Tom Gayner (02:48):
In the course of the last 30 years, my investing style has changed somewhat, and I would hope that that would be the case for anybody who’s been practicing the craft for 30 years. This is not a static world. It’s dynamic and it changes, and I think there are some fundamental principles which endure and are timeless, and last eternally, but there are other things that tactically change and it’s important to hold fast to the things that don’t change, but be flexible and adaptive to the things that do.

Stig Brodersen (03:21):
Let’s start there. You famously identified four pillars in your investment philosophy. Could you please elaborate on that?

Tom Gayner (03:28):
Sure. And that might be a helpful way of framing the things that have stayed the same and some of the things that have been different and adapted and dynamic as time has gone by. So I’ve written in the Markel annual report and spoken for years that there are four fundamental lenses that I look at any equity investment, any ownership enters through. So I want to buy a business that’s profitable, earns good returns on capital and doesn’t use too much leverage to do it.

Tom Gayner (03:55):
Number two, I want those businesses to be run by people who have equal measures of talent and integrity. Number three, I want the business to have reinvestment opportunities and the ability to grow or pretty good capital discipline, meaning the ability to do good acquisitions or pay dividends or do share repurchases. And fourth, I want to do that at a relatively what I’ve called fair price.

Tom Gayner (04:19):
So that’s the thumbnail sketch of what I’m looking to do and that really has been consistent for decades. Now, let’s go into each of those to think about the ways in which they represent internal principles and some things that would recognize the fact that things need to change. So buying a good business with good returns on capital that doesn’t use too much leverage to do it. Well, the one thing that is consistent through all time is the notion of not using too much leverage, because if you have a business which has okay returns on capital, but uses leverage to magnify those and get better returns on equity, there’s nothing wrong with that, but that introduces a degree of fragility to the business that concerns me.

Tom Gayner (05:01):
I’m not anywhere near as smart or as intelligent or on the edge of things as many of the guests you would have on this program. So what I want to do is create a margin of safety, margin of error, whatever you want to call it so that if I’m wrong, I’m not going to lose money. And to be investing in a business that has a lot of leverage that introduces an area of fragility to things, it introduces the ability that you can have the cards pulled from your hand in the middle of playing your hand and wipe out kind of risk that would really diminish… wipe out your returns at any particular instance.

Tom Gayner (05:36):
I want to stay away from it. That’s been consistent for decades. Now, among the things that’s tempting in today’s world as we live in a period of ultra low interest rates, it’s rational and logical to get cheap debt financing when you’re looking at running a business. So I don’t want to express that as an absolute. It’s a relative term. The idea of using some leverage in today’s world. I mean the government’s very much pushing you towards doing that and you probably should do some of it, but not too much of it and it’s a pretty gray line of an appropriate amount of leverages, but without tipping over into too much.

Tom Gayner (06:18):
Structure also goes into that in the sense that if you have overnight line of credit kind of money that reprices regularly, that is a substantially and fundamentally different thing than having 30-year fixed-rate financing. So for instance, a couple of my children have bought houses in the last couple of years at 30-year fixed rates, mortgages that create rent payments… I mean mortgage payments that are lower than rent payments. I have encouraged them to incur debt to buy a house and that’s a very, very different thing than having floating rate debt. So that’s consistent.

Tom Gayner (06:53):
Good businesses by definition earned good returns on capital, but the names of those businesses change over time. So when I look back and think about a company that actually fits the test of being a good business today, with the way that the world is changing and the way that the pace of change is accelerated and the forces unleashed by technological change, there are businesses that were fine businesses five, 10, 20, 30 years ago that aren’t anymore.

Tom Gayner (07:19):
So you always need to be on your toes and you always need to be thoughtful about what businesses are in fact fit that definition of good businesses or not, because returns on capital typically don’t straight line. They’re either getting better or they’re getting worse. So the ability to have something that’s not falling off a cliff strikes me as a fundamentally important thing. So I look at that and that’s really one of the reasons you go to work every day is because the names of those businesses change over time. You have to stay on your toes about that sort of thing.

Tom Gayner (07:50):
Point number two, managements with equal measures of talent and integrity, that’s again enduring. As my father used to say, you can’t do a good deal with a bad person. That doesn’t change. I don’t care what industry you’re talking about. I don’t care what geography you’re talking about. I don’t care what time frame you’re talking about. The idea of getting into business with somebody who doesn’t share your basic values and is a person of similar integrity as to what you have, that strikes me as non-sustainable.

Tom Gayner (08:18):
It strikes me as somebody’s going to win and somebody’s going to lose. So I try to involve myself in win-win transactions and win-win relationships. And if you’re dealing with somebody has an integrity challenge issue whatever, maybe it’ll go well for him, but I think somewhere along the line, it doesn’t for me. So just try to avoid those as much as possible. And that’s been consistent over decades. I think the older you get, the more experiences you have. Probably the better your skills are in making some of those judgments. And also maybe the more patience you have about being willing to forgo what may seem attractive, but you have a little tinge in your bones or a little bit of just unease in your gut tells you something about this doesn’t square up.

Tom Gayner (09:00):
It’s easier to walk away from those things when you’ve been doing it for a long time and have done well enough that you’re not as tempted by that sort of thing as perhaps you might have been when you were younger and less mature. The reinvestment side, again, that ties to the notion about the good business and the good returns on capital because again you can have a business which is a wonderful history of indeed being able to reinvest the money that it has made, but the ability to reinvest the next dollar, it’s not about the past, it’s about the future and you have to be thoughtful and think about what are the conditions and circumstances for this business going forward.

