Tag Archives: GEICO

Don’t Spare the Rod: Critique of Investment Research Reports

Time WarnerA beginning analyst sent me a research report to discuss: Ensco PLC Write-Up

Now before I start, realize that when I was beginning, my idea of a research report was to mimic Cramer.  Buy because the “chart” looks good and I gotta feelin’.  One time my hedge fund boss said his time was worth $1,000 an hour so the six minutes he took to read my incoherent report meant that I OWED HIM, $100.  Well, we all have to start somewhere.  The point of this exercise is to learn.

Buffett’s punch   idea may apply. If you only had twenty investment ideas over a lifetime–one every two to three years–would this be it? Would you put all of your money and family’s money into the idea and why?

Or, you pretend that you have a 45-second ride in the elevator to the top of the Time Warner building with Carl Icahn while selling your idea.

Bill Miller once said that money managers had the attention span of knats. You had to summarize your thesis and then give three or four supporting reasons within thirty seconds.

My critique of Ensco PLC

Instead of four paragraphs to tell me what Ensco does, perhaps you can be more succinct while putting forth what is compelling about your investment thesis.

ESV (Ensco, PLC) is an owner/operator of offshore contract drilling rigs/services that is trading at X% under tangible book value.  This is a cyclical, asset-intensive business subject to swings in natural gas and oil prices. Over a fully cycle, the company earns normal returns on capital of XX?

The price: Enterprise Value

Returns: over several prior cycles?

Capital structure and terms of debt?

Bottom line: this is a non-franchise or asset-based investment that is currently and cyclically out of favor.  OK.   But if this is an asset based business what are the assets worth?  You would need to dig into tangible book–what is there?   What is the current and expected replacement value of their assets? Liquidation value?  Is their fleet of rigs unique? Who are their competitors?  Any hidden assets or potential assets like, say, NOLs or assets outside their core business for example?

What is their cash flow and owner earnings?   I would like to see enterprise value over EBITDA-MCX over the past decade to get an idea of how the market priced ESV over a cycle.

Who is management? What skin do they have in the game? Are they good operators and capital allocators? Insider buying?  Who owns this company?  I don’t have much to go on in the above report so I jump to my handy VL: ESV_VL.  Whoa!  I see debt has jumped about 35% from 2013. How does their capital structure compare to competitors?   It seems like there isn’t much free cash flow. Capex eats up most of the company’s cash flow.

Where is the margin of safety? Book value has been growing but during an up-cycle in drilling. What happens in a prolonged down-cycle?  What are the risks?   You mention a DCF? Where did that come from? Your assumptions?

I will let others in the Deep-Value group chime in, but for a first-ever research report I give a D- which isn’t bad. At least the writer has good instincts to look at an out-of-favor company, but the core analysis of the assets needs to be provided. Also the competitive landscape.  Obviously, it is a business without a competitive advantage due to the low and cyclical nature of the returns, so how does this business compare operationally, financially and value-wise to their main competitors? Who are their customers and how are they faring?

The only way to improve is to write, practice and look at other reports. Go to www.valueinvestorsclub.com and sign up. Then look at the highest rated ideas and study those along side the 10-K of the company mentioned.

Study Other Examples of Research

Or The_Security_I_Like_Best_Buffett_1951  Warren Buffett on Geico.

https://sumzero.com/sp/bc_winner (you may have to paste into your browser) and as reference, Rockwell Automation Inc and ROK_VL from a Deep-Value member, Thomas Harris. We can critique this next if you wish.

Carl Icahn paid $500,000 for an investment bank to furnish a report on breaking up Time-Warner: lazard_twx (worth a look!) and Icahn was right about Time Warner

Analyzing Debt

Sell ABX

ABX Sombull along with Barrick Annual Report 2014 and Barrick 1 Q 2015



Stay with it………writing is hard and finding great ideas even harder.

