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Greg Speicher
Greg Speicher
Articles (62) 

Geico: The Security Buffett Liked Best

July 31, 2009

In 1951, Warren Buffett wrote an article about the Government Employees Insurance Company (GEICO) in the local newspaper entitled, "The Security I Like Best". The article is instructive because it clearly shows the factors that Buffett used to analyze and value a stock. The story of how Buffett came to own it provides a model of how to find and research a stock.

Buffett was first attracted to GEICO in the 50’s when he learned that his idol, Ben Graham, was chairman of the board and an owner. He thoroughly researched the company and invested three-quarters of his portfolio in the stock. Although he eventually sold his original position, in the late 70’s, he again, through Berkshire Hathaway, made a major investment in GEICO, when its share price tumbled as a result of underpricing its insurance risk. Finally, in 1996, Berkshire Hathaway purchased the balance of the company, and GEICO became a wholly owned subsidiary of Berkshire Hathaway. Today, GEICO continues to thrive and take market share under its low-cost model.

Here are some of the lessons we can take away from Buffett’s early purchase of GEICO.

1. Use public disclosures as a way to generate ideas. Buffett closely followed the investments of Benjamin Graham’s investment company, Graham-Newman Corp. As a result, he invested in Marshall Wells and Timely Clothes. He became interested in Geico, when he learned that Graham was the chairman and an owner. A great way to generate ideas today is to look at the public disclores of the equity holdings of large institutional investment managers, which are tracked here on Gurufocus.com. Caution! These ideas are a starting point and you should always do your own research to understand the company and why its stock may be undervalued.

2. Do thorough research. It was not enough for Buffett to know that Graham was chairman of Geico. He wanted to understand the company for himself. On a Saturday in 1951, Buffett took a train from New York to Washington and went to Geico’s office in downtown Washington. Since it was closed, he had to bang on the door until the janitor finally let him in to see an executive, Lorimar Davidson, who happened to be working. Buffett ended up spending four hours with Davidson. Lowenstein tells us in his biography of Buffett that, “He asked searching and highly intelligent questions. What was Geico? What was its method of doing business, its outlook, its growth potential? He asked the types of questions that a good security analyst would ask. I was the financial vice president. He was trying to find out what I knew.”

3. Invest based on the facts and have confidence in your own judgment. Ben Graham would say, “You are neither right not wrong because the crowd disagrees with you.” After Buffett returned from Washington, he was excited about what he had learned about Geico. He did additional research and found out that Geico’s profit margins were five times higher than those of its competitors and that their premium volume was growing at a fast clip. However, when he visited a number of insurance experts of the day to get their take, they told him that the stock was overvalued. In the end, Buffett proceeded to invest based on his own work, putting three-quarters of his portfolio into the stock.

4. Make meaningful investments. It is difficult to find a great company at a great price. If you do, you should commit enough capital to make a difference in your results. A 1% position in a great company, with a clear competitive advantage, that you understand, with great management, available at a significant discount, does not make a lot of sense. Think how a private investor would approach it, if he had a chance to invest a portion of his capital in the best company in town at a fair price.

5. Look for good economics with a competitive advantage. Capitalism breeds intense competition. As Bruce Greenwald wryly put it, "In the long run, everything is a toaster". Buffett recognized this and that GEICO was special. First, GEICO had great economics: its profit margin on underwriting was 27.5% vs. an industry average of 6.7%. Better yet, it appeared sustainable. Buffett identified that GEICO had a cost advantage over its competitors because it sold policies directly and therefore did not have to pay the industry-norm agent commissions. Moreover, this advantage was sustainable because the large established companies would not risk alienating their agents by providing an alternate direct channel. GEICO further reduced costs by focusing on lower-risk customers such as government employees, military personnel, and educators. Finally, Buffett liked the fact that most people have to purchase auto insurance and that, since premiums are paid in before claims are paid out, an insurance company gets to invest and benefit from the float.

6. If growth is part of your valuation, make sure its potential is grounded in reality. In spite of its rapid growth, GEICO had, until 1950, been licensed in only 13 states, plus Hawaii and the District of Columbia, and had a miniscule market share. Its growth potential was enormous. During periods of recession, Buffett recognized that GEICO would take share as consumers focused on reducing costs. GEICO continues to take share today for precisely the same reason.

7. Purchase shares at attractive prices. Buffett paid about eight times what he viewed as poor earnings, meaning he paid more like seven times normalized earnings.


Greg Speicher

valueinvestingfundamentals.blogspot.com

About the author:

Greg Speicher
http://gregspeicher.com/

Rating: 3.8/5 (19 votes)

Comments

PHILCIR
PHILCIR - 10 years ago    Report SPAM
Do you guys ever get tired of kissing this old goats ass?
tkervin
Tkervin - 10 years ago    Report SPAM
Philcir,

So you prefer to kiss the ass of younger goats?
rnagarajan
Rnagarajan - 10 years ago    Report SPAM
Interesting article. GEICO's advantage still persists to this day even against competitors like Progressive (see my article for a comparison: [www.rationalwalk.com]).

One thought that always comes to mind when I read about Mr. Buffett's trip to Washington to meet with Mr. Davidson is that this type of meeting could never occur today due to Regulation FD and other factors that make managements reluctant to talk to anyone informally. I understand why the regulations exist but it's too bad that aspiring Buffett followers cannot do this kind of legwork today.
SanLouisKid
SanLouisKid - 10 years ago    Report SPAM
Warren wrote a series of articles with this title. I have one on The Western Insurance Companies. He went to Kansas City to visit with Ray B. Duboc, the CEO of The Western, just as he did with Mr. Davidson at GEICO. After that visit he sold his GEICO stock and put 50% of this net worth in Western stock. Later he sold his Western stock (after a nice profit) and started buying GEICO again.

Rick

St. Louis, MO
reefhound
Reefhound - 10 years ago    Report SPAM
Rnag...I disagree with your comment that this type of meeting as between Buffett and Davidson could never occur today. Many people in management love to talk about their businesses informally (I'm, of course, talking about microcap size companies...not many of us run into or can get an appointment with say, Jeff Immelt).

I'm also not referring to inquiring about such things as what their earnings are going to be next quarter or other specific undisclosed financials. But you can ask them things such as about their competitive advantage or lack thereof, the regulatory environment, their ideas about growth, etc. By talking to them and then seeing what they do, you can determine whether they are shareholder friendly, etc., etc..

I have done this on a couple occasions and have spent up to 90 minutes talking to the CEO of a company (without an appointment). I liked his answers so much I have invested about 20% of my portfolio and am buying more. (As an aside, I especially agree with Speicher's Item #4)

Greg Speicher
Greg Speicher - 10 years ago    Report SPAM
SanLouisKid - Can you post a link to these articles by Buffett, or email upon request? I would be very interested in studying these. Thanks.

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