Is superinvestor Warren Buffett badly mismanaging Berkshire Hathaway
Earlier this week, my fellow Fool Rich Smith took a look at a recent study from data specialist SNL Financial and concluded just that. In "Warren Buffett: Great Investor, Lousy Insurance Salesman," Rich quipped that despite GEICO's heavy ad spending, "insurance companies getting significantly less media exposure than what Buffett's paying for are running circles around his cavemen, and stomping his gecko into a puddle of green goo."
Is this assessment on point? Well, let me put it this way: I think it gives us a good opportunity to look at two really important factors regarding Berkshire and GEICO.
Buffett, the (non) insurance salesman
First, Buffett doesn't run GEICO at all. GEICO is run by the sharp insurance executive, and 50-year GEICO veteran, Tony Nicely. And it's not so much that Nicely runs GEICO with input from Buffett -- Nicely runs GEICO, period. And he does so with Buffett's complete trust. Here's what Buffett had to say about Nicely in Berkshire's 2011 letter to shareholders:
GEICO's much-envied record comes from Tony's brilliant execution of a superb and almost impossible-to-replicate business model. During Tony's 18-year tenure as CEO, our market share has grown from 2% to 9.3%. If it had instead remained static -- as it had for more than a decade before he took over -- our premium volume would now be $3.3 billion rather than the $15.4 billion we attained in 2011. The extra value created by Tony and his associates is a major element in Berkshire's excess of intrinsic value over book value.
What may be even more surprising is that for much of the time Berkshire owned GEICO, Buffett didn't even manage the investments for GEICO. That hat was worn by Lou Simpson, who retired from GEICO back in 2010.
But here's the part that Berkshire shareholders -- and potential shareholders -- really need to take away from this: It's not just GEICO that Buffett doesn't manage. It's also BNSF Railway. And NetJets. And General Re. And Dairy Queen, RC Willey, See's Candies, Librizol, Justin Brands, Brooks, Benjamin Moore, The Pampered Chef, MidAmerican Energy, or any of the other companies that Berkshire owns outright. That's just not what Buffett does.
Why is this so important? Because as we ponder the day that Buffett is no longer around -- it will happen, folks; the man is in his 80s -- it's significant that the leadership at Berkshire's many subsidiaries will stay exactly the same. In other words, when Buffett heads to the great stock market in the sky, GEICO, with Tony Nicely at the helm -- as well as the CEOs of Berkshire's many other subsidiaries -- will keep right on geckoing along.
As for that ad spend
GEICO does, in fact, spend far more than its competitors on advertising. GEICO spent darn near $1 billion on advertising in 2011, while the total spent by Travelers
However, investors need to remember that GEICO is "primarily" a direct-response insurance company. That means it gets most of its customers via the phone and Internet -- enticed to call or log on because of ... yeah, you guessed it, advertising.
That's a big difference from its competitors. In its SEC filings, Progressive, for instance, tells us that its personal-lines segment is 57% agency business. Travelers notes that its personal insurance business is done "primarily" through agents. At Allstate
When stacking up the spending that GEICO does versus these other companies, then, it's critical to consider the total costs of acquiring customers. GEICO spends a lot of money on advertising, but, in return, it doesn't have to spend on agents (you didn't think they were free, did you?).
Getting a true apples-to-apples comparison of policy acquisition costs based on company filings is challenging because the companies mix together different business lines, break out numbers in different ways, and, of course, have varying business models. But if we think about company spending on the basis of paying for claims and then "everything else," in 2011 GEICO's "everything else"-to-earned premiums was right around 18%. State Farm, Allstate, and Progressive were all above 20%, some significantly so.
In short, GEICO may spend a heckuva lot more than its competitors on advertising, but its lean, mean direct-focused business model makes it much more profitable than its competition.
So is GEICO smarter than a caveman when it comes to advertising spending? Who cares! What it is, is more profitable than its competitors. And that's what I'm keeping my focus on.
What's Buffett focused on, though? According to Motley Fool banking expert Anand Chokkavelu, it's banks, and if Buffett were a smaller investor, there's one bank in particular that would probably be on his short list to buy. What is this mystery stock? Download a free copy of the special report "The Stocks Only the Smartest Investors Are Buying" to find out.
