on that position), I also have no interest in selling my shares. Here’s Porter’s tweet:

I want you to buy a stock I’m virtually certain is going to fall 20%+ by the end of the week.

What you’ll read below won’t make any sense to most “normal” investors. But for those of you who understand risk versus reward, this is the best set up you’ll see all year.

This is,…

— Porter Stansberry (@porterstansb) 23, 2025

They reported the earnings highlights on Thursday evening, but as usual they waited until this morning to hold their conference call to discuss the results, and it’s usually that call that drives the stock price (particularly any commentary they have about whether growth is slowing down since the end of the quarter, or is otherwise looking at all worse in the future than it was in the past).  This is how CEO Michael Kehoe described the business in his conference call remarks:

Kinsale is very much a “priced for growth” company these days… and it has grown. That continues this quarter, sort of, with the first half of 2025 so far showing 20%+ growth pretty much across the board on the earnings front, but there has also been a meaningful slowdown in premium growth over the past few quarters, and that also continued this quarter, with gross written premiums growing 5% and net written premiums just under 7%, which is their slowest year-over-year growth ever (gross written premiums is essential “policies sold”, before you account for reinsurance coverage… net adjusts for the reinsurance they buy to pass along some of that risk to other providers).

The combined ratio in insurance is the most common “key performance indicator” for a P&C insurance company, with numbers below 100% meaning you’re reporting an underwriting profit (claims paid and the expenses of operating the insurance company are lower than the net premiums earned for that period of time), and any number over 100% meaning you’re taking a loss on the insurance you sell, usually as a bid to grow fast or take market share.  The business has been profitable for most in recent years, but almost no P&C insurance companies can report a combined ratio anywhere near 75%… Kinsale can, thanks to the fact that they operate in specialty areas and have very low operating expenses, and they did so again this quarter, with a 75.8% combined ratio (78.8% for the first six months of the year). That’s exceptional, and right in line with the 75-80% average combined ratio for KNSL over the past few years. Being that profitable, for that long, has led to extraordinary compounding of value for Kinsale shareholders… and to a rich valuation, even though the price/book multiple has shrunk over time.

Kinsale sells only excess & surplus (E&S) lines of insurance, and they have taken that market by storm over the past decade, shaking up a slow and often neglected part of the insurance market with fast response times and technology-driven efficiencies in underwriting smaller risks… the profitability has been volatile, but averages out to being extremely high as they’ve grown, and they’ve also now accumulated enough of a reserve base that they’re starting to earn meaningful investment returns in recent years, too. This quarter, they ended up with about $140 million in profit, with about 1/3 from investment income and 2/3 from underwriting income.

The general trend has been that top-line growth is slowing down a little for Kinsale, even more than it has for “regular” insurers in recent quarters, but the growing investment portfolio is helping to counter that, and their reserving has been conservative enough to let them “release” excess reserves into earnings for most years (other than the 2017-2019 period that a lot of companies have had to re-reserve for, with Markel (MKL) making probably the most abrupt adjustment about 18 months ago when they surprised investors with a big new reserve reset that gave them a bad combined ratio for 2023), and Kinsale has consistently gotten better at squeezing their expense ratio even more (it’s around 20%, when most insurers would be delighted to get down to 30%), so their underwriting profitability continues to get a little better, even in quarters when there are some catastrophe losses (like during the LA fires in the first quarter).

It’s hard to say anything other than, “these guys just do it better than everyone else” — at least in their niche business area, E&S lines of insurance for small businesses and high-net-worth individuals. This kind of profitability and compounding makes it easy to hold on, even if we’re not likely to ever see the 50%+ earnings growth numbers that Kinsale was putting up when it was a much smaller company (it has since gone from about 1% market share in E&S lines to about 2%, so they still have plenty of potential to grow, and should be able to lead as the low-cost provider even when growth for the whole industry slows down, as it probably will someday). But there are some risks, and the incoming sales that we’d expect to provide future profit growth is now growing at a very pedestrian ~7% (those net premiums written), with that growth number coming down every quarter over the past year:

