Was Ben Graham’s big purchase of GEICO shares actually a value investment? Perhaps it was contrary to what many believe.
“In 1948, we made our GEICO investment and from then on, we seemed to be very brilliant people.” — Benjamin Graham, 1976
Both Benjamin Graham and Warren Buffett can attribute a large part of their success to GEICO. Both Graham and Buffett dived into GEICO shares, making the insurer the biggest holding in their portfolios at various points in their careers, and this risk paid off handsomely.
Graham first became involved with GEICO shares in 1948. Graham initially didn’t want to get involved with the company, he didn’t like insurance businesses because they were difficult to value, however, a significant controlling stakeholder in the form of the Rhea family was looking to offload its stake in GEICO and bankers found their way to the partnership.
As anyone who has researched Graham will know, the godfather of value investing rarely devoted more than 5% of his portfolio to any one position. He liked to own a well-diversified portfolio of cheap stocks, minimizing risk with both the low valuations and diversification.
- Benjamin Graham: Buying Good Stocks At Good Prices
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Nonetheless, this time around Graham decides to break his own investment rules and put 25% of the partnership's investment portfolio into GEICO, acquiring 50% of the company for $712,000. This might look like an uncharacteristic risk, but it's not as old as it first appears. Indeed, Graham reportedly acquired the position at a 10% discount to book value and then became Chairman of the Board to oversee his investment.
Benjamin Graham GEICO shares buy was all about simple value
In an interview with Barron's in February 1985, Walter Schloss, a student of Graham who went on to become an accomplished value investor in his right, described Graham's investment process with GEICO, as he was lucky enough to be in the office on the day the deal was done:
"I was in Graham's office the day he first brought Government Employees Insurance Co., which is GEICO. Warren Buffett owns one-third of the stock today."
"The funny part is that I was in Graham's office when a phone call came from the law, who said, "You brought your 50% of the company" -- and Graham paid something like $750,000 for 50% or something on that order. Anyway, he turned to me and said, "Walter, if this doesn't work out, we can always liquidate it and get our money back." He had no conception of the growth potential of this thing. He was just buying an insurance company cheap.
Q: he was worried about what he could lose?
A: Yes. Graham liked the idea of protection on the downside, and basically, that's what I do. I try not to lose money."
This was nothing more than a cheap stock for Graham, unfortunately, regulators were concerned about the fact an investment fund owned more than 10% of an insurance company. As luck would have it, the SEC bowed to investor demands and allowed Graham-Newman to maintain the ownership has long as the fund's ownership in GEICO was held directly by partners/shareholders. In the summer of 1948, Graham distributed the shares in the over-the-counter market. Over the next ten years, GEICO's business exploded and by 1958 and investment of $1,000 had grown to $47,500. Graham-Newman’s original 1948 investment of $712,000 was worth over $400,000,000 25 years later.
I believe there are several takeaways from this chapter in Benjamin Graham's and Warren Buffett's career. GEICO started off as a value investment, but as the business grew, Graham and Buffett held on and reaped the benefits. It's often said that in investing, your biggest gains come from just one or two ideas and that's certainly the case with GEICO shares.
This is probably the greatest example of how you can profit by letting your winners run, and how you can invest in potential growth stocks with reduced risk. That said, finding investments such as these which can generate such impressive returns is all but impossible, but that's the reason why both Buffett and Graham went all in on GEICO shares.