Tom Gayner (09:40):
Do those incremental dollars earn better returns or worse returns? Because your returns as an investor will converge towards what the incremental returns on the incremental dollars are over time. Now, the fourth point, buying things at a fair price, that’s probably the area where things have changed the most for me. So starting out, my original training was as an accountant. The original Ben Graham sort of security analysis and the time in which he wrote that book in the 1930s right in the aftermath of following the Great Depression sort of security analysis.

Tom Gayner (10:14):
There were things you could buy for less than the networking capital that the companies own. So it was a very straightforward sort of analysis and 100% appropriate at the time to think that way. And those were the original textbooks that I learned from and studied. It’s an accountant’s mindset and general nature to think that makes sense. It’s also something that’s external for yourself. So when you’re looking and doing calculations and writing things down on a piece of paper or doing a spreadsheet, you’re looking at something else and you’re guiding yourself in large measure by what those numbers and formulas, and ideas suggest.

Tom Gayner (10:56):
When you start to morph into the more qualitative aspects of things, you can’t put them in a spreadsheet. You can’t write them down. You have to make an internal judgment about these qualitative factors that it’s not verifiable and you can’t say definitively yes or no or put too precise a number to it. I think that is something that if you’re young and you’re doing that, you may be confident, but I think you’re probably wrong.

Tom Gayner (11:25):
When you’re older, you may have less confidence because you have scars. You’ve seen things. You know the mistakes that you’ve made, but you don’t overestimate your ability to make those sort of judgments and you know how important they are. So you’re willing to make them anyway and proceed with trepidation and humility. And that’s just a softer skill. It’s a skill that goes along with maturity in many ways and I think that’s the biggest single factor that has changed over the course of the 30 years that you speak of where relying more and more on that aspect of things and approaching it quite differently than what would have been the case 30 years ago.

Trey Lockerbie (12:07):
Wow. There’s a lot to impact there. I want to start with the price and determining the intrinsic value of something. And you talked about this quantitative approach very early in your career and how that’s evolved. I think a lot of our listeners can relate to that because a lot of our listeners, they have day jobs and they’re sitting on maybe some savings they want to put to work. Not necessarily entrusting just anyone to run the money for them, looking to learn how to invest for themselves, which I think is great.

Trey Lockerbie (12:33):
But I think when you start out learning about Ben Graham and that sort of quantitative style, it’s easy to find yourself going down the rabbit hole of stock screeners and looking at these ratios and then buying this basket of stocks just based on a few different numbers. And you’re kind of missing that qualitative approach. So lately, I’ve been looking at it sort of like a valuation sandwich where you can use the quantitative approach, use the screeners, filter down to a universe of stocks that’s worth digging in more into, but then really doing the work on the qualitative stuff.

Trey Lockerbie (13:06):
Because that’s what fills in the sandwich. That’s what’s in the middle. Understanding the story of the free cash flows, understanding where those might go. And then the final piece of the sandwich is the IRR calculation. So once you know where the free cash flows are going, running that calculation and then seeing where the price is related to your intrinsic value of it. Is that how you’re looking at it? Is it a similar approach? Is it a 80% qualitative, 20% quantitative? How do you look at it?

Tom Gayner (13:32):
Well, I’m tempted to answer. It’s a 47.38% quantitative and somewhere between yellow and green-

Trey Lockerbie (13:41):
Fair enough.

Tom Gayner (13:42):
… for the balance. I mean, I understand what you’re saying and you’re exactly right and those are the things that, I mean, easy overstates how hard that is. There’s real work that needs to be done, and should continue to be done by me as well as anybody else pursuing that. And that work is necessary, but I don’t think it is sufficient to draw conclusions. It’s data that is helpful and points you in directions, and it’s data that should be helpful in disproving things. So in terms of the scientific method, you think about things, you have a hypothesis and what you should be about as a scientist is working hard to disprove your hypothesis because you know you’re wrong, so you need to adapt and adjust and get to the next hypothesis.

Tom Gayner (14:24):
So for someone to just assert that they do qualitative work without doing the sort of things, you’re talking about, that’s a mistake and that’s not going to be a good answer either because if you develop a qualitative thesis, the types of things you’re talking about should provide some quantitative evidence that at least you’re not wrong. It doesn’t tell you you’re right, but it may tell you that you’re probably wrong. And if you’re probably wrong, then should keep working and keep moving along.

Tom Gayner (14:53):
I think there are other dimensions about what you just brought up. Again, so think about someone who’s younger, somebody perhaps a day job, somebody who perhaps is starting out and you’re trying to attract some clients, and you’re trying to get people to give you money to manage on their behalf. Well, if you look at somebody richer and older who might be a potential client, they’re going to ask you some questions about how you do things and why should I believe you? And what skill do you bring to the table versus all the other people who are pitching to manage money for me? And if you just give some soft soap of your thoughtfulness and your understanding of psychology and sociology and human behavior, I think you will struggle to get clients.

Tom Gayner (15:38):
So I understand the challenges that are involved, fortunately, and my path would be suggestive of how this can work. There’s an element of that qualitative, that quantitative sort of thing which you’re speaking of that can and should be done, and I did that, continued to do that, and some of it worked well enough, early enough that I gained credibility from some people who had some money to manage and then could build a track record over time, such that you have some documentation, some trail of evidence that suggests that this person does have a good sense for this sort of thing or not, and it takes time to do that.

