There is one company and investment that has had more to do with Warren Buffett (Trades, Portfolio)’s success over the years than any other: GEICO.
Although Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) is a huge conglomerate today with many different branches of its tree, a vast portion of Buffett, Berkshire and even Benjamin Graham’s wealth and reputation was built with GEICO.
The story begins in 1948 when Graham paid $712,000 for a 50% stake in GEICO and secured the position as chairman of the board. At the time, this was a relatively risky decision for Graham as, by acquiring 50% of the company, he had put 25% of his capital into one investment -- something he always advised against. GEICO was also a highflying, expensive growth stock, once again something he always tried to avoid. Nonetheless, he liked what he saw and pressed ahead with the investment.
Upon hearing his teacher had decided to take such a large position in a relatively unusual stock, a young Buffett took the train to Washington on a Saturday to find out more about GEICO. He found the office closed, but a janitor directed him to Lorimer Davidson, an executive at GEICO who spent four hours with this “highly unusual young man.” After the meeting, Buffett followed Graham by ploughing around 65% of his savings into the company -- yet another unusual move.
As Jason Zweig, "Intelligent Investor" columnist for The Wall Street Journal, put it:
“In short, they [Graham and Newman] broke their rules to buy the stock, and they broke their rules to keep it.”
The key to business success
To be successful in the insurance business, you need one of two things. Either 1) a specialised niche or 2) scale. GEICO can hardly be called specialized, but the company does have size to its advantage. It seems this is why both Graham and Buffett were attracted to the business. GEICO’s large size helped it achieve sector-leading profit margins and its reputation meant its growth potential was enormous. Buffett describes such a scenario in his December 1951 article, "The Security I Like Best":
“Probably the biggest attraction of GEICO is the profit margin advantage it enjoys. The ratio of underwriting profit to premiums earned in 1949 was 27.5% for GEICO as compared to 6.7% [for the sector average]…During the first half of 1951, practically all insurers operated in the red on casualty lines…Whereas GEICO’s profit margin was cut to slightly above 9%…”
Graham quit the money management business in 1956 and distributed GEICO holdings to investors, but Buffett held on. In 1975, after 36 years of profitable growth, he was offered a once-in-a-lifetime opportunity.
In 1975, GEICO reported its first loss in its history and was teetering on the brink of bankruptcy. Sensing blood, Buffett dived in and began buying the stock at $2. Here Buffett also started to use his already significant presence in the business community and financial backing to turn around the company’s fortunes. David Byrne was poached from GEICO’s fellow insurer Travelers Insurance (TRV, Financial) to help turn the business around, and Buffett helped recapitalize the company with $75 million in preferred convertible stock. The turnaround worked, and five years after Buffett started buying at $2, GEICO stock hit $15. In 1995, Berkshire purchased the whole business for $70 a share.
Without this opportunity, it is unlikely Buffett would be as successful as he is today. Granted, he still made an enormous fortune away from GEICO, but over the years the holding and subsequent earnings from the business after the acquisition provided both huge financial and intangible benefits for Berkshire.
Hitting a home run
Buffett always speaks about waiting for the home run ball and, in many ways, GEICO was his home run. It is difficult to calculate exactly how much he has made from GEICO over the years, but some rough numbers make it clear how lucrative the position must have been. The year GEICO was fully acquired, the business was paying out $1 per share in dividends. That is a 50% return per annum on the initial $2 purchase price. Buffett’s full position in the company was acquired over many years, so the exact average cost is likely much higher. Nonetheless, when Berkshire bought the 49% of GEICO it did not already own in 1995 for $2.3 billion, the business as a whole was worth $4.6 billion. When Graham bought his initial position in 1948, GEICO was worth $1.4 million, a compound annual growth rate of 17.6% excluding dividends. As Graham himself said in 1976:
“In 1948, we made our GEICO investment and from then on, we seemed to be very brilliant people.”Â
Disclosure: The author owns no stock mentioned.
Start a free 7-day trial of Premium Membership to GuruFocus.
