Warren Buffett has a business that has made him billions throughout the years, but the surprising secret to its success is simple.
The storied history
Buffett's history with Geico dates to when he was a student under his mentor Ben Graham. When he was just 20 years old in 1950, he learned Graham was the chairman of Government Employees Insurance Co., or Geico as we like to call it.
Shortly thereafter, Buffett decided to make a visit to the Geico headquarters on a Saturday afternoon. He happened to meet Lorimer Davidson, or "Davy," who proceeded to spend the next four hours telling him about not only Geico the company, but also about the insurance business in general.
When you consider Buffett has used insurance to propel Berkshire Hathaway into unimaginable success, it's no wonder he called that Saturday his "lucky moment."
And while he first began investing in Geico shortly thereafter, the biggest moves came after he built the Berkshire Hathaway empire we know it as today.
Through Berkshire Hathaway, Buffett began to aggressively acquire Geico as its stock price plummeted nearly 95% in the 1970s, after Davy -- who became CEO seven years after Buffett met him -- retired and troubles assailed it. As a result of his willingness to hold on to the company, the ownership of roughly one-third of Geico that cost $46 million would ultimately translate to a 50% stake. And Buffett bought the remaining half of Geico in 1995 for $2.3 billion.
A little back-of-the-envelope math reveals the original $46 million investment therefore represented a return of 5,000% over 20 years.
And considering Geico brought in $1.1 billion of underwriting profit just last year, it should come as no surprise that Buffett once said that "when I count my blessings, I count Geico twice."
The gift that gives and gives
In the less than 20 years Berkshire Hathaway has controlled Geico, the popular insurer has seen incredible growth. When it was first acquired, it controlled just 2.5% of the market and had $2.6 billion in of policies. At last count, its market share now stands at 10.2% and its premiums have risen to a staggering $18.6 billion.
So how has Geico managed to have such remarkable success? Let's re-examine Buffett's quote from his most recent letter to Berkshire Hathaway shareholders:
No one likes to buy auto insurance. But almost everyone likes to drive. The insurance needed is a major expenditure for most families. Savings matter to them -- and only a low-cost operation can deliver these.
The first thing we can see is that Geico offers a product to its customers that isn't simply something they want, but instead it's something they need. Unlike companies in areas like the clothing industry, it doesn't have to concern itself with worries about not keeping up with the latest market trends or falling victim to the mysterious and often fickle tastes of consumers. Instead, it provides a product that its customers, by law, must have.
Buffett also understands people will always seek the lowest prices. Or as the woman who founded Nebraska Furniture Mart taught him, "[I]f you have the lowest price, customers will find you at the bottom of a river."
But good investments aren't just made by finding businesses that meet those two qualities. The true key to success at Geico is the ability of its management -- including often-praised CEO Tony Nicely -- to ensure that it operates efficiently and in a cost-effective way.
Consider Buffett's quote from nearly 30 years ago in 1986:
The difference between Geico's costs and those of its competitors is a kind of moat that protects a valuable and much-sought-after business castle.
In 1995, after it had been purchased entirely, Buffett added:
But the ultimate key to [Geico's] success is its rock-bottom operating costs, which virtually no competitor can match.
In addition, after Geico significantly lowered its costs while boosting its productivity in 2005, Buffett said:
When we drive unit costs down in such a dramatic manner, we can offer ever-greater value to our customers. The payoff: Last year, Geico gained market share, earned commendable profits, and strengthened its brand.
Low costs don't just characterize the policies Geico offers to its customers, they extend to its corporate operations as well. Geico's ability to effectively manage its own costs and in turn deliver those savings to its customers has allowed it to have such astounding success.
When looking for stocks to buy, we can't just look at the external things a company offers to its customers, but we, too, must consider the ability of its management to ensure it's run in a way that is efficient and in turn delivers results to its shareholders as well.
And when we find companies that deliver on all of these fronts -- providing customers essential products at low costs while being run by remarkable management in an efficient way -- we, too, will find investments that end up being, as Buffett once described Geico, "the gift that keeps on giving."
Patrick Morris owns shares of Berkshire Hathaway. The Motley Fool recommends and owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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