Tom Gayner (16:17):
If I was starting over right now, maybe I’d go to dental school. I don’t know. I appreciate and understand the challenge that’s involved in getting things started. It actually ties to something else that you pointed towards talking about the notion of frugality and living beneath your means. And if I could bring that up now rather than later, it ties to that because by definition, if you’re living below your means, in one sense you’re already rich. You have whatever lifestyle and needs you have. You’ve acted and behaved in such a way that costs you less than the money you have coming in.

Tom Gayner (16:54):
So that means you have excess cash flow to invest. And whether that’s $10 a month or $10,000 a month or God knows what, as long as that number is positive, you have the opportunity and the ability to start making capital allocation decisions, to start making investment decisions and building that sort of track record, and you’ll create that trail of evidence even with small subs. But it’s very important among many other reasons in living. That’s one of them. It creates all sorts of behavioral advantages.

Stig Brodersen (17:25):
So in other words, by living within your means you can become a micro Markel having free cash flow that you can reinvest and compound in other ways.

Tom Gayner (17:34):
Exactly. It can be a Micronaut, but it’s extremely important that you’d be able to do that because there’s no way you will ever get the track record and the sense of confidence and the craftsmanship that just comes from actually doing it day after day, week after week, month after month, year after year.

Trey Lockerbie (17:53):
So I love that you just brought up the term craftsmanship, because I think that’s an underappreciated term as it relates to asset allocation. So for example, I heard you mentioned in an interview that to become a great investor, yes, it’s important to understand the numbers, but you might want to also be able to write a poem. And that really resonated with me having come from the music industry, before starting my own company and learning about business and accounting and then investing. I still take with me that bit of craftsmanship into my investing and I was fascinated to hear you describe it the same way.

Tom Gayner (18:27):
I’m delighted to hear of your background as a musician and I’ll tell you some stories about that if I may. So my father who was an accountant by training, he was the child of the depression and he graduated from a junior college in 1936. He was in Carlinville, Illinois. Actually, got a job in Streator, Illinois with an Owens, Illinois glass business that was there. So again, 1936, junior college, went to a very interesting school called Blackburn which still exists. Tuition room and board at the time was $25 a year which even in the depression is a good deal. And it was a work college where they had a farm, they raised animals, they did the carpentry, the painting, the electrical work.

Tom Gayner (19:13):
They cooked the food themselves as students to make it possible to provide an education. But one of the things he did to string together basic existence was he worked as a musician and he played the clarinet. And Southern Illinois and Central Illinois kind of had some call it, speakeasy that sort of unlicensed bars, whatever you want to call it and it worked and helped put food on the table. Got married right out of school as a musician and he played the clarinet his whole life. He played dixieland jazz did it for fun.

Tom Gayner (19:47):
I think the mathematical structure that underlies music is, A, it’s profound and B, it applies everywhere else. I too played the clarinet, not as well as my dad. I do claim to be a professional musician because it was at the apex of my career, I was paid one time playing a pit band of an orchestra per show, while in college. I made 25 bucks, but the definition of being a professional is that you get paid to do it.

Tom Gayner (20:13):
So I worked as a professional musician myself and I have the family heritage and lifestyle of having seen that. And the best music instruction, I ever had in my life was a guy who I used to take some piano lessons from, and I was never good at the reading of the music and playing off of written music. More it was improvisation and feel. But I was not a talented or gifted musician because I was limited. I should have spent more time and effort and discipline on the fundamental attributes of the music rather than just play what you feel.

Tom Gayner (20:47):
And that particular teacher, we never looked at a note. Everything was about math and music theory and intervals and describing the chord progressions in mathematical terms. And that clicked with my mind. So feeling, understanding, knowing those patterns and seeing that there’s underlying math whenever you’re listening to a piece of music, but yet there’s a sound that makes you feel something. I don’t know about you. Maybe if I studied it more maybe if I was a better mathematician or more diligent student, I would understand how to describe mathematically the way I feel when I listen to certain pieces of music. But I don’t know how to do that. But I know it’s real and the effects of things that can be described mathematically do have some sort of non-mathematical emotional dimension to them and I think music is just a great example of that.

Trey Lockerbie (21:42):
I like to say that a portfolio is like an album where you don’t want a bad song on the album and that the whole process between putting together an investment portfolio and an album is very similar in that you’re distilling down information. So you’re taking all the sounds possible, all the lyrics distilling them down into something great. Similarly thousands of stocks, whittling it down, distilling down the information into a portfolio that will outperform. Do you see it the same way?

Tom Gayner (22:09):
I think that’s a fabulous analogy. You can think about it as an orchestra, a piece of music, an album, whatever you want. It’s very rare. I don’t think there’s any piece of music. I mean, there are some pieces of music that you’ll listen to today that you listened to five years ago, 10 years ago, 30 years ago and they’re just sort of these enduring songs, albums, things that they’re just lifetime pieces for you. I’ll be willing to bet that none of them involve one instrument or one voice. It’s an ensemble of some sort, even a solo act, typically has a guitar accompanied with a rhythm section or a band, whatever.

