Berkshire Hathaway's (BRK.A -0.76%) (BRK.B -0.69%) legendary performance is undeniable. Since CEO Warren Buffett took over the failing textile business in 1965, the stock has returned investors 20% compounded annually -- doubling the S&P 500's average annual return in the same period.
This track record of success is why investors eagerly await Berkshire Hathaway's quarterly form 13-F, a required filing by the Securities and Exchange Commission (SEC) that discloses institutional investors' investing activity during the period. In the third quarter, Berkshire Hathaway purchased $1.7 billion in stock. However, a sizeable chunk of that amount is in a mystery stock on which Berkshire has requested confidential treatment.
Image source: The Motley Fool.
Buffett and his team at Berkshire occasionally request confidentiality when they accumulate a stock position and don't want to tip off the markets until they finish buying. The company last requested confidentiality when building stakes in Chevron and Verizon Communications in 2020.
The move has investors speculating over what could be the next big position for Berkshire Hathaway. One company that could be on the short list has previously earned high praise from Buffett and Berkshire Hathaway Vice Chairman Charlie Munger. Here's what that stock is and why it could be the next stock in Berkshire's $354 billion portfolio.
Is this the mystery stock that Berkshire Hathaway bought in the third quarter?
In the third quarter, Berkshire Hathaway sold off part of its holdings in Globe Life, Markel, and Aon, all insurance companies within the financial sector. However, in its third-quarter earnings report, the conglomerate reported that its cost basis for investments in banks, insurance, and finance stocks increased by about $1.2 billion.
There are numerous potential investments that Buffett and his team could've bought. One intriguing stock that the conglomerate could have added during the period is Progressive (PGR -0.97%). Progressive is the second-largest auto insurance company in the U.S., trailing only State Farm. The third-largest auto insurance company is Berkshire Hathaway's own GEICO, which it acquired in 1996.
When it comes to future leaders in the industry, Buffett sees it as a two-horse race between Progressive and GEICO. During Berkshire’s 2019 annual shareholder meeting, Buffett said
I have always thought for a very long time [that] Progressive has been very well run. They have an appetite for growth. Sometimes they copy us. Sometimes we copy them. And I think that will be true five years from now, ten years from now.
Even Munger sang Progressive's praises, saying, "In the nature of things, every once in a while, somebody is a little better at something than we are."
Progressive's underwriting discipline makes it a top dog in a highly competitive industry
To understand Progressive's stellar performance, you have to go back to 1965, when Peter B. Lewis, son of one of the co-founders, Joseph Lewis, took over the company. At the time, insurers commonly accepted that they would break even on their policies, and the actual returns would come from their investment portfolios. Lewis rejected this notion and instead set a goal that Progressive would earn an underwriting profit on its policies, even if it meant forgoing drivers who wanted lower-cost policies.
When it went public in 1971, the company prioritized achieving a combined ratio of 96, meaning it would earn $0.04 of profit for every dollar of premium earned. This philosophy has been core to Progressive's disciplined underwriting and is a big reason for the insurer's massive success.
You can analyze Progressive's disciplined underwriting by looking at its loss ratio. This ratio is one component of the combined ratio (the expense ratio being the other) and calculates the percentage of losses to premiums earned. Good companies can control losses and keep loss ratios in check, which Progressive has done exceptionally well. Over the last eight years, Progressive's loss ratio has averaged 72%, an excellent number in the highly competitive auto insurance industry. GEICO, also a solid underwriter, averaged 83% over that period.
Chart by author.
Berkshire Hathaway's head of insurance had this to say about Progressive's outperformance
Ajit Jain is Berkshire Hathaway's Vice Chair of Insurance Operations and is also on the board of directors. Jain has worked for Berkshire since 1986 and has extensive knowledge about its insurance operations. Buffett has showered Jain with praise, mentioning in his 2012 annual letter to shareholders: "Ajit insures risks that no one else has the desire or the capital to take on. His operation combines capacity, speed, decisiveness and, most important, brains in a manner unique in the business."
Jain appreciates Progressive's underwriting performance and has credited its outperformance to several factors, including its use of telematics. Telematics uses driver data like mileage driven, speed, and braking time and personalizes rates for drivers based on this information.
When it comes to pricing models, more data helps Progressive make more informed decisions, manage its risk well, and keep loss ratios low. In 2019, Jain said that GEICO is working on its telematics program and hoped to catch up to Progressive over time. However, as you can see above, Progressive continues to outperform on the important loss ratio metric.
A stellar stock to own, regardless of whether Berkshire is buying it
It's possible that Berkshire Hathaway sees Progressive's ongoing outperformance and decided to add shares to its $354 billion portfolio. Progressive's long history of collecting driver data is one part of its stellar underwriting performance, and maybe Buffett and his team caved and wanted a piece of the action.
However, investors can't know for sure if Berkshire is buying Progressive until the company posts its fourth-quarter filing (assuming the purchase is not still marked as confidential), which won't come out until mid-February. Regardless, Progressive has been an excellent long-term performer for investors, and even if Berkshire isn't buying it, it can make an excellent addition to your portfolio today.