Buffett’s 2014 Letter to Shareholders


Decades ago, Ben Graham pinpointed the blame for investment failure, using a quote from Shakespeare: “The fault, dear Brutus, is not in our stars, but in ourselves.”

Comments on the Berkshire Hathaway 2014 letter,  Part 1

Note the plug (page 6) for Where Are the Customers’ Yachts by Fred Schwed. That along with the Money Game by Adam Smith will teach you the ways of Wall Street. Also, see:

Intrinsic Value: Buffett reiterates that it is not a precise number for Berkshire nor, in fact for ANY stock.

GEICO delivers savings to its customers because it is a low-cost operation (source of structural competitive advantage).  The company’s low costs create a moat—an enduring one—that competitors are unable to cross.  Note Buffett’s comment on the animated gecko, a LOW-COST spokesperson.


Here’s how he explained it:

“In 2013, I soured somewhat on the company’s then-management and sold 114 million shares, realizing a profit of $43 million. My leisurely pace in making sales would prove expensive. Charlie calls this sort of behavior “thumb-sucking.” (Considering what my delay cost us, he is being kind.)

“During 2014, Tesco’s problems worsened by the month. The company’s market share fell, its margins contracted and accounting problems surfaced. In the world of business, bad news often surfaces serially: You see a cockroach in your kitchen; as the days go by, you meet his relatives.”

Buffett said the dawdling resulted in an after-tax loss of $444 million by the time Berkshire was no longer a Tesco shareholder. That, he added, is about 0.2% of Berkshire’s net worth. Only three times in 50 years has Berkshire recorded losses from a sale equal to more than 1% of its net worth.

Unfortunately, we don’t learn what exactly caused the loss. How did Buffett miscalculate intrinsic value?    Did management worsen, but if so, then how can an investor sidestep that?   I believe the economics changed as customers had more in-home deliveries and other choices coupled with poor store execution from Tesco.  I was disappointed with this explanation of the Tesco loss, but Buffett would reply that it was only 1/5 of 1%.

Nominal vs. Real Returns

During the 1964-2014 period, the S&P 500 rose from 84 to 2,059, which, with reinvested dividends, generated the overall return of 11,196% shown on page 2. Concurrently, the purchasing power of the dollar declined a staggering 87%. That decrease means that it now takes $1 to buy what could be bought for 13 cents in 1965 as measured by the CPI (Flawed or whats wrong with cpi)

I prefer measuring in gold grams, because gold is a store of value and market-based rather than concocted by Federal bureaucrats.DJIA-1900

There is an important message for investors in that disparate performance between stocks and dollars. Think back to our 2011 annual report, in which we defined investing as the transfer to others of purchasing power now with reasoned expectation of receiving more purchasing power–after taxes have been paid on nominal gains—in the future.”   (I wonder why Mr. Buffett makes no mention of the financial repression of ZIRP and NIRP?  It is the elephant in the room because of the devastating effect it has on savers and on calculating discount rates for investment.)

The unconventional, but inescapable, conclusion to be drawn from the past fifty years is that it has been far safer to invest in a diversified collection of American businesses than to invest in securities—Treasuries, for example—whose values have been tied to American currency. That was also true in the preceding half century, a period including the Great Depression and two world wars. Investors should heed this history. To one degree or another it is almost certain to be repeated during the next century.  Buffett’s comments are backed up by history as shown here:Triumphand triumph_of_the_optimists

Stock prices will always be far more volatile than cash equivalent holdings. Over the long term, however, currency-denominated instruments are riskier investments—far riskier investments. Than widely –diversified stock portfolios that are bought over time and that are owned in a manner invoking only token fees and commissions. That lesson has not customarily been taught in business schools, where volatility is almost universally used as a proxy for risk.  Though this pedagogic assumption makes for easy teaching, it is dead wrong. Volatility is far from synonymous with risk. Popular formulas that equate the two terms lead students, investors and CEOs astray.

