Warren Buffett’s GEICO investment was pivotal for two of the greatest investors of all-time. The history of GEICO’s stock is fascinating, with many ups and downs.
This post will discuss the rise, fall, and rise again of GEICO’s stock.
It will talk about how Warren Buffett’s mentor, Benjamin Graham, bought GEICO and saw it become his very best investment (beating all his others combined).
And we’ll cover what made GEICO so special—how the company’s moat and price of its stock led to breathtaking returns for Buffett and Graham.
These stories are described in detail in Scott Chapman’s excellent book, Empower Your Investing. We talked with Scott in a great interview on our podcast; we also recommend checking out his book if you’re looking to become a better investor.
The Origins of GEICO
GEICO was an insurance company with humble beginnings.
The founder had a simple idea. Cut out the middle man (insurance agents) while only offering auto insurance to the best drivers.
Statistically, the best drivers were government employees. So, the company only provided auto insurance to them. Hence the name, Government Employees Insurance Company.
With the focused business model, GEICO was able to outperform its competitors significantly over the long term.
Buffett bought, sold, and then bought GEICO again.
He eventually went on to buy the company outright for his company Berkshire Hathaway. Buffett then ramped up the marketing spend of GEICO, propelling it to a leader in auto insurance. It is a great cash cow to this day.
Buffett and GEICO
It’s interesting to note that Buffett’s big purchases into GEICO did not happen until almost 3 decades after he had first discovered the company.
In 1951, Buffett bought $10,282 worth of GEICO stock.
One year later, Buffett sold out for $15,259.
Unfortunately, that was a mistake. If Buffett would’ve held GEICO for the next 20 years, his stake would’ve been worth $1.3 million (a 25% CAGR return).
Buffett did buy back into GEICO in the late 1970s, purchasing $4.1 million worth of common stock. He then helped save the company by buying an additional $19.4 million of convertible stock in the company. He bought over $20 million more several years later.
These investments earned legendary returns.
As Scott Chapman reported:
As Buffett stated decades later on CNBC, if he had to pick just one company to own—it’d be GEICO. It was a company that changed his life forever.
The Ups and Downs of GEICO
Though this was a great company, it was not without its trials. Its stock went through a very turbulent period after Buffett first discovered the company in 1951; it almost went bankrupt.
By 1951, GEICO’s growth rate was already impressive. Throughout the 1940’s, the company grew its number of policyholders by an average of 19% annually. Its founder, Leo Goodwin, led the company to a 50x stock return from 1948-1958.
The next CEO did very well for GEICO as well. From 1958-1970, Lorimer Davidson grew premiums by an average of 16% annually.
It contributed to Buffett’s mentor, Benjamin Graham, holding a $400 million stake in GEICO, from a $712,000 initial purchase. Like mentioned already, Graham’s gains from GEICO outpaced all of the other investments over his career, combined.
Then, things went downhill.
The auto insurance industry went through two fundamental changes in the 1970’s.
First was inflation. Costs skyrocketed as prices everywhere increased. When the cost of everything from new cars to car parts to mechanic services were all going up, auto insurers feel increased pain each time they have to pay out on accident claims.
Further perpetuating the problem was the pricing ceiling on policy premiums. Since states had to improve rate increases by insurers, GEICO’s profitability evaporated. Getting state approval was a slow, grinding process.
GEICO’s dramatic success saw a dramatic fall—the stock dropped from $42 to $5 in less than a year.
Without profits, the company needed outside capital to keep it afloat. Unfortunately for them, it looked bleak. The capital was nowhere to be found.
The Turnaround of GEICO
Enter the white knight, Warren Buffett.
Buffett knew just how strong the business model of GEICO was. He cared deeply about his teacher and hero, Benjamin Graham, who still held shares in GEICO (it was Graham’s largest position).
He also saw the grave situation the company had found itself in.
The bottom line is that GEICO got a new CEO. Buffett met the CEO and had a deep conversation with him, was impressed, and bought his first $4.1 million in shares.
Buffett then went to work helping the company raise outside capital. No investment bank wanted to help, but GEICO found one in Salomon Brothers. GEICO put out some convertible stock, Buffett pledged to buy any outstanding shares from the offering, and the issuance was successful.
With the capital intact, GEICO was able to buy reinsurance on its policies, greatly reducing its downside risk and negative effects of inflation.
The stock went from a low of $2 to $8, in less than a year after raising fresh capital.
Then the stock really went on a tear.
Turnaround CEO Jack Byrne cleaned up and steered the ship in the right direction again. The company became lean and efficient, grew at a high clip, and bought back lots of shares.
GEICO was the outlier in a tough market environment.
Their stock handily beat the market, thwarted disaster, and became what Buffett called in 2006 his “single best investment.”
Lessons from GEICO: The Business Model
GEICO had several inherent competitive advantages that allowed it to grow at such a great rate. Let’s go through some of those as described in the book.
1—Higher margins through lower costs
Part of the brilliance of GEICO’s founder was to look at what the industry was doing and dare to disrupt it.