Tom Gayner (22:48):
A couple years ago within the Markel annual report, I wrote about Bruce Springsteen and the E Street Band and the conclusion that he had come to about the reason that band had endured and been successful over time is because he came to the acceptance of how important everyone else around him was, and they came to the acceptance of how important he was. But the ensemble creation of all that is a loose analogy for a portfolio that has multiple components, multiple pieces, multiple things that knit it together as a congealed and embedded sound that’s attached to it, and is able to endure the fact that sometimes you lose a musician along the way and a new one comes in every once in a while.

Tom Gayner (23:32):
The Philadelphia Orchestra has been around for a long time. I don’t know who plays second violin at the Philadelphia Orchestra but somebody does. And somebody did 10 years ago, 30 years ago, 50 years ago, 100 years ago. The Philadelphia Orchestra still goes on. So there’s all of those pieces, which balance out into the production of that ensemble, that music and it’s similar to a portfolio where it’s not a single stock, it’s not a single idea, it is a collection. It is an amalgamation. It’s an ensemble that comes together that works.

Stig Brodersen (24:05):
Shifting gears, Tom, I notice that you compensate your managers on a five-year rolling average. I find the way you think about your organization very inspiring because it’s clearly another piece to the puzzle of asset allocation that all CEOs must consider. Could you talk a bit more about how you evaluate your managers and ensure that they have the right incentives at all times?

Tom Gayner (24:27):
Well, I think that the five-year compensation calculation, which we do have here at Markel is a very valuable mechanism and tool to try to make sure that we’re thinking as long term as possible. Of course, I’ve been here long enough that there’s been a lot of rolling five-year averages. Every year one roll is on and one roll is off. So I’ve been here long enough that that really stretches beyond five years towards whatever my lifespan is. So it seems like a square deal for me. It seems like a square deal for our shareholders.

Tom Gayner (24:59):
Then if things go well for Markel, I get paid. If things don’t, I don’t get paid and it’s measured over a long enough period of time. They can see whether there was real value added or not. So I joke that if I ever get fired from this job, the next job I wanted to do is to be a maker of 12-year-old scotch whiskey, so that it would be at least 11 and three quarters years before somebody knows if I actually know what I’m doing or not. But think about that. If your job really is to make 12-year-old scotch whiskey, there is a discipline and there is a process, and there is a craftsmanship and a time-tested way that would suggest that these are reasonable ways in which to make 12-year-old aged whiskey.

Tom Gayner (25:41):
So it’s not like you just play around for 11 and three-quarters years and then show up and try to do something. That’s not going to work. But if that is really what you’re trying to do is to make great 12-year whiskey, there are steps that you should do and you need to be operating in a culture and environment where you’re not going to be second guessed or micromanaged or pulled off the task midstream because it really will take that amount of time before people could discern whether you were good at what you did or not.

Tom Gayner (26:12):
I think that is one of the unique features of Markel. We’ve tried very much to build the culture where people just have it in their bones and in their way of doing things. We’re trying to build something that has an indefinite timeframe that lasts forever. And the way to do that is to think as much as possible like an owner like you were trying to hand off a business to the next generation of your family or your closest friends that you really care deeply about and you want to hand it off to them in a better way and in a better spot than the way it was when you got there.

Tom Gayner (26:44):
As long as you can embed that in the people and the systems and the culture of things, I think you’ll do very, very well. I don’t know if you heard the Charlie Munger interview that took place earlier this week at Caltech, and he talked about in the investing world, it’s more important to not be stupid than it is to be really smart. So I can see ways in which business breaks that sensation of long-term values and long-term thinking pretty clearly, easy stories, stuffing inventory channels, doing unnatural acts to me this quarter’s budget, all of those sorts of things.

Tom Gayner (27:20):
You don’t have to go find war stories about that, but you can just continue to orient yourself towards, “Look, if I take care of this customer, if I make them happy, if I do the very best I can for them, and I make a reasonable rate of return for doing so, that will compound the marvelous things over time. And there’s absolutely nothing that should stop it. And if nothing stops it and positive compounding continues to occur, that produces epic results over time.

Trey Lockerbie (27:47):
I want to go back to that 2019 shareholder letter. There’s this ominous sentence in there that says, “Barring any major catastrophe, we expect the same returns in 2020. And we both know 2020 has just been this unbelievable year, full of uncertainty. How have you navigated your portfolio through this year? What has been the biggest change to your strategy?

Tom Gayner (28:13):
Thank you for reading the letter and thank you for pointing that out. They say hindsight is always 20-20. In this case 2020, I hope we put that in the rear view mirror in so many ways, in ways way more profound than business or what happens at Markel. I’m talking about our society in our world. I hope we can get this in the rearview mirror and learn some important and profound lessons that’ll make life a better place.

Tom Gayner (28:39):
So that said, one of the positive features about 2020 is here we are and we’re in December and almost at the end of the year. We’re still here while there have been epic unforeseen challenges this year. The whole point of Markel was to be resilient and the first order of business for any biological creature is to not die, survival, because again, compounding cannot take place if the chain is interrupted. We took some gut punches in terms of insured losses in the first quarter and Markel Ventures collection of businesses.

Tom Gayner (29:17):
There were a lot of businesses where we were deeply surprised and were dealing with unprecedented business conditions. We had to figure it out. Obviously, investment markets had a lot of volatility to them, but that said, we operated with enough margin of safety and with enough margin of error that even though these things took place that none of us had anticipated or specifically planned for, or prepared for or had a good strategic plan about.

