When investors think of Warren Buffett (Trades, Portfolio), they usually think of Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial). The conglomerate has become synonymous with the Oracle of Omaha over the past few decades as he has grown the business from a struggling textile concern into one of the largest groups on the planet.
Berkshire's insurance business has been the engine room of the group since the early 1970s. The insurance business has provided capital for Buffett to invest in the stock market and a steady stream of income to support other businesses. The leverage achieved by using the capital in the insurance group has helped turbocharge Berkshire's expansion over the years.
The best investment
Despite the company's success, Buffett has singled out Berkshire as being one of his worst investments of all time. If Berkshire was his worst investment, then what was his best investment? Buffett explained at the 2005 annual meeting of shareholders:
"So, we've — probably, in terms of what it's done already and where it's going to go over time, probably the single best investment was the first half of Geico, which we purchased for $40 million."
Buffett first became involved with the stock in the early 1950s. He put more than a third of his net wealth in the business when he first discovered the opportunity. Based on this track record, one can argue that this company is his oldest investment and a business he knows better than any other.
Indeed, he has now had some interaction with the enterprise, in one way or another, for at least 70 years. It is one of the most outstanding examples of the buy what you know mentality and long-term investing in Berkshire's portfolio.
In 2005, Buffett highlighted the reasons why he believed this was such a valuable acquisition. While he said he learned a lot from See's Candy, and it threw off a lot of cash to acquire other investments, its growth has always been relatively constrained.
In comparison, Geico's cash generation and balance sheet always provided more flexibility for growth. As the Oracle explained:
"But Geico — some of our businesses have growth potential, some don't. And we don't require growth potential as part of a business. If a business makes good money and we can use it to buy other businesses, one of the advantages of the Berkshire system is we have a tax efficient and kind of frictionless way of moving money to the best opportunities. And Geico, internally, has still enormous possibilities for growth."
Over the past few decades, Geico has continued to expand across the country while reinvesting billions of dollars back into the business to attract more customers. It is now one of the top three auto insurers in the country. There's plenty of room left for growth in the years ahead.
And as Buffett explained in 2005, one of the reasons why this insurer has been so successful is the fact that it can move capital around and diversify into other businesses, as well as providing capital for other parts of Berkshire.
This is one of the greatest advantages the conglomerate has over other companies. Its insurance division provides a tremendous amount of capital, which can then be used to buy up other businesses, or moved to other divisions to fund expansion and capital spending, therefore removing the need for borrowing from the market.
The market often overlooks this part of the Berkshire model. Without the leverage provided by the insurance businesses, it seems likely the group would be nowhere near as big as it is today. That seems to be why Buffett picked Geico out as his best investment in 2005.
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