The business of selling and underwriting insurance policies is one of America's oldest and most staid segments of financial services. The story of how a once-tiny provider in this space rose to an industry leader, however, is anything but boring.

It involves a company, GEICO (The Government Employees Insurance Co.), which became a premier insurance brand, let alone a well-known household name. This tale also revolves around two of the most well-known investors of all-time, Benjamin Graham (the founder of fundamental security analysis) and his student, Warren Buffett.

In 1948, 12 years after GEICO's founding, Graham's company (Graham-Newman Corp.) bought 50% of GEICO for $712,000. As part of the deal, he became the insurance carrier's chairman of the board. By 1972, the value of this investment had grown to $400 million, a 562-fold increase. Years later, Graham would observe that such an investment raised his firm's profile. As he famously once put it: "we seemed to be very brilliant people."

Jason Zweig, who has written extensively on Benjamin Graham's career and investment prowess, wrote a particularly revealing column in the Wall Street Journal on this topic. In his piece, he detailed how Graham's GEICO investment broke several of his own rules. This included 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.¹

Interestingly, the one company for which Graham threw out the playbook was also the company that accounted for most of his success. Graham, in his own words,² admits to the fact that one lucky and large bet on GEICO might have been the reason for his investment 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,² admits to the fact that one lucky and large bet on GEICO might have been the reason for his 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." 

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, D.C., Buffett wrote a research report with a buy recommendation. Buffett put his money where his mouth was and invested a little more than $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 Buffett, a native Nebraskan who had earned the "Oracle of Omaha" nickname along Wall Street.  

Due to his relationship with Graham, the esteemed entreprenuer was already on GEICO's board of directors -- although he was not then an investor. Presented with a distressed company that he thought was capable of a smart and well-managed turnaround effort, Buffett's Berkshire Hathaway (BRK-A) began buying shares at slightly more than $2.

This rebound story took hold sooner than most investors might've expected. In one year, a Buffett-backed GEICO returned to profitability.

But his commitment to such an investment plan wasn't fleeting. 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 and operates as a subsidiary of Berkshire Hathaway, it is not possible to determine Buffett's exact gain. By some estimates, though, he's profited by more than $20 billion from his original investment in the company. 

Yes, an investment in GEICO has certainly packed a wallop for Buffett. It's 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?

At IFA, our wealth management strategy is built around a philosophy that answering such a question ultimately results in a conclusion of: "No." Still, nothing we know about investing dictates that both luck and shrewd decision-making are mutually exclusive. 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 some important distinctions. At one end of the spectrum is the active fund manager who simply buys shares of a company with an expectation those prices will appreciate in value. By contrast, there might be a Benjamin Graham or a Warren Buffett -- a large investor who buys a substantial part (or all) of a company and fully participates in the running of that business.

The former is only a supplier of financial capital. At the same time, the latter investor is a supplier of both financial and human capital, and for that, he or she should expect to receive a higher return. Either way, though, the story of GEICO suggests that it certainly helps to be lucky!

 Footnotes:

1. Jason Zweig, "Was Benjamin Graham Skillful or Lucky?", Wall Street Journal, December 13, 2012.
2. Benjamin Graham, "The Intelligent Investor," fourth revised edition, Postscript, pg. 289, 1973 (originally published in 1949).   

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