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Lou Simpson WSJ Interview

lou%20simpson.jpgLou Simpson, has long managed the investment $4 billion portfolio of GEICO, the insurance company Berkshire Hathaway owns. He is also the only man other than Warren Buffett who has managed stock investments in Berkshire’s portfolio.  Like Warren Buffett, he has a general distaste for technology stocks. He favors intensive research to find attractive companies to invest in and a willingness to bet on just a handful of stocks.  In 2004, the only time that Berkshire ever stated Geico’s performance separately, Mr. Simpson over 24 years had posted a 20 percent average annual gain, surpassing the Standard & Poor’s 500-stock index by 6.8 percentage points.  Mr. Simpson is known for eschewing publicity so it is a unique opportunity to learn more about him.   

On many occasions when the media announces that Berkshire Hathaway has taken a sizable stake in a publicly-traded business, it is actually a position initiated by Mr. Simpson for the GEICO portfolio.  You can learn a lot by reading about one of his rare interviews, given in 1987 with the Washington Post.  Lou Simpson said:

Think independently - We try to be skeptical of conventional wisdom, he says, and try to avoid the waves of irrational behavior and emotion that periodically engulf Wall Street. We don’t ignore unpopular companies. On the contrary, such situations often present the greatest opportunities.

Invest in high-return businesses that are run for the shareholders - Over the long run, he explains, appreciation in share prices is most directly related to the return the company earns on its shareholders’ investment. Cash Flow, which is more difficult to manipulate than reported earnings, is a useful additional yardstick. We ask the following questions in evaluating management: Does management have a substantial stake in the stock of the company? Is management straightforward in dealings with the owners? Is management willing to divest unprofitable operations? Does management use excess cash to repurchase shares? The last may be the most important. Managers who run a profitable business often use excess cash to expand into less profitable endeavors. Repurchase of shares is in many cases a much more advantageous use of surplus resources.

Pay only a reasonable price, even for an excellent business - We try to be disciplined in the price we pay for ownership even in a demonstrably superior business. Even the world’s greatest business is not a good investment, he concludes, if the price is too high. The ratio of price to earnings and its inverse, the earnings yield, are useful gauges in valuing a company, as is the ratio of price to free cash flow. A helpful comparison is the earnings yield of a company versus the return on a risk-free long-term United States Government obligation.

Invest for the long term - Attempting to guess short-term swings in individual stocks, the stock market, or the economy, he argues, is not likely to produce consistently good results. Short-term developments are too unpredictable. On the other hand, shares of quality companies run for the shareholders stand an excellent chance of providing above-average returns to investors over the long term. Furthermore, moving in and out of stocks frequently has two major disadvantages that will substantially diminish results: transaction costs and taxes. Capital will grow more rapidly if earnings compound with as few interruptions for commissions and tax bites as possible.

Do not diversify excessively - An investor is not likely to obtain superior results by buying a broad cross-section of the market, he believes. The more diversification, the more performance is likely to be average, at best. We concentrate our holdings in a few companies that meet our investment criteria. Good investment ideas--that is, companies that meet our criteria--are difficult to find. When we think we have found one, we make a large commitment. The five largest holdings at GEICO account for more than 50 percent of the stock portfolio.

Posted on Saturday, April 29, 2006 at 12:04AM by Registered CommenterRafael Velez in | Comments Off

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