Tom Gayner (29:46):
It was okay. We’ve lived to fight another day and answer the bell for the next round of the fight and we went out and tried to take care of our people, tried to take care of our customers and operate in a prudent and reasonable way. And as the year has gone by, things have recovered quite nicely in any of the dimensions you want to talk about specific to the business of Markel whether that’s the insurance company results, whether it’s the collection of Markel Ventures results, whether it’s what’s happening on the investment side. And all of that doesn’t guarantee smooth sailing into 2021, but I certainly appreciate and think that this has been a real acid test and a real battlefield test of the fundamental architecture of the three engines we talked about here at Markel where we try to run a good insurance business, we try to run good industrial and service businesses and we try to invest the money thoughtfully.

Tom Gayner (30:38):
If we do all of that and don’t, again, use something like too much leverage, which would create fragility into the system, some years you compounded higher rates, some years you compounded lower rates. But as long as the train keeps moving forward, that’s the definition of compounding.

Stig Brodersen (30:54):
Well, in the year like 2020, it’s easy to find yourself in triage mode where you’re just showing up existing positions. And therefore, I’m also curious to know what happened back in March 2020 when all those stocks went on sale. Did you have enough bandwidth to focus on new potential investments?

Tom Gayner (31:11):
Well, I think there are several layers behind your question and several layers, and having a thoughtful answer to that. One is there’s an important distinction between strategy and tactics. So in terms of the fundamental strategy of Markel and the three engines, and running the profitable insurance business, running a profitable industrial and service collection of businesses and investing thoughtfully, that’s strategy, and that hasn’t changed one iota. And I don’t anticipate any changes in that basic strategic level of design and architecture for Markel going forward.

Tom Gayner (31:46):
Now tactically, any given day, you’re presented with opportunities that are within that strategic framework. Yes, tactically, with perfect hindsight. I hate to use the word 2020 again, but with perfect hindsight there are things that I would have done differently in March or April or May than what we did, and I think I will be justly and appropriately criticized for making some tactical errors through that time. But I felt my first and foremost responsibility was to be a steward of the capital and a long-term steward of the future of the Markel Corporation.

Tom Gayner (32:23):
So in looking at what possible rewards existed with different things and what possible risk were associated with different things, I chose to err on the side of caution. And at this point, again, tactically there are some other actions that could have been taken which would have resulted in better results this year, but they increased the likelihood of persistency for Markel and that we would be able to make subsequent tactical decisions in July and in August, and in 2021, and in 2025, and in 2030. And that’s what I thought was more important to do.

Tom Gayner (32:58):
I’d also add again this just gets to layers and it ties to the notion of what you talked about when you’re starting in the business and being quantitative and wanting to hit some home runs to attract attention and attract clients and get a pot of money to manage. IRR math, highlights that sort of thing because there’s a time dimension that the quicker your money comes back, the better your IRR is.

Tom Gayner (33:23):
Buffett once gave an example and this is a 15 or 20-year-old example where he said, “There’s two bonds out there and they’re government bonds. One of them pays 8% and one of them pays 6%.” And you know how old the example is when you’re talking about government bonds paid eight and six, and the audience wasn’t just shocked and said, “What country are you from? What are you talking about? Those were real interest rates that existed 20 years ago.” And he said, “So which one should you buy?” And he said, “You don’t have enough information to answer that question, because what you really need to answer that question comprehensively is a few more things.

Tom Gayner (33:59):
One, the 8% bond is a current coupon bond. So every six months you’re going to get a coupon payment on your 8% bond. Your 6% bond is a zero coupon bond. So the coupons are reinvested by definition at that 6% rate. Now, you don’t know what’s going to happen to interest rates. As it turns out, and again Buffett in his focusy way, whether he meant to or not, kind of predicted the future, pretty doggone well.

Tom Gayner (34:29):
The reinvestment rates if you were buying government bonds, continue to go down. They’ve fallen off a cliff. So frankly, the answer to that question posed 20 years ago. You as an investor would have been better off buying the bond that had a 6% coupon than an 8% coupon. And that just doesn’t seem normal or natural or intuitively correct, but what it speaks to is the persistency of the return for a long period of time at a reasonable rate. And there’s a lot of retirees and people who’ve behaved very prudently who were faced with real challenges by the fact that there was this glitzy return to a retiree of 8% on a government bond.

Tom Gayner (35:11):
But that really wasn’t the good investment to make. The better investment to make was the 6% that compounded for the next 30 years because it was a zero coupon bond. Another way of thinking about that, that’s Aesop’s fable, the tortoise and the hare. So it is so tempting to think that hares are better investors than tortoises. I suspect in many times they’re way better traders, way better traders than tortoises. But oftentimes, they’re not as good an investor as what the tortoise is. And what the tortoise really does is earn a durable return over a long period of time. And that’s the game I’m playing.

Tom Gayner (35:50):
That’s what I think I have some skills at. I know I’m not fast like the hare, but I think I can be steady and enduring like the tortoise. And trying to find what it is that you’re good at. And again, this is the distinction between so many people that I’ve heard on your podcast, they are way better at being fast than I am. So if I try to compete with them at that sort of stuff, I’m going to lose. They’re going to beat me.

