Sold: Montpelier Re (MRH)

Investing life has been quite boring for the last two years—come to think of it, so has other aspects of life :( I didn't buy anything for several years now and haven't posted much on the blog either. I've been reading quite a bit though, but haven't found any compelling ideas.

In any case, I just sold off one of my very first investments—one I made before I started this blog—for a small gain. That investment is a small reinsurance company called Montpelier Re (MRH). I bought it in February 2007 and sold it today (March 2012).

Purchase price (approx): US$ 17.96
Sale price: US$ 19.49

Simple return (excl dividends; US$): 8.4%
Total return (US$): 14.1% (2.67% annualized)

Post Mortem

Overall the investment was a poor one. It outperformed the S&P 500 slightly but underperformed most indexes including long bonds.

Reason for Selling

I decided to sell because the market had rallied strongly and I felt Montpelier Re is the type of investment that can decline significantly if there is a correction. There is always of the possibility of this company being bought out at a premium but that's unpredictable.

I also didn't feel the company was anything special and doing anything exceptionally well. Management's share purchase in the last year was a very good move—kudos to them—but their poor investment in mortgage bonds (with their insurance float/portfolio) a few years earlier destroyed shareholder wealth and introduced risk.

Of note, I didn't feel confident in the risk. This company, like most insurers, was a black box—I didn't know this when I invested—and I wasn't confident with its catastrophe risk. In particular, the stock fell sharply in 2009 and I always pondered buying more but wasn't confident with the company—when you get that feeling, you pretty much know it's not the right investment. Overall, my investment style and skill had changed over the years and this didn't fit my goals.

Major Mistake

I made a major mistake with the purchase of this stock. I basically overpaid for it. I bought it after this company almost went bankrupt after hurrican Katrina but I didn't realize the valuation was too high.

This is such a newbie mistake and seems obvious in hindsight but I didn't realize that the best metric to value insurance companies is price-to-book. I mistakenly used the P/E ratio—Montpelier was trading at a low P/E of around 5 at that time—but it was misleading.

On top of likely overpaying for the company, the insurance industry has seen valuation compression and that made it even worse (I talked about it in a post a few years ago). As the data from Morningstar shows, Montpelier's P/B declined from around 1.1 in 2007 to the present 0.8.

I think I paid 1.2x book value but my feelings are that, ignoring an insurance bubble, this company doesn't deserve anything above book value. After investing and following these these small-cap reinsurers for a while, my opinion is that they are very risky and have non-zero probability of catastrophic failure. Since they are in the reinsurance business, sometimes they hit by things that you don't expect. For example, Montpelier Re took sizeable losses from the Fukushima nuclear disaster in Japan but Montpelier Re doesn't even operate (directly) in Japan.

After this sale, I have no major holdings now (other than some legacy and mistake investments). I have to re-compute all my numbers and provide an update but I think I'm around 95% cash right now.


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