It is true, of course, that owning equities for a day or a week or a year is far riskier (in both nominal and purchasing power terms) than leaving funds in cash-equivalents. That is relevant to certain investors-say, investment banks—whose viability can be threatened by declines in asset prices and which might be forced to sell securities during depressed markets. Additionally, any party that might have meaningful near-term needs for funds should keep appropriate sums in Treasuries or insured bank deposits.

For the great majority of investors, however, who can—and should—invest with a multi-decade horizon, quotational declines are unimportant. Their focus should remain fixed on attaining significant gains in purchasing power over their investing lifetime. For them, a diversified equity portfolio, bought over time, will prove far less risky than dollar-based securities.

Note the multi-decade horizon. Stocks were unchanged from 1964-1981, please see page 79: A Study of Market History through Graham Babson Buffett and Others.  Read what Buffett has to say about stock markets. Some say it is Time to exit because of high valuations for big-cap stocks in the U.S. market. So even if stocks decline for a decade but your holding period is MULTI-Decade, then hold tight.  Tough to do, but history seems to bear his thesis out: valuing-growth-stocks-revisiting-the-nifty-fifty.  I prefer to act like the pig farmer in A Study of Market History (see link above).

If the investor, instead, fears price volatility, erroneously viewing it as a measure of risk, he may, ironically, end up doing some very risk things. Recall, if you will, the pundits who six years ago bemoaned falling stock prices and advised investing in “safe” Treasury bills or bank certificates of deposit. People who heeded this sermon (to panic) are now earning a pittance on sums they had previously expected would finance a pleasant retirement. (The S&P 500 was then below 700; now it is about 2,100.) If not for their fear of meaningless price volatility, these investors could have assured themselves of a good income for life by simply buying a very low-cost index fund whose dividends would trend upward over the years and whose principal would grow as well (with many ups and downs, to be sure).


Investors, of course, can, by their own behavior, make stock ownership highly risky. And many do. Active trading, attempts to “time” market movements, inadequate diversification, the payment of high and unnecessary to managers and advisors and the use of borrowed money can destroy the decent returns that a life-long owner of equities would otherwise enjoy. ….Anything can happen anytime in markets. And no advisor, economist, or TV commentator–and definitely not Charlie nor I–can tell you when chaos will occur. Market forecasters will fill your ear but will never fill your wallet.

A plug for Jack Bogle’s The Little Book of Common Sense Investing.  Basically, Buffett is saying keep it simple, think and hold L O N G – T E R M, avoid high fees and commissions, and don’t use leverage. 

Next, let’s look at Berkshire–Past, Present and Future in Part II

Geico Case Study; Klarman Sees Collapse


As David Ricardo, a successful speculator who, in his early retirement, became one of the finest economists of the early nineteenth century, explained in 1817:

It has been my endeavor carefully to distinguish between a low value of money and a high value of corn, or any other commodity with which money may be compared. These have been generally considered as meaning the same thing; but it is evident that when corn rises from five to ten shillings a bushel, it may be owing either to a fall in the value of money or to a rise in the value of corn…..

The effects resulting from a high price of corn when  produced by the rise in the value of corn, and when cause by a fall in the value of money, are totally different. 


You can never read enough about a great business and the importance of HOLDING ON to reap the benefits of growth.  If you can combine patience with the knowledge of understanding the moat of a great business, then you will have an outstanding investment career.

Geico Case Study and  wedgewood partners second quarter 2013 client letter

Klarman’s Speech (Thanks to a reader)

His latest speech also includes a distinct tone of regret over where the current state of affairs is taking the U.S. He sounds positively saddened by how things are run in his country. In Klarman’s words:

“Like all of you, I am worried about our future, I am concerned about the prospect for upcoming generations to have the same opportunities that ours did, and I’m saddened that our generation was handed something unique, the stewardship of the greatest country in the history of the world– and we are far down the path of making it less great.”

Klarman Slams Myth Of Efficient Markets

Klarman said that the idea that financial markets are efficient is foolish, and he goes on to describe how that will always remain the case. Markets are governed by human emotions and they do not follow laws of physics—prices will unpredictably overshoot, therefore the academic concept of market efficiency is highly incorrect.

