Here is a look into the mind of Buffet when he was just 21. He was still a student at the University of Columbia embracing the teachings of Benjamin Graham.
In 1951, as Geico was one of its key holdings of Graham (Graham is also Chairman of the Board), Buffet would want to know more about the company. He took a train down to Washington on a Saturday where the Geico office was closed. He was persistent enough to get the building janitor to lead him to Lorimer Davidson who was the only one working that day. Davidson would eventually be the CEO in 1958.
The encounter gave him a huge head start in the business of insurance that would be one of the key foundations for his future investment framework. Free float in the form of premiums if successfully invested would unleash the power of compounding.
Buffet came up with the thesis of investing in Geico after the meeting and have it published.
Here are the few key investment merits of Geico then based on the article:
- The insurance industry has the following advantages:
- Lack of inventory
- No collection issues
- Minimal labour Problems
- No Raw Materials Problems
- Product and Equipment obsolescence is also absent
2) Geico have a great business model where they could charge 30% lower than competitors, as they do not have any agents or branch offices.
3) It has good growth numbers where policyholders have increased from 3754 in 1936 to 143,944 in 1950. Premiums have also increased from 103k to 8 million.
4) Profit margin was way in excess of competitors of underwriting profit to premium coming in at 27.5% versus an industry average of 6.7%. Underwriting ability is critical for the profitability of an insurance company as substandard underwriting could lead to massive losses.
5) He sees good management in Leo Goodwin who guided the impressive growth since inception.
6) Directors owned close to one-third of the total shareholdings and hence have skin in the game.
7) Trading at 8x PE in what is a poor year for the industry is not excessive given their growth profile.
Buffet invested 50% of his own investment funds into Geico acquired through his years of running the paper route and pinball machines business. He invested 10k and divested one year later with a 50% gain in 1952. He have found a better bargain to put his funds to work. Have it held on, his 10k investment would be worth 1.3 million dollars in 1970.
That “taught me a lesson about the inadvisability of selling a stake in an identifiably wonderful company,” Buffett said in his 1995 annual letter to shareholders.
Buffet did buy back big-time into Geico in 1976 where they are on the brink of bankruptcy when prices have fallen from 60 dollars to 2 dollars due to a bad underwriting period that led to massive losses. Eventually, Buffet through Berkshire took Geico private in 1995 and it is a paramount pawn to Berkshire’s growth for the years ahead.
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