In this case, GEICO gained customers through lower prices to specific customers. They targeted a specific niche of customers through direct marketing.
By lowering marketing expenses through eliminating sales agents, and lowering claims paid out by insuring the safest drivers, GEICO had industry-leading expense ratios and profit margins.
In fact, GEICO had as much as 4x higher margins than its peers.
When you have higher margins than your competitors, you can do many great things to succeed. For one, companies with higher margins can afford to invest more aggressively in growth.
The brilliance of aggressive investment, enabled through higher profit margins, shown through once Buffett got involved in its later days. Outspending competitors, and utilizing advantages of scale to advertise nationally, led to the successful gecko campaign and (still famous today) “15 minutes can save you 15% or more on car insurance.”
2—Tollgate/repeat purchase feature
Repeat purchase companies can be fantastic businesses, especially because once a company earns the business of its customer, it (generally) no longer has to spend many resources to keep earning those revenues.
This frees up capital and resources to work on growing the business rather than maintaining it.
Contrast this to certain retailers.
Retail can be a tough business because you have to constantly fight competition and lower prices. Unless a retailer has brand loyalty mindshare with its customers (Costco or Target), it must constantly spend and allocate resources just to keep earning the business of its customers.
Auto insurance companies are not completely immune to this—customers can and do switch when they see lower prices.
But, auto insurance has more of a repeat purchase feature since it is a required monthly expense.
You have to have insurance to get around in your car. Pretty much everyone in the United States uses a car in their daily life. So, auto insurance businesses resemble more of what Buffett calls a tollgate model than a discretionary and one-time model.
Which can contribute to higher margins and/or more capital returned to shareholders through buybacks or dividends.
3—High returns on capital
The low expense ratio and high profit margins can help a company earn high returns on capital. But also, the lack of needing capital investments through working capital or capital expenitures combined with high margins makes for an especially advantaged return on capital business.
Thought leader Michael Mauboussin has published papers suggesting that high return on capital businesses are correlated with higher valuation multiples— and the logic simply makes sense.
When a company needs less capital to grow (earning higher returns on its capital), it will be easier for a company to grow.
A company can then reinvest more than its peers to grow faster, and/or return more of its capital to shareholders.
No company can reinvest to infinity for infinite returns, so high returns on capital has a growth ceiling with every business.
But, having higher returns on capital is certainly a great feature to have; many companies have turned into fantastic long term investments from their ability to compound capital at a superior rate.
Float is a feature of insurance businesses which gives a company a “free” source of financing.
When a company gets “free” financing, it can take in lots of capital and put it to work without having to pay an interest rate on it.
This is differentiated from your more traditional businesses, which generally have to borrow money or raise outside capital if they want to raise outside capital above and beyond their profitability.
Insurance businesses like GEICO generate lots of upfront capital. An insurer might collect premiums from a customer for years before ever needing to payout a claim.
That could be years of “free” profits for an insurer through the returns it makes by investing that upfront capital (“float”).
The very best insurance companies combine strict expense control (for underwriting profits) AND superior capital allocation to generate the most optimal growth for a business.
Ironically, Warren Buffett’s Berkshire Hathaway has become the quintessential model for a company that invests float in the most optimal ways. He does it by buying the stocks of the very best businesses, and holding them for the long term.
Lessons from GEICO: The Stock
It should go without saying that stock returns like GEICO’s are very rare.
The stock has been a true outlier. A unicorn. Once in a generation story.
But there are still a few characteristics we can observe about GEICO when Buffett invested that we can apply to find other great investments in the stock market today.
1—The company’s TAM was huge
In the early days of GEICO’s torrid growth rates, the company was only licensed in 15 states. That means there was a full 35 states where GEICO could expand its niche business model to.
Its “TAM”, or Total Addressable Market, was huge.
So, growth rates of 20%+ were not out of the picture. Sustaining high growth was not only possible, but easy to maintain because the company could just replicate its model to other geographical areas.
2—The stock traded at a lower multiple
GEICO traded at about 8x its earnings at a time when its peers traded at higher multiples. With hindsight, this looks silly; GEICO obviously had the better business model and should’ve traded at a premium to its peers rather than a discount.
Buying a stock that Wall Street has not yet recognized as a superior business can provide a huge boost to your returns, as the earnings multiple (P/E ratio) of a stock reverts to where it should be.
Say GEICO traded at an 8x multiple while its peers traded at a 16x. If Wall Street finally recognizes that GEICO is at least as good of a business as its peers, then the stock will be re-rated to a 16x multiple. That’s a 2x in price without any growth from the business.
It multiples your total return when you get it right.
3—High growth rate already in place
Remember one of the key statistics highlighted earlier in this post– by 1950, GEICO had grown its number of policyholders by an average of 19% annually over its last 10 years.
Growing policyholders is an easy way to grow revenues without having to do anything to pricing.
Combined with its large TAM, the company was able to maintain a fantastic growth rate in policyholders which led to outsized returns.
Maybe Isaac Newton said it best, which works sometimes in the stock market: “objects in motion tend to stay in motion.”