Tom Gayner (36:14):
But there’s not that many people who really do it the way I do it. So I don’t need the same skills as what they need. And by the way, it has, and I hope and trust. Although it’s not certain. We’ll continue to produce very good returns for Markel and the people associated with it and really run the business, which really means taking care of people whether that’s our customers or whether it’s our employees for this institution to continue to grow in the way that it has and provide livings for so many people and provide valuable products and services. That’s fun. That’s encouraging, that’s uplifting and that’s what I’m trying to do.

Trey Lockerbie (36:55):
Well, as Buffett likes to say, no one likes to get rich slowly. And I’m glad you brought up Buffett, because he and Munger are very outspoken about not liking companies reporting EBITDA. And in your 2019 letter, you point out that Markel Ventures uses EBITDA and referred to it as the least worst proxy to describe the sense of economic profitability. Could you please elaborate on your thoughts on EBITDA as a reporting metric and why you consider it to be the least worst metric?

Tom Gayner (37:24):
A couple of points. I’m not opposed to getting rich quickly. I just don’t know how to do it. So therefore I’ve embraced the idea of doing so slowly because I think I have a chance of doing that. So point number one, to your comments about EBITDA, again, yes Buffett and Munger have written extensively. Munger is normally more colorful way, has spoken in very derogatory terms about EBITDA and he’s not wrong. But you have to dig one layer deeper.

Tom Gayner (37:53):
So if anybody’s using EBITDA, couple things, one, that is the language that exists in the world of businesses being bought and sold especially in and out of the public markets. So because the community of people who own these businesses is talked to by people who use language, it’s important for me to at least understand and recognize that language and how it works. Here’s a long story, but I hope it makes the point. I don’t know if the name Anatoly Dobrynin means anything to you. He was the Russian ambassador to the US, and I think he was in that job 30, 40 years.

Tom Gayner (38:33):
So he might have started with somebody like Johnson and through Nixon and Ford, and maybe went up to Clinton. I don’t know, but he was in that job for a long time. And what made him especially skilled and talented at his job was he was in the west for a long enough period of time that he truly understood western ways, and western language, western values, and western culture, but he was Russian as well and he truly understood and knew Russian ways, Russian language, Russian culture such that he was able to communicate and be a bridge between those two worlds.

Tom Gayner (39:10):
That’s the definition of what an ambassador’s job is. So I take with humility and understanding the way in which Buffett and Munger would criticize the word EBITDA because it is used in a world that’s not their world. Okay. But I think as an ambassador and somebody who needs to be able to communicate with that world, I need to understand the language in the terms. Point number one. Point number two, EBITDA is a word that in and of itself just doesn’t tell you enough.

Tom Gayner (39:38):
It is a tool and that tool can be used well and productively or not well. And the nature of the business that you’re describing sort of gives you a pretty good sensation of what sort of shades of gray you should attach to someone using the word, EBITDA. If you were talking about a steel mill, and that steel mill cost a billion dollars to build 10 years ago, and you’re depreciating against that historical billion dollar cost, which is what gap accounting would cause you to do. And then 20 years from now, you’re going to need to build a new steel mill.

Tom Gayner (40:14):
It’s not going to cost you a billion dollars to do it then, it’s going to cost you $10 billion to make up a number. Well, you really should have been depreciating against the replacement cost, which is 20. Not the historical cost which is one. So if you’re using EBITDA to describe the earnings and the cash flow generation of a business like that. You’re kidding people. You’re probably kidding yourself. So that’s where EBITDA really falls off the rails, and it is not a good description at all.

Tom Gayner (40:42):
I’m looking at you get up there with the microphone and the headphones, and it brings to mind the picture of a radio station. And if you think about a radio station, and I actually worked as a DJ at a radio station when I was a teenager, and I remember looking like you look right now with the setup in the microphone, if you’re talking about a radio station, EBITDA is a very accurate tool to describe the cash flow generation of a radio station, especially if you’re the person who bought it within the last couple of years. Because you paid some price that was related to and derived from the cash flow characteristics of the business and the cash flow requirements, the capital spending requirements on a radio station, they’re not zero, but they’re not very much.

Tom Gayner (41:27):
I mean, you need to modestly update and keep your equipment up to date, but relative to the amount of money that the station makes, it’s not the capital expenditures that make it good. It’s the show. It’s the talent. It’s the energy. It’s the program, whatever, which is current period expense not capitalized expense. So depending on which kind of business you’re looking at, EBITDA is either a horrible description of what’s really going on or a pretty good one. And if you look at the array of Markel Ventures businesses, I would say we are much more radio station like than steel mill like.

Tom Gayner (42:03):
And you don’t just have to take my word for it, you can look at years of the financial reports, the public financial disclosures and look at what the capital expenditures are, which is captured in depreciation, the D of EBITDA. So adjusting for amortization and backing out the purchase price, I think is legitimate and that’s really what EBITDA does. And the D in our case is de minimis. If you were to look at a business and you see the D number being big rather than small, then EBITDA, however big D is, that is exactly inversely proportionate to how accurate EBITDA is at conveying the underlying economics of the business. So you just have to dig a little deeper and think about it.

Stig Brodersen (42:50):
Tom, going back to one of your four investment philosophy principles, you want to invest in a company that is run by management with integrity. How do you qualify such a qualitative fact?

Tom Gayner (43:02):
It’s a spectacular question and it has both quantitative and qualitative aspects to it. So quantitatively, if you look at a company and a management team that has produced pretty good results and they’ve done it over a period of years, that is a very good tell and marker that it’s being run well, because when customers are doing more business with you every year, there’s more revenues and proportionate profitability, that is a marketplace stamp of approval that, “Hey, this company is doing something for me.”

