Boring Portfolio

<THE BORING PORTFOLIO>
On GEICO
And Compensation Issues

By Dale Wettlaufer (TMF Ralegh)

ALEXANDRIA, VA (June 16, 1999) -- Constantly monitoring electronic communications across the globe, the Boring Intelligence Agency picked up on one of this month's most useful posts regarding Berkshire Hathaway (NYSE: BRK.A). Actually, this comes from a member, Texirish, of a group of shareholders I hang out with. Texirish mentions the recent Best's Review edition that contained the lengthy article on Berkshire. He says there was a great article from John Nauss of CPCU (Chartered Property & Casualty Underwriter) in the hard copy edition of the June issue that didn't make it onto the Web page.

Texirish's summary follows:

"In his letter, Nauss referred to a BestWeek article of March 22, 1999 concerning lessons that Buffett's letters to shareholders provide on the business of insurance. He commented on the plans and goals for Geico, and factors that will affect Geico's goal of growing from a 3.5% market share in auto insurance to a 10% share.

"He asks: What is it about Geico that makes it plausible that they will achieve this goal? He then goes on to discuss the "focused" bonus compensation plan for all employees that Buffett put into place when he acquired Geico. Features are:

  1. It is tailored to the economics of the specific operating businesses.
  2. It is simple in character, so that the degree to which goals were being achieved could be easily measured.
  3. It is directly related to the daily activities of plan participants.

"Under this plan, bonuses paid to Geico employees increased from 16.9% of compensation in 1996 to 26.9% in 1997 and 32.3% in 1998. So, the operational goals Buffett targeted -- increased market share and continued underwriting profitability -- benefited Geico employees at the same time they benefited BRK shareholders. He also pointed out that the bonuses were not capped as many companies tend to do. Buffett feels that he's more likely to get exceptional operating performance from Geico if his employees are paid exceptionally when they produce that performance. Nauss comments that he believes that a great deal of the "high energy selling" at Geico results from this incentive plan.

"He then points out that a similar compensation plan has been implemented at General Re, and wonders if it will have the same effect. Nauss concludes with the [following] quotation:

"Yes, Buffett has a great financial mind that can comprehend the ins and outs of insurance financial transactions. But, his greatest contribution may well prove to be his insight into human character and the secret behind motivating high performance from his employees.

"Clearly Buffett's skills as an exceptional business manager do not receive equal attention with his skills as an investor. And yet, as was pointed out at the last annual meeting, it is the skills that Berkshire brings to managing businesses that adds real value to private businesses purchased at a "fair" price.

"Warren and Charlie commented that they simply get out of the way and let their managers focus on running their businesses without interference or concern about other factors. But they do more. They create, perhaps, the best operating environment for businesses that exist anywhere. This environment includes wise evaluations without extensive meetings and documents ("we know the business") as well as capital access, focused compensation, and freedom to do one's best. These deserve greater attention from the business community.

"Tex"

There's not really much I want to add here. The reason why the Berkshire position dominates the Boring Portfolio is exactly due to what Texirish is talking about. When I mention Warren Buffett to someone that doesn't know him, I describe him as a businessman or CEO, not as an investor. After all, a good CEO and chairman should be, by definition, a good investor, and a good investor should have some of the same skills as a good CEO. But when you think of Berkshire these days, start out with the idea that it's one of the world's highest-capacity property & casualty underwriters. Then take into account this member of the insurance industry saying "this guy knows how to motivate and retain great people."

When I think of the younger executives down the line that are soaking in this management style and the overall way of doing things at the company, the certainty of my estimation of the value of this company is strengthened. This straightforward way of providing exceptional rewards for people who perform exceptionally is differentiating strength at Berkshire and is another reason why I believe the Boring Portfolio will outperform the market during a lengthy downturn.

That is, by the way, one of the goals of this portfolio. If you can decline less than the overall market during downturns, you will compound off a higher base on the way back. And hopefully we will have the liquidity to take advantage of very good values when they come along. This isn't to say that I'm timing the market whatsoever. This is just to say that I demand a lot of value for each dollar I shell out. Part of that is because I could be wrong. Part of it is that I see that being the way to outperform over the long run.