“Academics are deliberately blind to the fifty plus year track record of Warren Buffett as well as those of other accomplished investors, for if markets are efficient, how can Warren Buffett’s astonishing success possibly explained?”

In his speech Klarman mentioned value-investor Ben Graham’s explanation of markets, where he says that Mr. Market is to be perceived as an eccentric counter-party which should be taken advantage of, but one should not follow its emotional advice. He also agrees with Ben Graham’s idea that assets should be bought at a significant discount to keep your margin of safety.

“As when you build a bridge that can hold 30 trucks but only drive 10 trucks across it, you would never want your investment fortunes to be dependent upon everything going perfectly, every assumption proving accurate, every break going your way.”

Klarman said that the current economy is being built like a house of cards that will implode. Huge deficits, empty government promises, pretty pictures painted to ease voters and reliance on external markets to keep your currency afloat, have all disrupted the margin of safety in U.S. economy.

Klarman Encourages Going Against The Grain

He says that investors have become increasingly speculative and subject themselves to frenetic trading, even the holding period of 30-yr treasuries has fallen down to a mere couple of months. Investors increasingly rely on technology to judge their performance not merely on a monthly or quarterly basis—it has now become an hourly practice.

“The performance pressure drives investors to into an absurdly short-term orientation…. If your track record is going to be considered by investment committees every quarter, if you are going to lose clients and possibly your job because of poor short term performance, then the long term becomes almost completely irrelevant.”

Read more: http://www.valuewalk.com/2013/07/klarman-economy-house-of-cards/

Learn Accounting; Industry Metrics; Amazon; Geico Valuation; Klarman, Textbook Pubs. are Toast

“Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now. Over time, you will find only a few companies that meet these standards – so when you see one that qualifies, you should buy a meaningful amount of stock. You must also resist the temptation to stray from your guidelines: If you aren’t willing to own a stock for ten years, don’t even think about owning it for ten minutes. Put together a portfolio of companies whose aggregate earnings march upward over the years, and so also will the portfolio’s market value.” –Warren Buffett

To the Austrians, economics is not a tool of social control, it’s a framework for helping us understand humanity, its history, and our plight in the world”–Peter Boettke

Accounting and Financial Metrics of Industries

Learn more about accounting and a good source of industry metrics (please don’t share my secrets!)http://mgt.gatech.edu/fac_research/centers_initiatives/finlab/index.html

Heilbroner, a socialist, admits socialism is a total failure: http://reason.com/archives/2005/01/21/the-man-who-told-the-truth

Game over for text-book publishers


Valuation of GEICO

http://www.scribd.com/doc/78448120/Warren-Buffett%E2%80%99s-1995-GEICO-acquisition. There is something important missing in this valuation. Can anyone point it out?

Is America’s Debt a Problem?


Klarman and the Importance of History

Facing History and Ourselves.   I am sure this has been posted before, but if not, view this.   http://vimeo.com/32333102

Charlie479 Discusses AMZN

A generous reader shared this: Interesting comments from Charlie479 on AMZN (from VIC). Another example of an investor who thinks strategically and like a business person.

charlie479   12/20/11 11:25 PM AMZN one of the best companies I forgot to say that I chuckled thinking about the analyst making the “I want to buy Amazon at 100x earnings” pitch. I suppose that doesn’t necessarily make it mispriced but the earnings power is certainly higher than current GAAP net income. I think they could easily raise their prices by $0.63 per each $25 order (not exactly the same thing, but if Super Saver shipping was $0.63 instead of free, would that really change shopper behavior?). If they managed the business to maximize current profits like this, that $0.63 increase per $25 would double earnings. If sales grow like they did the past 12 months then suddenly the multiple isn’t looking so crazy. I’m not saying this makes AMZN one of the top half dozen stock investments in the world but the p/e might not be awful if your thesis is right.