Tom Gayner (43:35):
As I wrote, a great company is a company that does things for their customers rather than to their customers. And if you’re serving your customers and doing things for them, that increases the odds that they’ll come back and want to do business with you again and refer other people to you and your reputation will help you in the marketplace. And a lot of that really does tie to that aspect of integrity.

Tom Gayner (43:58):
There’s other aspects of it that are really a matter of quantitative feel, and I don’t think you should not trust your own judgments about whether you think people running these businesses are good people or not so good people, and what are their motivations and styles. Trust your gut a little bit. Trust your visceral reactions to how you feel about people when you encounter them. And again, a business that has not been successful, that has not put reasonable, not perfect numbers, but not reasonable numbers on the books for a long period of time is one that… One of the reasons for that is maybe they don’t have that fundamental value that you’re looking for. So okay, move on. Look at something else.

Trey Lockerbie (44:39):
Right. And I’ve heard you talk about leverage and how that might be a key indicator for determining how much integrity the management has. Can you elaborate on that?

Tom Gayner (44:48):
I will. And indeed I want to give credit to Shelby Davis, as I do this. So the very earliest years when we were starting to buy the Markel Ventures businesses and move outside the realms of insurance and buy these businesses that we had not had first-hand experience operating before, I remember being with Shelby and it was in Omaha during one of the Berkshire meetings, and the convening, and running into people and just having a meal with people or having a drink with people or running into somebody in a hallway or a bar that we did.

Tom Gayner (45:23):
He and I were talking about this new strategic initiative of Markel to indeed, look at what Berkshire had done and go from passive minority stakes and businesses to controlling stakes and owning businesses. I was sort of asking him about his experience who’s older and wiser guy than I was, and trying to hone in on exactly that point about integrity. His response as Shelby often could just put his finger right on it. He said, “Well, if you want to buy a business that’s not run by crooks, buy one where they don’t have any debt.”

Tom Gayner (46:01):
So I leaned in and asked about that. He says, “Think about it. When you’re financing the business with debt, you’re borrowing money, somebody else’s money to run your business. If you’re financing business with equity, well, that’s your money.” Now, crooks don’t want to steal their own money. They want to steal somebody else’s money. So it’s actually a tell. Not perfect but it is a tell that generally speaking businesses which are financed largely with equity tend to have a different character and nature of people running them than businesses that are financed with a lot of debt, because the risk reward for the managers is different when you have a heavily debt finance business than when you have a heavily equity finance business.

Tom Gayner (46:50):
If it’s equity and it’s yours, and it’s your family’s assets, and if you lose that money, I mean, you’ve lost everything. You’ve you’ve lost your livelihood, you’ve lost your business, you’ve lost your reputation and it is awful. If you run a business and it’s externally financed, and it’s not really your equity capital in the game, it’s not great, but you can move on. And there’s countless examples of that. Given the fact that I feel that I’ve attached myself and my reputation to this business, I want partners and colleagues who feel the same way about it. I don’t want to attach myself to people who might run things into a wall and not care as deeply and as much as I do.

Tom Gayner (47:35):
I’m not saying we won’t make mistakes. We do make mistakes. We make them regularly and I pray that we never get into a period where we don’t make any mistakes because that means we’re not doing enough. We need to be willing to take risk and try things, but let’s be thoughtful and prudent. As our former chair Alan Kirshner used to say, “Let’s make some new mistakes, not make the same ones.”

Stig Brodersen (47:59):
With that said, I would like to speak about Warren Buffett again, because he has countless times been asked about macro and yes, he sometimes gives a few hints here and there about some of his macro beliefs, but most often he drives hold the point of being oblivious to the macro environment. A good business should be able to not only survive but prosper during almost any kind of macro environment. that is his thesis. But given today’s extreme environment, we just talked about debt for instance. The debt levels are an extreme level and is getting worse every day. Does macro weigh into your investment strategy at all?

Tom Gayner (48:35):
It weighs, that Buffett again, he talks about sort of the quadrants, and think about the one axis how important something is and on the other axis how knowable it is. So the macroeconomic environment is on that axis of things that are really, really important but it’s not knowable. So he tries to spend his time on things that are knowable and important. The macroeconomic environment is amazingly challenging right now.

Tom Gayner (49:05):
Charlie Munger in his interview earlier this week in Caltech just talked about these are unprecedented conditions in the world of finance. I mean, there is no human history that speaks to and captures what’s going on in finance right now. So there can be macroeconomic forces that are incredibly important that may cause some specific investment decisions we make to not work out. I get that and I understand that, but as frustrating or as challenging or as excess stomach acid producing as it might be, I can’t control it and I don’t know how to really use those forces to my advantage.

Tom Gayner (49:44):
So I try to acknowledge those forces and make sure they don’t destroy me. I joked recently. I said, “I looked at some of the things…” If those stocks were countries, they’d be Switzerland. And if you think about Switzerland, yeah, they don’t win wars, but they don’t lose wars because they don’t fight wars. I’m trying to make sure that the things I own are not caught up and disrupted. And I’m willing to not be the disruptee as long as I’m not to disrupt it. And to think about the things that I mean again, we’ve joked in this time of the notion of 12-year-old scotch whiskey.