Totally Different Issues to Follow

By the way, speaking of Buffett, I'll repeat once again that this is not the portfolio where I do things that I think Warren Buffett would do. It's the portfolio where I do things that are the result of my particular, idiosyncratic experiences in life. That is, I bring insight to areas where Warren Buffett might not and he, of course, brings insight to a heck of a lot of things where I would be clueless. So he lives his life and sets an example by sticking to his areas of competence. The key takeaway there is that he sticks to HIS areas of expertise.

Buffett also was able to mold his view of the world in ways that made sense to him but didn't match in every aspect the ways the two people whom he admired most, his Dad and Ben Graham, went about things. If there is any inconsistency between the way I do things and the way Warren Buffett does things, that's 100% acknowledged by me. I admire Buffett most of any teacher of business I've ever had besides my father, but there's just no way I'm going to satisfy people that hold me up against Buffett and say "you're not doing it according to Buffett's teachings."

There's no way I'm going to keep from deviating, perhaps in major areas, from Warren Buffett. I won't apologize for it, but I will try my best to explain it on the Boring Portfolio message board. The message I would have for people who follow the Boring Port is that you have to have a good grounding in fundamentals and it's great to have giants influence your thinking, but in the end you must do your own thinking and take advantage of your own insights that shake out of your own life. I think if you tune into the Bore Port as a hitchhiker's guide to divining the way of Warren Buffett, you will be disappointed, especially if you're a person that notices inconsistencies.

The Bore port is neither Rule Breaker, nor Rule Maker, nor "deep value," nor any other classification. I will at times make high-risk investments with the chance of losing a significant percentage of capital. If that's the case, I'll be thinking in terms of a multiple outcome analysis rather than fixating on a single assumed outcome. When I say I think Net.B@nk is worth anywhere from $22 15/16 to $53 13/16, I really can't do much better than that. The market doesn't force you to do any better than that, either. Intellectually, that doesn't deviate in the least from what Ben Graham has to say about valuing a business. There's value in making that call. Does it reflect my uncertainty? Yes. Does a lower price compensate for some degree of uncertainty as to the future of the business? In my mind, yes. I really don't think that's the way Warren Buffett approaches investments. That's just where I deviate some from what Buffett thinks about things.

There are particular elements of the banking industry that I feel pretty certain about. And there are particular elements of Net.B@nk's business that I have identified as its value drivers in my recent articles on the company. Most "value investors" will probably be appalled that I'm looking at a branchless "Internet bank" trading at a giant multiple to earnings. All I'll say on that is that I'm pretty clear as to how I'm looking at the investment proposition and the operational aspects of the company that will decide its value over the long run. If it makes sense to me based on my peculiar background of knowledge and I believe I am getting the value necessary to meet my long-term return on investment goals, then it will have met my tests. How it meets others' tests and whether it's a Rule Breaker, Rule Maker, or a traditional "value stock" cannot be the final arbiter in my decision making process.

I'm open to questions, comments, and reasonable flames on the Boring Portfolio board.

Congratulations to the Sabres on game 4. Outstanding. Good luck in Dallas tomorrow!

Call Your Boss a Fool.

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06/16/99 Close
Stock Change   Bid
APCC  +  1/2   19.56
BRKb  +10      2325.00
CSL   +  1/16  48.06
GTW   +1 3/8   65.44

                  Day     Month   Year  History
        BORING   +0.71%   1.21%   5.79%  42.05%
        S&P:     +2.25%   2.20%   8.56% 121.39%
        NASDAQ:  +4.27%   1.91%  14.83% 141.88%

    Rec'd   #  Security     In At       Now    Change
  8/13/96  200 Carlisle C    26.32     48.06    82.57%
  4/20/99  460 American P    14.48     19.56    35.13%
 12/31/98   12 Berkshire   2276.17   2325.00     2.15%
   2/9/99  100 Gateway 20    72.38     65.44    -9.59%


    Rec'd   #  Security     In At     Value    Change
  8/13/96  200 Carlisle C  5264.99   9612.50  $4347.51
  4/20/99  460 American P  6659.25   8998.75  $2339.50
 12/31/98   12 Berkshire  27314.00  27900.00   $586.00
   2/9/99  100 Gateway 20  7237.50   6543.75  -$693.75


                             CASH  $17972.40
                            TOTAL  $71027.40

</THE BORING PORTFOLIO>