MKL: Uncertainty Analysis

In the last post, I valued MKL using three different methods and came up with a value between $786-$1,219. This is a wide range.

In some ways, this is not surprising, because like it or not, when you invest in MKL you are investing a growth story. It may not be a sprinter like a high flying 30%/year growth stock, (that runs out of breath after 400m). It is a marathon runner with a steady low to mid teen rate of compounding.

In any case, I thought it might be worthwhile to reconsider some of the valuations in the previous post, and slap on some variability in the projections.

The two key parameters are return on the investment portfolio, and the leverage ratio: In the base case, I assumed 5.5% and 2.4, for these parameters, respectively.

Let us assume that the leverage is uniformly distributed between 1.8 and 3, and the investment returns follow a triangular distribution with range 4-8% and mode 5.5%. These distributions are graphically shown below.

disb

Simple DCF

I picked 100,000 Monte Carlo samples from each of these two distributions. I assumed no correlation between the two parameters.

For each one of these 100,000 samples, I followed the same valuation process as the base case, and got 100,000 different estimates of the intrinsic value. The distribution of these intrinsic values looks like this.

pic1

The mean value is $868/share. There is a long tail, which holds out the small possibility that MKL is seriously undervalued. But, overall it seems likely that the intrinsic value today is probably lower than the stock price (~$950).

Three Separate Units

The only additional assumption I make here concern the profitability of the insurance division. In the base case analysis, I assumed MKL earns 3% on its premiums. Here, I assume a normally distributed return, with mean = 3%, and a standard deviation =3%.

pic2

In the base case, we saw that the profits from the insurance division contributed about 10% of MKL’s value. This is greater than the contribution from Ventures. So I can probably get away with being sloppy with Ventures. I simply use the base case earnings number of $79M.

This gives the following distribution of intrinsic values:

pic3

The average is $1090/share which is greater than the current price.

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