Tom Gayner (50:19):
But one of our long-term holdings has been Diageo and they are the makers of Johnny Walker whiskey and you look at Johnny Walker Black, I point out that bottle and I say look at the label. Look closely at the label. One of the things you’ll see on it, it says since 1820. Wow. Well, what kind of things have happened since 1820? I don’t know make your own list. Civil war, jet engines, telephones, the internet, washing machines, penicillin. Make whatever list you want. Modern society, a lot has been done since 1820 and yet that brand still exists.

Tom Gayner (50:53):
I don’t know if you know the backstory of Johnny Walker, but scotch whiskey, not unlike in its day, the tax authorities, the governmental role created a moonshine industry in Scotland just as the case here. And Johnny Walker himself was a pharmacist and he was trusted in his community. He had integrity. So just like if you buy bad moonshine and you’re drinking and you could go blind, the reason people bought whiskey from Johnny Walker is because they trusted he had integrity. That brand was of value and the brand still is of value today.

Tom Gayner (51:31):
And the fundamental reason it is because you as a consumer trusted it. If you’re an investor in 1820, you know Johnny Walker and you know his worth, and skills, and integrity and thoughtfulness, and long-term orientation as a human being, and he has this business that he’s starting up, you could not have predicted the macroeconomic things that have happened since 1820. You didn’t know there was going to be a Civil War. You didn’t know there were going to be jet airplanes. You didn’t know there were going to be telephones. You didn’t know there’s going to be smartphones.

Tom Gayner (52:05):
So all those things happened and they altered the landscape in many, many, many ways. But you could have made some judgment about it. Was this a good thoughtful guy or not? Well, that was the important decision. And by the way, sometimes, you’re going to be wrong and this gets back to the math and the dynamics of having a portfolio. The things that you were wrong about if there was Johnny Walker and 15 other people that you decided to back at that particular time, and 14 of them faded away, and proved not to be as able and as good as what Johnny Walker was at what he did, it’s okay. All of those 14 things could have gone to zero, complete epic utter wipe-outs.

Tom Gayner (52:45):
The amount of money you’ve made by being able to compound with something over a long period of time swamps the amount of money you lost where you got it wrong. So it’s a very asymmetric risk reward. Invest in something you think is enduring, offers tremendous returns especially compared to the small stuff you’re staking to try to get there.

Tom Gayner (53:08):
I am very, very, very, very lucky in that I invest within the context of the Markel Corporation. And if you look at the history of our business, with very rare exceptions, and there’s been exceptions of periods of time. This has been a profitable business all the way along especially when you start looking at any annual year generally speaking this business has produced an underwriting profit and our industrial services businesses have produced cash flow as well. What that gives me is cash flow and that cash flow invested in a reasonable persistent dollar cost averaging way enables you to buff out the times you were wrong.

Tom Gayner (53:52):
I might have bought something and been wrong immediately for the first six months because the business cycle went in a different direction or made that particular investment go through a tough patch. But if I’m buying more six months from now and six months after that, and six months after that, it smooths itself out in a dollar cost averages such that if I’m more right about the fundamental nature of whether that’s a good business or not, the passage of time plus cash flow enables the real returns to take place. And it comes from the judgment about the business itself.

Trey Lockerbie (54:25):
So going back to the 1986 initial shareholder letter from Markel Corp, it talks about using a strategy of specialization and diversification. And I’m curious about the diversification piece because diversification is known as a decent prudent strategy for mitigating risk. But even Buffett would say that risk comes from not knowing what you’re doing, and those who don’t know what they’re doing should diversify. So naturally he suggests that most retail investors should just stick with index funds. And I’m curious if you agree with him on that.

Tom Gayner (54:59):
I think index funds are one of those examples in investing where a great idea gets done to the point where it gets overdone and ultimately becomes a bad idea. I don’t know where we are in that spectrum when it comes to indexing, but I suspect we are somewhere along that path. So indexing in its early days when John Bogle pioneered it, I think it made all the sense in the world and he was exactly right. But where we are now, you have a lot of money “invested” in things without a fulsome understanding of what it is one actually owns, why you actually own it, and whether fundamentally you would think that’s something you want to do or not. And it just seems to me that that is probably a bridge too far and there is value in trying to understand, comprehend and think about whether you want to be associated with a business or not.

Trey Lockerbie (55:51):
Not to mention the risk of liquidity too because if everyone is in an index fund and something goes south at the market and every one of those people are trying to sell their index fund, what happens to the index fund price?

Tom Gayner (56:02):
I think you can answer your own question. I think I’m going to agree with you.

Trey Lockerbie (56:07):
Well, Tom, we cannot thank you enough for coming on the show. I know our listeners are going to get an incredible amount of value from this wide-ranging discussion with all the wisdom and insight that you brought. I encourage people to go check out Markel Corporation, read the shareholder letters. This is a wonderful company with high integrity. And I know I really enjoyed it, So I really hope we can do this again soon. Thank you so much.

Tom Gayner (56:30):
Thank you so much. I appreciate the opportunity, and we’ll do the best we can.

Trey Lockerbie (56:34):
All right. So as we let Tom go, just one more quick thing. Please remember to subscribe to our podcast feed. We know a lot of you are listening to this episode, but are not subscribing. Please make sure to do so, and every weekend you’ll learn more about investing from amazing guests like Tom Gayner. All right. That was all the train I had for you for this week’s release of The Investor’s Podcast. Preston and I will be back next weekend with a new interview with insightful guests.

Outro (56:59):
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