I’ve occasionally wondered if someone could beat Amazon if they had $80 billion. I don’t think they could take over the #1 spot but I do think they could become competitive in a lot of areas. I would probably use the $80 billion to start several category-specific internet retailers, develop a large selection within that category, and drive turnover by capturing mind share as the expert in that category and as the lowest price seller, initially at losses. This is more or less the Amazon playbook, and companies like Diapers.com (before being bought), Newegg, and Blue Nile have managed to carve out niches. I bet there will be more. I think if VCs or public markets are willing to lose enough money for awhile, it isn’t that hard to replicate the warehouse network and other logistical moats.

Another reason to temper the who-needs-another-pipeline thought I posed in the previous comment is that consumers sometimes choose retailers for reasons other than price and selection. Certain bricks and mortar retailers will always have an advantage in terms of convenience (e.g. convenience stores, insightful eh?). And customers like to touch and try on certain products, like clothes, so I don’t see Amazon getting anything close to 50% share in those categories. Freshness matters, too, so it’s not clear grocery can be effectively penetrated by Amazon, and I bet that is a large portion of the Global Retail sales denominator. So, perhaps the current internet retail number at 3% is lower than what most people think, but maybe the maximum theoretical internet retail percentage is also lower than what most people think.

charlie479  12/20/11 10:47 PM AMZN one of the best companies

I think Amazon is one of the most admirable companies in the world. It has the expense advantages in rent and labor over B&M retailers that you mention, and it has cost advantages over other internet retailers as well. The massive sales volume makes the fixed cost percentages very low, and the inventory turnover in many products is so high that it can accept lower gross margins and still generate higher ROIC than competitors who charge a larger markup. The lower markup attracts more customers and generates more volume, which only reinforces the edge. It is the higher-turn/lower-markup Borsheim’s dynamic that Buffett describes.

The advantages aren’t limited to cost either. The high turnover also allows them to carry a huge number of SKUs at adequate ROIC, so they can offer customers the widest selection in many categories. For certain categories, after I browse Amazon and then Wal-Mart, I’ll come away feeling that Wal-Mart doesn’t have much of a selection. It’s hard to make Wal-Mart look narrow. Amazon is the first/last place many people shop because they know it has the widest selection and it’s likely to have that selection in stock.

Another non-price advantage is that they’re the most trusted internet retailer. I actually think those customer satisfaction ratings might be understating the difference. Their return policy and customer service is great. Even if a product is available from discountworldxyz.com at a slightly cheaper price, I’ll pay more to get it through Amazon because I know it’ll be the product I ordered, or else I’ll be able to return it. Who wants to deal with negotiating shipping costs or return policies with anyone else? I don’t think this is simply Amazon being more generous than discountworldxyz.com. They have the low-cost structure described in paragraph #1 that allows them to accept higher return costs while still generating better ROICs. I also suspect that their extensive review database reduces some of the likelihood of returns.

I think many retailers like Best Buy are at such a severe selection and cost disadvantage (even adjusting for sales tax) that their businesses are in trouble in the long-term. I even worry about beloved Costco. I no longer have no-price-comparison-needed-let’s-just-buy faith when walking down the aisles at Costco because Amazon has better prices frequently enough to make me doubt. More broadly, as someone who is cheering for the Costcos (no financial rooting interest, I just root for them because I admire them), I worry that Amazon will get to such scale one day that it’ll be a more efficient overall system for one UPS guy to drive from the Amazon warehouse and cruise through your neighborhood dropping off everything you and your neighbors need for the week. That might sound crazy but the current system of having you and all your neighbors separately drive SUVs 15-20 minutes to Costco to each walk through the aisles hand-picking and then checking out, doesn’t sound that efficient by comparison. I haven’t read anything about Bezos explicitly saying that’s his endgame but I wouldn’t be surprised if that’s in the 10 year wish list. If they end up with the cheapest and widest pipeline, there might not be much need for other pipelines.