Value Investing

Warren Buffett On Lou Simpson And His Successful Investing Strategy

One of our favorite investors here at The Acquirer’s Multiple is Lou Simpson. Simpson, the Vice Chairman of GEICO, was mentioned in Buffett’s 1986 Berkshire Hathaway Shareholder Letter in which he said:

“The second stage of the GEICO rocket is fueled by Lou Simpson, Vice Chairman, who has run the company’s investments since late 1979. Indeed, it’s a little embarrassing for me, the fellow responsible for investments at Berkshire, to chronicle Lou’s performance at GEICO. Only my ownership of a controlling block of Berkshire stock makes me secure enough to give you the following figures, comparing the overall return of the equity portfolio at GEICO to that of the Standard & Poor’s 500 (below).

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These are not only terrific figures but, fully as important, they have been achieved in the right way. Lou has consistently invested in undervalued common stocks that, individually, were unlikely to present him with a permanent loss and that, collectively, were close to risk-free.

In sum, GEICO is an exceptional business run by exceptional managers. We are fortunate to be associated with them.”

Warren Buffett On Lou Simpson

(Source: 1986 Berkshire Hathaway Shareholder Letter)

Simpson later outlined the five principles of his successful investing strategy in an interview he did with The Washington Post. Here’s an excerpt from that interview:

Simpson says there is no mystery to his stock market magic. A voracious reader, the 50-year-old vice chairman of Geico searches daily newspapers, magazines, annual reports and newsletters for clues that might spark investment ideas. His four-member investment team uses computer screens to identify stocks that, on the basis of financial data, appear to be bargains.

“Lou has made me a lot of money,” Buffett said. “Under today’s circumstances, he is the best I know. He has done a lot better than I have done in the last few years. He has seen opportunities I have missed. We have $700 million of our own net worth of $2.4 billion invested in Geico’s operations, and I have no say whatsoever in how Lou manages the investments. He sticks to his principles. Most people on Wall Street don’t have principles to begin with. And if they have them, they don’t stick to them.”

According to Simpson, his investment principles are as follows:

1. Think Independently. “We try to be skeptical of conventional wisdom and try to avoid the waves of irrational behavior and emotion that periodically engulf Wall Street. We don’t ignore unpopular companies. On the contrary, such situations often present the greatest opportunities.”

2. Invest in High-Return Businesses Run for the Shareholders. “Over the long run appreciation in share prices is most directly related to the return the company earns on its shareholders’ investment. Cash flow, which is more difficult to manipulate than reported earnings, is a useful additional yardstick. “We ask the following questions in evaluating management: Does management have a substantial stake in the stock of the company? Is management straightforward in dealings with the owners? Is management willing to divest unprofitable operations? Does management use excess cash to repurchase shares? The last may be the most important. Managers who run a profitable business often use excess cash to expand into less profitable endeavors. Repurchase of shares is in many cases a much more advantageous use of surplus resources.”

3. Pay only a reasonable price, even for an excellent business. “We try to be disciplined in the price we pay for ownership even in a demonstrably superior business. Even the world’s greatest business is not a good investment if the price is too high.”

4. Invest for the long-term. “Attempting to guess short-term swings in individual stocks, the stock market or the economy is not likely to produce consistently good results. Short-term developments are too unpredictable.” (Simpson’s one exception to this long-term principle is his occasional purchase of stocks of companies that are targets of publicly announced, friendly takeover bids.)

5. Do not diversify excessively. “An investor is not likely to obtain superior results by buying a broad cross-section of the market. The more diversification, the more performance is likely to be average, at best. We concentrate our holdings in a few companies that meet our investment criteria. Good investment ideas — that is, companies that meet our criteria — are difficult to find. When we think we have found one, we make a large commitment. The five largest holdings at Geico account for more than 50 percent of the stock portfolio.”

Simpson’s antidiversification principle contradicts the advice that financial planners often give to less sophisticated, individual investors. Individuals often are encouraged to diversify their holdings, to minimize the downside risk of any single bad investment.

But Simpson said that for him, one of the keys to successful investing has been to make a relatively small number of investments. He said Buffett illustrates that concept with the notion of a lifetime fare card with only 20 punches, so they must be used wisely.

“One lesson I have learned is to make fewer decisions,” Simpson said. “Sometimes the best thing to do is to do nothing. The hardest thing to do is to sit with cash. It is very boring.”

Simpson said that his biggest mistakes in the stock market have been that he sold stocks too early. His technique of buying bargain stocks apparently leads him to sell stocks after they are discovered by other investors and move up in price. But some of those stocks continued their ascent after he sold.

“We do not have any hard and fast rules on selling,” Simpson said. “We do not sell that well.”

You can read the full interview at The Washington Post here.

Article by Johnny Hopkins, The Acquirer's Multiple