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Kinsale has fantastic profitability measures, earning a 30% return on equity recently (about 25% for the past six months, their expectation is “at least low-to-mid 20s”)… but it is also valued to reflect that high profitability and their historically high growth, so you have to pay about 6X equity to buy in (book value per share is now about $74, so they’re at about 6.5X book today).  If you do the math, that means folks who pay 6X book value for a company with a 30% ROE would earn about 5% on what they paid, which makes for a PE ratio of well over 20 (I did some rounding in all of that, so the forward PE for Kinsale is actually about 25 at the moment). That’s a perfectly reasonable valuation for a highly efficient company that’s growing earnings at 20% per year, as KNSL is still doing, with great margins and conservative underwriting… but, of course, it’s a lot to pay for an insurance company if it isn’t growing fast, you’ve gotta be special to earn that kind of valuation.

In comparison, WRB is at about 3X book and also earns a lot, with a ROE of almost 20% recently, so that’s a return of about 7% from your purchase price if you buy today… and the one that always looks pretty compelling, but is in maybe the most competitive business of all and riding serious success in technology integration and marketing, is Progressive (PGR), which is trading at almost 5X book but has recently had a ROE of 38%, giving them also a ~7% yield. Those are just different ways to invert, to give us a different perspective — a 5% earnings yield inverts as a PE of 20, 7% is a PE of 14-15, etc.

As an aside, I’ve been scared off from Progressive because of its massive size and the incredible marketing competition between them, Berkshire’s GEICO, State Farm and the other consumer-focused mass-market insurers, but that’s been a mistake Progressive has been one of the all-time-great insurance investments… and the dream is that Kinsale can follow a sort of similar path to Progressive, taking market share by bringing technology into underwriting and fulfillment to grow and take more meaningful market share from the bigger and stodgier players who are much less nimble.

In an interesting coincidence, Progressive and Kinsale actually have almost identical shareholder returns over the past five years, though Kinsale has seen its multiple compress during that time (from almost 10X book to 6-7X book) and Progressive has seen its multiple expand (from 2.5X book to about 5X), so they seem almost to be trying to meet in the middle.  Kinsale has also grown revenue and earnings much faster — but it’s relatively tiny, since Progressive has a market cap near $150 billion and KNSL is still around $10 billion (I note that not to compare them directly, they’re very different businesses, but to offer up the potential that Kinsale has a lot of optionality to enter different businesses and keep scaling up, even though it has already doubled their market share in the E&S market, great past growth doesn’t mean there’s a “lid” on the future).

I remain very impressed by Kinsale founder/CEO Michael Kehoe, and the conference call didn’t change my mind — they still have a good handle on the business, and they are still finding pockets of good growth… the slowdown in net premium growth is somewhat worrisome, or will be if it continues for a long time, but this is how they described the current situation:

“Overall, it is a competitive market with the level of competition varying quite a bit from one industry segment to another. Our commercial property division saw premium drop by 16.8% in the second quarter due to high levels of competition and rate declines. Absent this division, Kinsale’s premium grew by 14.3% in the second quarter.”

And they made it clear that they think a lot of the new competitors in their space are being stupid, and will eventually pay for that:

“Some fronting companies are posting unsustainable gross loss ratios of 100% or higher signaling capital destruction. Notably… the top six E & S fronting carriers are projecting twenty twenty four gross loss ratios well below ours despite consistently worse experience in older accident years and consistently worse loss development. Either they, as a group, have experienced a miraculous turnaround or they are under reserving. Eventually loss reserves turn into paid claims and posting inadequate reserves only pushes the problem down the road for a time. The situation is reminiscent on a smaller scale of the mortgage crisis of two thousand and eight, where you had a misalignment of interest between the originators and bearers of risk, which resulted in a fundamental mispricing of that risk. Given the size of the problem, this will not be as significant for the economy as the mortgage crisis, but it will be very significant for the insurance industry and for some players in it in particular.”

