The following segment was excerpted from this fund letter.
Brown & Brown (NYSE:BRO)
We first purchased this company in 2007 in our Mid Cap strategy.
As an insurance broker, it gets paid a commission on the premiums that its mostly small business clients pay. Since clients need to maintain insurance coverage even in business downturns, Brown & Brown’s revenues tend to be very steady year by year. Yet, our investment underperformed for the seven years after our initial purchase, and it wasn’t because we paid a high price – the stock traded at a moderate price to earnings (P/E) of 17x at the time. The culprit was profits.
After increasing sixfold over the seven years before our purchase, earnings per share were essentially flat from 2007 to 2014, going from $0.68 per share to $0.71 per share. No wonder our investment underperformed the Russell Midcap benchmark over that period. The sources of sluggish profits were manifold, including management turnover, a change in its acquisition strategy, moderate under-investments in dealing with the shift towards more complex insurance needs among its customer base, and a heavy exposure to Florida, a state hit especially hard during the Great Financial Crisis.
Perhaps some of these factors could have been foreseen in 2007, it’s hard to say. What we can say, though, is that by 2014, we had the full explanation of these factors in hand, and our continuing research indicated that many of these factors were being addressed or were likely to diminish in importance. The exposure to Florida had declined, and the negative impact of the Great Financial Crisis on the state’s economic growth was receding.
Management departures were stemmed, and we had full confidence in the CEO, who was a long-term employee and an owner-operator willing to make changes to address long-term health. One of them was to make the investments needed to keep up with the increasingly complex insurance needs of its clients. And finally, we felt that its acquisition strategy was a change, but a positive and necessary one. Because of these assessments, we felt that the future looked bright, much brighter than the recent past, and we added significantly to our investment during 2014 and 2015. We turned out to be right.
The company is on track to produce close to $3 per share in earnings in 2023; as a result, its stock price has followed suit with strong performance as well, to the point that our investment has now outperformed the benchmark since our original purchase, despite the many years of underperformance initially. This is an example of a long-term earnings cycle based on microeconomic factors, mostly internal to the company itself. We feel that our research style is well-equipped to analyze these kinds of cycles.
“Madison” and/or “Madison Investments” is the unifying tradename of Madison Investment Holdings, Inc., Madison Asset Management, LLC (“MAM”), and Madison Investment Advisors, LLC (“MIA”). MAM and MIA are registered as investment advisers with the U.S. Securities and Exchange Commission. Madison Funds are distributed by MFD Distributor, LLC. MFD Distributor, LLC is registered with the U.S. Securities and Exchange Commission as a broker-dealer and is a member firm of the Financial Industry Regulatory Authority. The home office for each firm listed above is 550 Science Drive, Madison, WI 53711. Madison’s toll-free number is 800-767-0300.Any performance data shown represents past performance. Past performance is no guarantee of future results. Non-deposit investment products are not federally insured, involve investment risk, may lose value and are not obligations of, or guaranteed by, any financial institution. Investment returns and principal value will fluctuate. This website is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. This letter was written by Haruki Toyama, Head of Mid and Large Cap Equities and Portfolio Manager on the respective strategies. Although the information in this report has been obtained from sources that the firm believes to be reliable, we do not guarantee its accuracy, and any such information may be incomplete or condensed. All opinions included in this report constitute the firm’s judgment as of the date of this report and are subject to change without notice. This report is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. Equity risk is the risk that securities held by the fund will fluctuate in value due to general market or economic conditions, perceptions regarding the industries in which the issuers of securities held by the fund participate, and the particular circumstances and performance of particular companies whose securities the fund holds. In addition, while broad market measures of common stocks have historically generated higher average returns than fixed income securities, common stocks have also experienced significantly more volatility in those returns. Diversification does not assure a profit or protect against loss in a declining market. The S&P 500® is an unmanaged index of large companies and is widely regarded as a standard for measuring large-cap and mid-cap U.S. stock-market performance. Results assume the reinvestment of all capital gain and dividend distributions. An investment cannot be made directly into an index. Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of Russell Investment Group. Russell Midcap Index is a market-capitalization-weighted index representing the smallest 800 companies in the Russell 1000 Index. The average Russell Midcap Index member has a market cap of $8 billion to $10 billion, with a median value of $4 billion to $5 billion. Russell 2000® Index measures the performance of the 2,000 smallest companies in the Russell 3000® Index, which represents approximately 11% of the total market capitalization of the Russell 3000® Index. The Russell Top 50® Mega Cap Index measures the performance of the largest companies in the Russell 3000 Index. It includes approximately 50 of the largest securities based on a combination of their market cap and current index membership and represents approximately 45% of the total market capitalization of the Russell 3000, as of the most recent reconstitution. The Russell Top 50 Index is constructed to provide a comprehensive unbiased and stable barometer of the largest US companies. The Index is completely reconstituted annually to ensure new and growing equities are reflected. The Russell Top 200® Index measures the performance of the largest cap segment of the US equity universe. The Russell Top 200 Index is a subset of the Russell 3000® Index. It includes approximately 200 of the largest securities based on a combination of their market cap and current index membership and represents approximately 68% of the Russell 3000® Index, as of the most recent reconstitution. The Russell Top 200 Index is constructed to provide a comprehensive and unbiased barometer for this very large cap segment and is completely reconstituted annually to ensure new and growing equities are included. Upon request, Madison may furnish to the client or institution a list of all security recommendations made within the past year. Holdings may vary depending on account inception date, objective, cash flows, market volatility, and other variables. Any securities identified and described herein do not represent all of the securities purchased or sold, and these securities may not be purchased for a new account. Past performance does not guarantee future results. There is no guarantee that any securities transactions identified and described herein were, or will be profitable. Any securities identified and described herein are not a recommendation to buy or sell, and is not a solicitation for brokerage services.
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