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The Washington Post: Geico's Top Market Strategist Churning Out Profits; Lou
Simpson's Stock Rises on His Successful Ideas

By David A. Vise, 11 May 1987. The Washington Post

It was Good Friday, the stock market was closed, and the man who manages a $2 billion portfolio of securities
from his Chevy Chase office was happy. Free from phone calls and other interruptions related to the financial
markets, Louis A. Simpson sat in his Geico Corp. office and read 15 annual reports.
"That to me is a good day," Simpson said. "I found it to be enjoyable and productive."
Simpson's good days have turned into good years since he joined Geico as the insurance company's chief
stock market strategist in 1979. For the past seven years, Simpson's ability to pick stocks for Geico has placed
him in the top tier of money managers nationwide.
Simpson says there is no mystery to his stock market magic. A voracious reader, the 50-year-old vice
chairman of Geico searches daily newspapers, magazines, annual reports and newsletters for clues that might
spark investment ideas. His four-member investment team uses computer screens to identify stocks that, on
the basis of financial data, appear to be bargains.
But there is more to Simpson's research than crunching, or analyzing, numbers and combing periodicals. After
identifying a stock for a possible purchase, Simpson or a member of his staff will attempt to arrange a meeting
with that company's senior management. Because of the large blocks of stock that Simpson can buy for Geico,
management often complies with such requests.
Simpson's reputation as a long-term investor, rather than a short-term trader, also helps him gain access to
management. If management refuses to meet, Simpson typically will not buy the stock. Once he makes a
commitment, Simpson expects meetings with the company's management to continue as long as Geico owns
its stake.
"One of the things I have learned over the years is how important management is in building or subtracting
from value," Simpson said. "We will try to see a senior person and prefer to visit a company at their office,
almost like kicking the tires. You can have all the written information in the world, but I think it is important
to figure out how senior people in a company think."
Simpson also gets investment ideas by talking with other high-powered stock pickers. He has a close
relationship with Omaha investor Warren Buffett, Geico's biggest stockholder, who controls almost 41 percent
of the company's shares through Berkshire Hathaway Inc. (Berkshire also is a major stockholder in The
Washington Post Co.)
Like Simpson, Buffett spends his days, and sometimes his nights, trying to profitably invest insurance
company funds in the stock and bond markets. Besides making money on the insurance policies they write,
Geico, Berkshire Hathaway and some other leading insurers have increased their returns through stock market
investments.
But even Buffett, long regarded as one of the market's premier long-term investors, says he takes a back seat
to Simpson. In the 1986 Berkshire Hathaway annual report, Buffett explained this predicament to
shareholders. The report included a chart comparing Simpson's results with the performance of the Standard
& Poor's 500 stock market average. In 1986, Simpson's stocks had an overall return of 38.7 percent, more than
double the S&P 500's 18.6 percent return.
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"Indeed, it's a little embarrassing for me, the fellow responsible for investments at Berkshire, to chronicle
Lou's performance at Geico," Buffett wrote. "Only my ownership of a controlling block of Berkshire stock
makes me secure enough to give you the following figures. These are not only terrific figures, but, fully as
important, they have been achieved in the right way. Lou has consistently invested in undervalued common
stocks that, individually, were unlikely to present him with a permanent loss and that, collectively, were close
to risk-free."
Buffett said he talks to Simpson about once a week.
"Lou has made me a lot of money," Buffett said. "Under today's circumstances, he is the best I know. He has
done a lot better than I have done in the last few years. He has seen opportunities I have missed. We have
$700 million of our own net worth of $2.4 billion invested in Geico's operations, and I have no say
whatsoever in how Lou manages the investments. He sticks to his principles. Most people on Wall Street don't
have principles to begin with. And if they have them, they don't stick to them."
According to Simpson, his investment principles are as follows:
(a) Think Independently. "We try to be skeptical of conventional wisdom and try to avoid the waves of
irrational behaviour and emotion that periodically engulf Wall Street. We don't ignore unpopular
companies. On the contrary, such situations often present the greatest opportunities."
(b) Invest in High-Return Businesses Run for the Shareholders. "Over the long run 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 if the price is too high." Invest for the long-term. "Attempting to guess short-term swings in
individual stocks, the stock market or the economy is not likely to produce consistently good results. Short-
term developments are too unpredictable." (Simpson's one exception to this long-term principle is his
occasional purchase of stocks of companies that are targets of publicly announced, friendly takeover bids.) Do
not diversify excessively. "An investor is not likely to obtain superior results by buying a broad cross-section
of the market. 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."
Simpson's anti-diversification principle contradicts the advice that financial planners often give to less
sophisticated, individual investors. Individuals often are encouraged to diversify their holdings, to minimize
the downside risk of any single bad investment.
But Simpson said that for him, one of the keys to successful investing has been to make a relatively small
number of investments. He said Buffett illustrates that concept with the notion of a lifetime fare card with
only 20 punches, so they must be used wisely.
"One lesson I have learned is to make fewer decisions," Simpson said. "Sometimes the best thing to do is to
do nothing. The hardest thing to do is to sit with cash. It is very boring."