And Kinsale is one of the few insurers that uses the “float” terminology that Warren Buffett loves so much, they did note on the call that their float had grown to $2.9 billion this quarter, which is about 14% growth in just six months, so that’s growing faster than book value (which is now just over $1.7 billion), but Kinsale is so much more profitable (and historically faster growing) than the average insurer that we don’t really use that “price+book” as a valuation tool — maybe in the future it will come into play as those numbers grow, but KNSL today trades at well over 2X price+book.

I think the most apt description of the past few years is that Kinsale has been “growing into” its valuation, particularly over the past 18 months or so, with the stock more or less stuck in a range near this price. With continuing great operating performance, eventually the share price will start to respond — I don’t know if that’s next week, or in a year or two when the growth in the book value has driven them to trade at, say, only 4X book, but I’m pretty confident it will happen.

The real risk is probably increased competition from other players in the E&S market, and that’s obviously happening right now, but they mostly can’t easily or consistently compete with Kinsale profitably, at least for smaller accounts, so the low-cost nature of Kinsale’s business, and their efficient and fast underwriting, is still a competitive advantage, and given how slowly some of the legacy players adapt, it may well remain an advantage for a very long time.

And the E&S market itself shrinking is a risk as well, as the insurance industry tries to adapt and cover more risks in the “admitted” market… but given how fast the world is changing, both for liability coverage (social inflation, actual inflation, medical inflation) and for property coverage (inflation and increasingly unpredictable weather events and catastrophes), combined with the slow reaction time of state insurance regulators, I think it’s more likely that the E&S market for customized insurance continues to grow faster than the standard “admitted” market, as is definitely happening right now.

At this extreme level of profitability, with clearly excellent operating performance and improving investment returns but slowing top-line growth, I’m mindful of the risk for this richly-valued growth company when that slower growth in premiums written filters through to slower growth in net income, as is essentially inevitable… but also not particularly worried about this growth slowdown right now, since even growing premiums at 10% going forward should be enough for excellent returns if we’re patient.  I’m happy to wait for the business to continue compounding into something that could potentially be much larger.

This is what Kehoe said about growth, which serves as a reminder that he’s been saying 10-20% is a reasonable growth rate “through the cycle” for years now, even though growth was well over twice that high for large chunks of that time:

“I think 10% to 20% over the course of the cycle is a it’s a good faith estimate and it’s actually I think a conservative one. I think one of the challenges of estimating the near term growth is that there is going to be a fair amount of variability over the years. Right now, we’re in a period of heightened competition.”

I’m not raising my “buy under” prices for Kinsale (still “max buy” of $488), just because I want to see how things continue to develop and I think there’s a meaningful chance that they could have a weak few quarters as they wait out some of the competition… but I have a lot of confidence in Kinsale’s ability to find profitable underwriting niches, and to win business and be more profitable than their competitors because of their very low cost structure, so I expect it to work out very well over time.

And yes, so far Porter has been wrong about the stock falling 20% on the earnings news.  If it had, I’d be more tempted to buy right now.

Roko (ROKO-B.ST) reported some solid progress for their first half-year as a public company — nothing flashy, and they’re not showing great growth (organic growth is only about 3%), but they’re acquiring decent growth as they buy more companies, and the margins and cash flow have improved slightly (other than the cost of going public). The stock has gotten a bit more popular of late, so it has jumped meaningfully higher — from what I can tell, that’s for no particular reason other than some fans of Lifco have found the stock, perhaps with a little “relief that things are going as expected.”

