Lady Fortuna

The Luck of a Gecko: The Impact of GEICO on Benjamin Graham's and Warren Buffett's Success

Lady Fortuna

Unless you have been living under a rock, you are certainly familiar with the GEICO Gecko and the GEICO caveman. The story of how this once tiny company became a premier insurance brand and a household name involves two of the most well-known investors of all time, Benjamin Graham (the founder of fundamental security analysis) and his student, Warren Buffett. An excellent presentation/case study on GEICO was done by David Rolfe of Wedgewood Partners.

In 1948, twelve years after GEICO’s founding, Graham’s company, Graham-Newman Corporation, bought 50% of GEICO for $712,000 and secured the Chairman of the Board position for Graham. By 1972, the value of this investment had grown to $400 million, a 562-fold increase. In Graham’s own words, "In 1948, we made our GEICO investment and from then on, we seemed to be very brilliant people." Jason Zweig, one of the foremost authorities on Benjamin Graham, wrote a column on this topic1 in which he detailed how Graham’s GEICO investment broke several of his own rules such as not putting more than 5% into any single company (GEICO was 20% of Graham-Newman) and not holding onto companies that no longer met the requirements of a value investment. Interestingly, the one company for which Graham threw out the playbook was also the company that accounted for most of his success.

 


The Intelligent Investor

Author: Benjamin Graham
Year Printed: 1973
Edition: Fourth

Learn more about this book at IFA Library.

Graham, is his own words, admits to the fact that one lucky and large bet on GEICO may have been the reason for his life time of investment success:

Ironically enough, the aggregate of profits accruing from this single investment decision far exceeded the sum of all the others realized through 20 years of wide-ranging operations in the partners’ specialized fields, involving much investigation, endless pondering, and countless individual decisions. Are there morals to this story of value to the intelligent investor? [One] is that one lucky break, or one supremely shrewd decision — can we tell them apart? — may count for more than a lifetime of journeyman efforts.” (The Intelligent Investor, 4th revised edition, Postscript, pg. 289): 

As for Warren Buffett, his introduction to GEICO came in 1950 while he was Graham’s student at the Columbia Business School. Shortly after a trip to GEICO’s headquarters in Washington, DC, Buffett wrote a research report with a buy recommendation. Buffett put his money where his mouth was and invested a little over $10,000 (about half of his net worth at the time). About two years later, he sold his GEICO shares for about $15,000. Had he held them for 20 years, they would have grown to about $1.3 million.

GEICO is no simple rags-to-riches tale. In the mid-1970’s, the company ran into serious financial problems, the result of extremely rapid growth combined with new and onerous government regulations such as no-fault insurance requirements. The stock fell from a high of $61 per share in 1972 to a paltry $2 per share in 1976. GEICO appeared to be headed for certain bankruptcy. Enter the Oracle from Omaha.

Due to his relationship with Benjamin Graham, Warren Buffett was already on GEICO’s board of directors, although he was not then an investor. Presented with a distressed company that he thought he could help turn around, Buffett’s Berkshire Hathaway began buying shares at a little over $2. In one year, GEICO returned to profitability.

Through the years, Buffett steadily increased Berkshire’s stake in GEICO, until he bought the remaining 49% of it in 1995 for $2.3 billion. Since GEICO is no longer a publicly traded company, it is not possible to determine Buffett’s exact gain. David Rolfe estimates the market value of GEICO at $14 billion versus a cost basis of $2.4 billion for a gain of $11.6 billion.

Yes, an investment in GEICO has certainly packed a wallop for Buffett, a reality which leads us directly back to Benjamin Graham’s question: can we tell the difference between an incredibly lucky break and an extremely shrewd decision?  My conclusion is “no”, but there is no law that says the two cannot be combined. Perhaps this is the position that Michael Maboussin, the author of The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing would take. In either case, it is extremely important to draw a distinction between an active fund manager simply buying shares of a company with the expectation that they will appreciate versus a Benjamin Graham or Warren Buffett who buys a substantial part or all of a company and fully participates in the running of said company. The former is only a supplier of financial capital, while the latter is a supplier of both financial and human capital, and for that, he should expect to receive a higher return. But... it certainly helps to be lucky!

 

1. Jason Zweig, “Was Benjamin Graham Skillful or Lucky?”, Wall Street Journal, December 13, 2012.