Most value investors will be aware of Warren Buffett (Trades, Portfolio)’s famous "Security I Like Best column," the piece he wrote for The Commercial and Financial Chronicle in December 1951 at the ripe old age of 21.
The security featured in this article was GEICO, which Buffett liked thank for its tremendous growth potential and attractive valuation. At only eight times earnings Buffett believed “no price is being paid for the tremendous growth potential of the company.” This was the first time Buffett disclosed his love for GEICO and the rest, as they say, is history.
GEICO wasn’t the only cheap insurance stock that Buffett wrote about for Commercial and Financial Chronicle. A year later he returned with another pick in the form of Western Insurance Securities Co.
Buffett: The other security I like best
Published a year after the GEICO recommendation, Buffett opened his new piece on the topic with “again my favorite security is the equity stock of a young, rapidly growing and ably managed insurance company.” Buffett has always expressed a love of insurance companies so it some comes as no surprise to Buffett followers that essentially the first two public stock picks of his career were but in the insurance industry. The article goes on to say “although Government Employees Insurance Co., my selection of 15 months ago, has had a price rise of more than 100%, it still appears very attractive as a vehicle for long-term capital growth.”
So,what was there to like about Western? Well for a start the company was exceptionally cheap. Buffett noted that the “price range in Moody’s financial manual was $12 to $20” compared to earnings per share of $16. The stock traded over the counter.
And this is just the start of his analysis in the article. In many ways, the piece from Buffett is a great insight into how his mind works and his valuation process, as simple as it is. Buffett computes the current valuation of the company based on existing earnings and gives a rough estimation of Western’s growth potential, based on existing policyholder numbers.
“The casualty insurance industry during the past several years has suffered staggering losses on automobile insurance lines. This trend was sharply reversed during late 1952. Substantial rate increases in 1951 and 1952 are being brought to bear on underwriting results with increasing force as policies are renewed at much higher premiums. Earnings within the casualty industry are expected to be on a very satisfactory basis in 1953 and 1954. Western, while operating very profitably during the entire trying period, may be expected to report increased earnings as a result of expanding premium volume, increased assets and the higher rate structure. An earned premium volume of $30,000,000 may be conservatively expected by 1954. Normal earning power on this volume should average about $30 per share with investment income contributing approximately $8.40 per share after deducting all senior charges from investment income.
“The patient investor in Western Insurance common can be reasonably assured of a tangible acknowledgement of his enormously strengthened equity position. It is well to bear in mind that the operating companies have expanded premium volume some 550% in the last 12 years. This has required an increase in surplus of 350% and consequently restricted the payment of dividends. Recent dividend increases by Western Casualty should pave the way for more prompt payment on arrearages.”
Still, despite this growth potential, the shares were only trading at “a discount of approximately 55% from the Dec. 31, 1952, book value of $86.26 per share.” As well as comments on valuation and growth potential, as usual, Buffett’s analysis also contained a section on management’s reputation and time with the company.
“The management headed by RayDuBoc is of the highest grade. Mr. DuBoc has ably steered the company since its inception in 1924 and has a reputation in the insurance industry of being a man of outstanding integrity and ability. The second tier of executives is also of top caliber.”
All in all, an interesting early analysis from history's greatest investor.