So I’d say things are still on track, this is still a smallish company (US$3 billion or so) with very proven leadership, and they are following the Lifco game plan just fine, with a reasonable amount of debt and, so far, a focus on acquiring good and capital-light companies that should be able to help them compound shareholder value over time. It’s not necessarily going to be quick, and the stock is not cheap at ~40X earnings and 5X sales, but the name brand is clearly attracting “quality” investors of late, as I noted a while back in noting that ROKO is in the RW ETF portfolio, and Chris Mayer has also disclosed on Twitter/X that he owns shares. That’s no guarantee that the share price will move still higher, but it’s a nice bit of reassurance that other folks see what we do in this stock.  That sentiment will wax and wane with fluctuating business performance, as we’ve seen with the smaller Teqnion, so we don’t want to get too excited and just buy at any price, but for this small position I’m encouraged enough to at least keep holding.

On the smaller side of the Swedish serial acquirer universe is little Teqnion (TEQ.ST), which has been fighting through it’s second real “restructuring” over the past year or so, in response both to economic headwinds for some of their small industrial subsidiaries and to some weak operating performance that has necessitated additional management oversight.

The bad news? Earnings are flat. Especially if you ignore the “boost” they got from the fact that the earnouts owed for their subsidiaries were lower than expected (which means those companies are doing less well than they expected, so they don’t have to pay out as much in “bonus” earnout cash to the folks who sold them the company).

The good news? They bought a bunch of appealing-looking little companies earlier this year, which will ramp up their non-organic growth, and they have doubled down on their oversight and management of their more troubled subsidiaries, something that has been slow to come for this management team that prizes decentralized decisionmaking. They’ve even gone from using “CEO Coaches” to help their subsidiaries to actually putting in a more active supervision from regional managers who can push for more accountability at the business level whenever there’s any sign of things turning ugly. And following the weakness at several of their subsidiaries in recent years, Teqnion has replaced the CEO’s at about 20% of their subsidiaries recently, which they say is already showing signs of helping those businesses when it comes to efficiency and sales, but isn’t really showing up in the group numbers yet. And management continues to have the right incentives, at every level (both the subsidiary CEOs and Daniel and Johan at headquarters), with bonuses tied to free cash flow generation. That’s all good, and reinforces my decision to be patient with this group as they try to build.

It’s been a tough year or so for Teqnion, and it’s admirable that CEO Johan Steene and Deputy CEO/CXO Daniel Zhang continue to host their quarterly Q&A for (disappointed) shareholders, answering questions for an hour or so and being honest about the challenges they face. They’ve also had their first meaningful subsidiary dispute that I’m aware of, with the managers of Reward Catering, the only company they’ve bought in Ireland, suing over the earn-out accounting at Teqnion — which shouldn’t have a meaningful financial impact, but certainly caused some strife with a subsidiary, something they don’t want.   Here are a couple comments that stood out to me:

Daniel on what they watch from subsidiaries:

“… basically, we have implemented five different KPIs on two profit levels and two margin levels and one return on capital level for the different time perspectives. And if everything looks good feelings, but defined in Excel formulas, the CEO can run their company as if it was their own, with basically full autonomy, of course, following the CEO instructions and the board instructions. But when one or more of these things becomes red, then things gets escalated from the country head in UK, CEO coaches in Sweden up to here.

“And there are different routines for handling that, and that is something that we’ve implemented more clearly this year, which we, of course, believe will have effect going forward.”

And on the trajectory of the business:

“Maybe the starting point is that we truly believe that when when looking at the actual operations, the lowest point is behind us and that we’re moving now in a trajectory that is upwards, which we’re happy about, that it’s upwards. Are we happy about the actual delta and about the speed, the momentum?

“No. We are not. We do believe that there is a lot more to be done. So it’s not that we feel that, okay, we have bottomed out, and now let’s go on vacation. We feel that we’re gonna use that energy and, of course, a little bit of happiness that we do feel that that is behind us and build on that momentum….

“The acquisition piece, in the beginning of the year, we said that we’re going to have a big acquisitive year and that we were going to buy more than six companies. We’re at seven so far. I do not feel that we’re done yet without making any promises.”

