It is often said most investors make the majority of their money from just one or two trades. For Warren Buffett (Trades, Portfolio) and Benjamin Graham, this trade was Geico.
Would either of these two investors have built the reputation they have today without the well-known insurance company? It is possible, of course, but history is what it is, and we can only take away what we know for sure.
The initial story of Buffett and Geico is well known. On a Saturday in January 1951, Buffett took a train to Washington D.C. and headed for Geico's headquarters after learning Benjamin Graham was chairman of the board. There he met Lorimer Davidson, who later became the company's CEO.
Davidson spent hours discussing the business with Buffett; when he returned home, he went straight out to buy the stock. Buffett described his next steps in Berkshire Hathaway's (BRK.A, Financial)(BRK.B, Financial)Â 1995 letter:
“You may think this odd, but I have kept copies of every tax return I filed, starting with the return for 1944. Checking back, I find that I purchased GEICO shares on four occasions during 1951, the last purchase being made on September 26. This pattern of persistence suggests to me that my tendency toward self-intoxication was developed early. I probably came back on that September day from unsuccessfully trying to sell some prospect and decided - despite my already having more than 50% of my net worth in GEICO - to load up further. In any event, I accumulated 350 shares of GEICO during the year, at a cost of $10,282. At year end, this holding was worth $13,125, more than 65% of my net worth.
You can see why GEICO was my first business love. Furthermore, just to complete this stroll down memory lane, I should add that I earned most of the funds I used to buy GEICO shares by delivering The Washington Post, the chief product of a company that much later made it possible for Berkshire to turn $10 million into $500 million.”
In his article, The Security I Like Best, Buffett laid out three reasons why he found Geico so attractive: valuation, growth and profit margins.
In the article, Buffett noted the stock was trading at just eight times forward earnings at the time, based on 1950 earnings, a miserable year for the industry. The multiple did not reflect the fact that over the 14 years prior, premiums written had increased in value from $103,000 to $8 million, a compound annual growth rate of 36.5%. Lastly, as Buffett highlights in his article, in 1949 Geico booked a ratio of underwriting profit to premiums earned of 27.5%, compared to the industry average of 6.7%.
What happened next in the Buffett-Geico story is very interesting, in my opinion. Buffett has said luck has been highly instrumental in his success. With Geico, he profited handsomely in the years after his initial purchase, but then sold in 1952. Over the next several years, the shares charged higher but the business nearly collapsed:
“Alas, I sold my entire GEICO position in 1952 for $15,259, primarily to switch into Western Insurance Securities. This act of infidelity can partially be excused by the fact that Western was selling for slightly more than one times its current earnings, a p/e ratio that for some reason caught my eye. But in the next 20 years, the GEICO stock I sold grew in value to about $1.3 million, which taught me a lesson about the inadvisability of selling a stake in an identifiably-wonderful company.
In the early 1970's, after Davy retired, the executives running GEICO made some serious errors in estimating their claims costs, a mistake that led the company to underprice its policies - and that almost caused it to go bankrupt. The company was saved only because Jack Byrne came in as CEO in 1976 and took drastic remedial measures.”
In the next two parts of this series, I am going to take a look at the next chapter of the Geico story, and the company that persuaded Buffett to sell his position.
Disclosure: The author owns no stocks mentioned.
