Some of you may know the story of GEICO. It was started in 1936 by the Goodwin family. They put up 25% of the initial capital, with the other 75% coming from a single outside source.
Ben Graham entered the picture in 1948. He was offered a deal to buy 50% of the company. He wasn’t the first or even the second person offered the deal, but he was the first to not turn it down. And he broke all of his own rules by accepting.
GEICO was nothing like the deep value cigar butt that usually caught Graham’s eye. It was a growing insurance company and, as Graham relayed in a postscript to The Intelligent Investor, “the price was moderate in relation to current earnings and asset value.”
It was overpriced not long after the deal, but Graham, a bit out of the ordinary, held on.
I can’t say the same for everyone else. Which is where things get interesting. I’ll let Walter Schloss pick up the story from here:
You know the Government Employees Insurance story, that they never should have bought it at all because it was illegal?
It’s still true today — an investment company can’t buy more than 10% of an insurance company without the approval of the SEC. They’d paid $750,000 for half the company. Fred Greenman, who was Graham’s attorney and an old friend, had brought the GEICO deal to them.
When Graham bought the stock, the SEC said, “You can’t buy more than 10%. You violated the SEC laws, even if it was inadvertent.”
Manny Cohen, a tough administrator at the SEC, said, “You’ve got to get rid of it. Go back to the people who sold it to you and see if they’ll take it back.”
So they went back to the family from whom they’d purchased the interest and tried to sell it back. But they said, “No. We don’t want it. We sold it. Forget it.”
Next, the SEC looked at the profit-sharing arrangement and asked themselves how they could make sure that Graham-Newman wouldn’t get any profits out of it.
The answer that they came up with was to require Graham-Newman to distribute the GEICO shares to its shareholders at cost. So that’s how Graham-Newman stockholders go their GEICO stock and became millionaires.
Even more ironic, the 25% of GEICO stock that was not owned by Graham-Newman and other outsiders was retained by the founders’ family – when Leo Goodwin died, he left the stock to his son.
His son went into other ventures. But instead of selling his stock to finance them, he borrowed against his GEICO stock. When it collapsed in 1976, he was wiped out. The bank sold him out and he committed suicide.
Warren bought most of that stock when it went way down. And that’s how Warren got the GEICO stock that Goodwin had owned.
So that’s the short history of GEICO. The whole thing was pathetic in a way — some people became millionaires, some didn’t benefit at all and others went broke.
And David Dodd, the late co-author of Security Analysis, said to me when the stock was way down, “I’ve always lectured at my course at Columbia, ‘Don’t let paying taxes affect your judgment of when to sell.’ And I didn’t follow my own advice.”
He had 125,000 shares of GEICO. And when it went up, he didn’t sell it because he didn’t want to pay taxes.
When I first went to work for Graham-Newman, they were offering Graham-Newman stock to their stockholders at net asset value or a slight premium. At the time, I took all the money I had, which was about $3,000, and put it into Graham-Newman stock.
When Graham-Newman was forced to distribute it, I received GEICO stock. Subsequently, GEICO spun off Government Employees Life Insurance.
When Edwin was born, I sold my GEICO stock to pay for his birth. Then, when my daughter was born, I sold my Government Employees Life Insurance stock to pay for hers.
But you never know how things are going to turn out. It could have gone the other way. It’s funny also that I would have been better off to sell my Graham-Newman stock and keep my GEICO stock. But because I was working at Graham-Newman, I didn’t want them to think I was being disloyal.
By the time 1948 ended, Graham-Newman held no GEICO shares. All the shares were distributed to Graham-Newman shareholders in July 1948.
A few years later (1951), Buffett would buy shares of GEICO after graduating from Columbia. Graham was on the board, which got Buffett looking into the company.
It makes me wonder how many of those original shareholders actually held on for the long run? How many gave up too early? How many gave up too late?
Obviously, Schloss didn’t. Buffett didn’t either. He sold his shares in 1952 for a tidy profit, of course.
Both of them would miss out on a huge growth spurt that would make a $27 share bought in 1948 be worth $16,349 in 1972.
But then again, 1972 was when things got rough.
Buffett wouldn’t buy it again until 1976. In that four-year time span, GEICO’s shares fell over 95% from its ’72 highs.
GEICO, eventually, recovered and then some. Berkshire would buy it outright in 1995 (Buffett relayed his side of the GEICO story in his 1995 letter).
It’s a wild story with several great lessons. However, it’s not entirely unique. Similar investor stories play out multiple times over through the ups and downs of every company.
OID interview with Walter and Edwin Schloss
1995 Berkshire Letter
- The Psychology of Money – M. Housel
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- How Beauty Companies Price Lipstick – Racked
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- When It Comes to Self-Driving Cars, There’s Waymo and Then There’s Everyone Else – Ars Technica