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Simpson did not always know he would end up picking stocks for a living. After graduating in 1954 from a
North Shore Chicago high school, he enrolled at Northwestern University to study engineering. "I am a
mechanical misfit. I was a misfit in engineering," Simpson said. He transferred after one year to Ohio
Wesleyan University, where he pursued a double major in accounting and economics.
In 1960, he completed a master's degree in economics at Princeton University. Simpson considered a career
teaching economics, but soon abandoned that in favour of a job with a Chicago investment firm. The deciding
factor, he said, was that the Chicago job offered greater financial rewards. Before Buffett and former Geico
chairman Jack Byrne persuaded him to join Geico in 1979, Simpson worked about 10 years as a money
manager and in other capacities for Western Asset Management Inc. in California.
If Simpson were working on Wall Street for an investment firm, his annual salary would be higher than the
$700,720 he was paid last year, Byrne said. However, as compensation for meeting certain performance goals
and as increased incentive to stay with the company, Simpson received $395,400 in bonuses in 1986 and
1,800 shares of Geico stock worth more than $200,000.
Through stock options and other special stock programs, Simpson owns 54,423 Geico shares, worth about
$6.4 million, according to the company's proxy statement. He also has been granted options to buy another
100,000 Geico shares during the next five years at $98.75 a share. Those options are worth about $2 million at
current market prices. During the next three years, Simpson is scheduled to receive another 8,750 Geico
shares if performance objectives are met. Those shares are worth about $1 million at current market prices.
Simpson said his incentive compensation is based on an evaluation of performance over three-year periods,
giving him time to make long-term investments.
"Lou is a quiet guy who would like to do his job quietly and not get mixed up in a lot of the things that go on,"
said one former Geico director. "He was trained as an economist and so dealing with numbers is an easy thing
for him. The most important attribute in that job once you have the basic training is to read, and keep reading
and reading until you come up with ideas. In this modern world, everybody would rather talk on the phone
than do the basic work. Lou does the basic work. He doesn't talk to that many people."
The former director said one reason Simpson has excelled is that Geico Chairman William B. Snyder and
former chairman Byrne have allowed him to make long-term investments, rather than worrying about next
quarter's stock market results. Simpson also has been permitted to make big bets on a small number of stocks.
While Geico has profited through Simpson's bets, money managers at many other companies have been
forced to diversify their holdings, leading to results that tend to be closer to market averages.
"I taught him everything he knows," cracked Byrne, who now heads Fireman's Fund Insurance Co. Byrne said
Geico would be a strong insurance company even with mediocre investment results. However, "Simpson
pounded out huge returns for us year after year." Byrne said Simpson's success has helped boost the price of
Geico stock from $2 a share in 1975 to about $120 a share today.
"I pondered for eight years what makes Lou knock the cover off the ball," Byrne said. "Lou is very bright,
with an economics background from Princeton. But the woods are filled with bright guys. It has more to do
with his personality. He is very, very sure of his own judgments. He ignores everybody else.
"He gets one or two really strong ideas a year and then likes to swing very hard," Byrne said. One of his best
hits was in Potomac Electric at $17 a share, where he got 10 to 12 percent annual dividend and the stock is
now worth $45 to $50 a share, he said.
If Simpson's trading has so dramatically increased Geico's profitability, then why doesn't the company return
some of those profits to its automobile policyholders in the form of lower insurance rates? Simpson said the
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reason is that the company has a number of "constituencies" to consider, including policyholders, employes,
regulators and, of course, stockholders.
Simpson said his $2 billion Geico portfolio is about two-thirds invested in bonds and one-third invested in
stocks. His three biggest stock holdings on Dec. 31, 1986, were Ashland Oil Inc. (purchased for about $57 a
share, closed Friday at almost $62); MAPCO Inc. (purchased for about $39 a share, closed Friday at $61.25)
and American General Corp. (purchased for about $33.50 a share, closed Friday at $37.50). These accounted
for more than one-third of the $604 million market value of Simpson's Dec. 31 stock holdings. The portfolio
also included three of the regional Bell companies, Bell Atlantic, Bell South Corp. and U.S. West Inc., and
several electric utility companies, including Potomac Electric Power Co.
Simpson said that his biggest mistakes in the stock market have been that he sold stocks too early. His
technique of buying bargain stocks apparently leads him to sell stocks after they are discovered by other
investors and move up in price. But some of those stocks continued their ascent after he sold.
"We do not have any hard and fast rules on selling," Simpson said. "We do not sell that well."
In several of the recent Geico annual reports, Simpson predicted, inaccurately, that his hot streak was over.
The 1986 annual report is no exception. "With the market near all-time highs," he wrote, "our past
performance will be virtually impossible to replicate."
"I have a high level of confidence that prophecy will be fulfilled this year," Simpson said. "The performance
of Geico equities {stocks} has been better than I expected for a longer period of time than I expected. It can't
continue. The market just won't allow it."
But Simpson has been wrong about this before