And the relatively rare nature of the “problem” subsidiaries:

“When it comes to the companies that are performing or not, we we don’t have this normal distribution of, you know, most companies performing to the average. It’s quite a bit in the opposite actually, where we have a bunch of companies that are performing very well. The majority of them are in The UK, but we also have a lot of companies here, maybe not a lot, but we have some companies here in Sweden that are performing on that level as well, growing with 20% margins. But we have this third group, which is not something that we like, companies that are losing money, which is really hurtful. As a group, they are moving in the right direction.

“But on individual levels, I mean, we do have some quick turnarounds, which we have shown also on the whiteboard where the financial results are actually already seen and will improve even more going forward. We also have some companies where they have plateaued out in the other direction, which is something not great. But as a group, they are moving in the right direction.”

So things are moving in the right direction, but they’re still at a point where about a third of their subsidiaries are not making a profit, and four of those are in a real “turnaround” situation with very active changes coming down from above.  It’s not ideal, but I like this management team and I like the strategy, and I’m willing to be patient… though I’m not in a hurry to buy more, and won’t be updating my “buy” levels this quarter — it’s worth nibbling if you agree with my confidence in the long-term potential, but it’s not cheap enough that there’s any rush..

Any more little updates?

The push from the big boys to buy into large royalties continues — Triple Flag (TFPM) bought Orogen’s 1% royalty on Silicon Merlin recently (the project has been renamed the Arthur Gold Project by operator AngloGold Ashanti), for roughly $300 million, and this week Franco-Nevada (FNV) bought a 1% royalty on that same project from Altius Minerals for about $275 million (Altius is keeping the other 0.5%). Altius and Orogen had collaborated on early exploration and prospect development around that deposit starting about a dozen years ago, so I’m assuming those royalties all covered essentially the same territory, and it makes sense that they’ve both changed hands at similar prices this year, as the project moves a bit closer to development (Altius has also been in arbitration with AngloGold Ashanti over the extent of this royalty and the lands it covers, and has generally been “winning” that arbitration, but it’s not finalized and ~10% of the purchase price is contingent on that being cleared up).

So… now we wait to see when AngloGold Ashanti pushes forward and gets closer to actually building a mine that will feed those royalties. Right now they’re working on the Pre-Feasibility Study that’s expected to come out maybe late this year, then they’ll have to move on to a feasibility study and get financing and finalize all their permitting, then they can make the final investment decision and get construction underway. I suspect that will take five years or so, so the everpresent risk is “what will the gold price be then” — but things could move a little bit faster if AngloGold really pushes it, we’ll see.

And as we’ve seen time and time again, it’s certainly easier for larger companies like Franco-Nevada to buy and hold these valuable-but-years-from-production royalties than it is for the smaller companies like Orogen, or even somewhat larger ones like Triple Flag or Sandstorm. The lesson from Sandstorm’s “too eager” push to grow quickly a decade ago is that if you’re a $1-2 billion company spending $300 million on a royalty that won’t be producing for five years, investors are going to ask about it constantly and become a bit frustrated, so we’ll see if that becomes a challenge for Triple Flag in the months ahead (they’re not that small, with a market cap close to $5 billion now, so it will probably be OK)… but if you’re a $10-30 billion company like Royal Gold or Franco-Nevada, those big investments are much easier to absorb, and investors are much less likely to get antsy or impatient.   I don’t own Altius right now, but this is good news from them, and a reminder that part of their goal is to be counter-cyclical — selling projects and royalties when the underlying commodities are doing really well, and buying into the stuff that’s more hated, so they’re sticking to their knitting.

And that’s all I’ve got for you today, dear friends — there are a few stories I didn’t check in on this week, mostly because my thinking hasn’t changed significantly, and if you’ve got questions about anything feel free to shout those out with a comment below.

Disclosure: of the companies mentioned above, I own shares of Amazon, Alphabet, Exor, Vistra, WisdomTree Japan SmallCap Dividend Fund, Roko, Teqnion, Kinsale Capital, Berkshire Hathaway, Chubb, BWX Technologies and W.R. Berkley. I will not buy or sell any covered stock for at least three days after publication, per Stock Gumshoe’s trading rules.

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