At the Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) 2019 annual meeting earlier this month, Warren Buffett (Trades, Portfolio) discussed the profits of the auto insurance industry.
Berkshire owns Geico, which is currently one of the largest auto insurers in the country behind State Farm. The company is vying for the top position with another publicly traded entity called Progressive Corp. (PGR, Financial).
Geico and Progressive are two well run, highly efficient businesses that have produced fantastic returns for their respective owners over the past several decades.
According to my calculations, excluding dividends paid to investors, shares of Progressive have delivered a compound annual return of 16.3% since the beginning of January 1990. One of the first investors to spot the company's potential back then was the renowned value-focused fund Sequoia.
A rich heritage
Sequoia can trace its roots back to 1969, when its founders, William J. Ruane and Richard T. Cunniff, set up the fund to take on clients leaving Buffett's first investment partnerships. Buffett asked Ruane if he would take his investors as he believed the guru was the best man for the job. Since then, Sequoia has gone on to establish itself as one of the best value funds of all time.
I recently stumbled across some of the fund's early letters to investors, which date back to 1974. I thought it would be interesting to go back and look at some of its initial investments, particularly Progressive, which accounted for nearly a quarter of its common stock portfolio throughout the first half of the 1990s.
The managers first mention this position in the 1994 letter to investors. Specifically, they wrote:
"This company is a very successful insurer of 'non-standard' automobile drivers, those who, for various reasons, have difficulty obtaining insurance from most standard auto insurers... Most standard insurers duck when offered this opportunity but Progressive is generally ready to take it at any price. The company's aggressive plans for long-term growth are very interesting, but we note that this growth will come at the sacrifice of near-term earnings progress."
The letter goes on to say Wall Street was generally ignoring the company at the time because its focus on long-term market share growth came at the expense of near-term profitability. Sequoia was happy to overlook the short-term turbulence and concentrate on the company's long-term potential instead.
The next time the company was discussed was in the 1998 letter to investors:
"In a market characterized by high volatility, Progressive stock provided investors with a particularly wild ride in 1998 and year to date 1999. The company has historically not provided quarterly earnings guidance to 'the Street' and does not manage its business for smooth quarter to quarter earnings progression but rather for long-term growth, a practice we applaud. The resulting earnings 'surprises,' both on the up and the downside, contribute to the volatility of Progressive' s stock price. In addition, in the second and fourth quarters of 1998, the sharp slowing in Progressive's premium growth rates raised investor concerns that the intensifying competition in the auto insurance industry may depress Progressive' s growth and margins. Competition is clearly intensifying in the industry after a long string of years of unexpectedly benign cost trends and resulting fat margins. We believe this is a predictable, if perhaps less pleasant, stage of the insurance cycle. While it wouldn't surprise us if Progressive' s earnings growth is sluggish for the next couple of years relative to its own aggressive goals, we still have confidence in this unusual company's longer term prospects."
This gives us an exciting insight into the way Sequoia was approaching the investment. The managers were more than happy to look past the insurer's near-term problems, unlike the rest of Wall Street. Through conversations with industry experts, they understood the company had an advantage over competitors and were not unnerved by the stock's volatility.
The position is also discussed in Sequoia's 1999 letter, where, once again, its managers praised the company for sticking to its standards, not chasing growth and focusing on the long term.
Transcripts of Sequoia's annual meetings in the early 2000s follow the same track. In the first few years of the new millennium, the fund's managers continued to make it clear that despite share price volatility, Progressive had an excellent long-term outlook.
Concentrate on the long term
While these extracts do not give us a lot of insight into the methods Sequoia used to analyze Progressive, what they do show is the fund's clear focus on finding companies that have terrific long-term potential. Additionally, investors can draw many parallels between Progressive and Amazon (AMZN, Financial) in the early years.
Both companies ignored the appeal of chasing earnings growth and stuck to what they knew best.
The results have been identical for both companies. By sticking to what they know, taking a long-term perspective and reinvesting back into the business, both Progressive and Amazon have grown from small disruptors into the most prominent companies in their respective spaces. They are both growth stories that cannot be ignored.
Disclosure: The author owns shares of Berkshire Hathaway.
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