Commentary

Undervalued Company of the Week – MCY

Mercury General Corporation (MCY) 

The company of the week this week is Mercury General Corporation (MCY), the insurance company engaged primarily in auto insurance in California.  The company also sells a variety of products outside of California.  As we did last week, we will be looking reviewing the company using Warren Buffett’s approach for the Business & Management Review.  We will also use Benjamin Graham’s overall philosophies to guide our Financial & Value Review.

Business & Management Review

1.  Is the business simple and understandable?

     Insurance is and always has been a simple and understandable business.  From the customer’s view, the customer pays a little bit of money each period in exchange for the assurance that in the event of unplanned occurrence, they will be provided with the funds they need.  From the insurer’s view, each customer is analyzed based on risk factors that determine the amount of premium the customer has to pay.  Then the insurer takes in more in premiums than they expect to pay out in claims and keeps the difference.

2.  Does the business have a consistent operating history?     

Mercury has operated as an insurance agency since its inception in 1961.  The company has had a positive net income for over 10 straight years, has paid a dividend for over 10 straight years, and has increased earnings by over one third in the last 10 years.  According to its latest annual report, the company has “created shareholder value by adhering to underwriting standards, focusing on cost controls, effectively managing our claims process and developing strong partnerships with our independent agents. Historically, this uncompromising commitment has enabled us to perform better than most of our competitors. Mercury’s attention to detail, embedded in our culture, has served our shareholders, employees and customers well over the past 40 plus years. We will continue to focus on these standards.”

3.  Does the business have favorable long-term prospects?

     Insurance itself is a product that will be needed by individuals and institutions for the rest of time.  The products may change as technologies change (will automobiles be the same in 100 years as they are today?), but the overall concept will remain.  Mercury has historically been one of the pioneers of risk-based insurance.  The people in Florida and California face different premiums and policies than the people in Illinois due to the different risks involved.   In addition, Mercury is well diversified geographically across the nation.  Geographic diversity is critical for an insurance agency to prevent catastrophic losses from natural disasters.  We believe that the concepts of risk-based insurance and geographic diversity give Mercury a strong business plan and favorable long-term prospects.

4.  Is management rational?

    Mercury is still led by its founder, George Joseph.  During his tenure, the company has grown considerably, and has increased dividends at an average rate of 20% on an annual basis since 1986 – a difficult feat to accomplish over a 20 year period.  The management is focused on building their non-Californian premiums in an attempt to become even more geographically diverse.  Mercury currently maintains a combined ratio of 91.9% compared to the industry average of 95% (anything below 100% means the company is achieving profitable underwriting).  We believe these accomplishments are evidence that management has acted rationally in the past and can be assumed to continue to act rationally. 

5.  Is management candid with its shareholders?

Management appears to be candid with its shareholders.  In the latest annual report’s letter to shareholders, the management mentions its position and plans regarding the Krumme vs. Mercury litigation, a lawsuit the company is involved in considering the charging of broker fees.  The company also has an average investor relations page.


6.  Does management resist the institutional imperative?

    As stated above, Mercury has been a pioneer of risk-based premiums and other insurance industry methods.  Throughout our research of Mercury, we have found no evidence to suggest that Mercury has behaved in a manner consistent with following the institutional imperative.
 

Financial and Value Review

Upon our review, we find Mercury General Corporation to be suitable for the defensive and enterprising investor following Benjamin Graham’s value investing strategy.  The company has a sufficient size, earnings stability, dividend record, and earnings growth.  In addition, we find the PE ratio to be 12.66, and the PB ratio to be 2.04, both levels below our limits for defensive investors.  We believe all companies that are suitable for defensive investors are also suitable for enterprising investors.

We believe the company has potential to reach $80/share in the next few years. 

Neither of us held a position in Mercury General Corporation at the time of publication.  Also, please read our disclaimer and Our Methods.

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