Concentrated Investing. Carlisle Tobias E.

and the investors argue for large bets when situations with unusual risk/return arise. It is important to note that the risk referred to here is the risk of permanent loss of capital and not the more commonly used academic metric of volatility. The investors in this book are willing to suffer through periods of temporary (but significant) loss of capital in an attempt to find opportunities where the probability of the permanent loss of capital is small. In other words, they attempt to find situations that offer a strong margin of safety where one’s principal is protected either by assets or by a strong franchise and an unlevered balance sheet.

      The investors in this book come from very different backgrounds ranging from an English major to an economist, but somehow they ended up in quite similar places in terms of their general investment philosophy. The singular trait that unites these investors, and separates this group from the herd of investors who try their luck on the stock market is temperament. Asked in 2011 whether intelligence or discipline was more important for successful investors, Buffett responded that temperament is key:2

      The good news I can tell you is that to be a great investor you don’t have to have a terrific IQ. If you’ve got 160 IQ, sell 30 points to somebody else because you won’t need it in investing. What you do need is the right temperament. You need to be able to detach yourself from the views of others or the opinions of others.

      You need to be able to look at the facts about a business, about an industry, and evaluate a business unaffected by what other people think. That is very difficult for most people. Most people have, sometimes, a herd mentality, which can, under certain circumstances, develop into delusional behavior. You saw that in the Internet craze and so on.

      ..

      The ones that have the edge are the ones who really have the temperament to look at a business, look at an industry and not care what the person next to them thinks about it, not care what they read about it in the newspaper, not care what they hear about it on the television, not listen to people who say, “This is going to happen,” or, “That’s going to happen.” You have to come to your own conclusions, and you have to do it based on facts that are available. If you don’t have enough facts to reach a conclusion, you forget it. You go on to the next one. You have to also have the willingness to walk away from things that other people think are very simple. A lot of people don’t have that. I don’t know why it is. I’ve been asked a lot of times whether that was something that you’re born with or something you learn. I’m not sure I know the answer. Temperament’s important.

      Munger says of Buffett’s theory:3

      He’s being extreme of course; the IQ points are helpful. He’s right in the sense that you can’t [teach] temperament. Conscientious employment, and a very good mind, will outperform a brilliant mind that doesn’t know its own limits.

      In the next chapter we meet Lou Simpson, the man Warren Buffett has described as “one of the investment greats.”4

      CHAPTER 1

      Lou Simpson: The Disciplined Investor: A Portrait of Concentration

      Stop the music.

– Warren Buffett to Jack Byrne, chairman of GEICO, after meeting Lou Simpson in 19795

      In 1979, GEICO, an auto insurance company based in Washington, DC, that had been brought close to bankruptcy just three years earlier was searching for a new chief investment officer. The company’s recent near-death experience, and the perception of insurance companies’ investment efforts as hidebound, and highly risk-averse, had made the search difficult. The recruiter, Lee Getz, vice chairman of Russell Reynolds, did find a candidate who later turned it down because his wife refused to move to Washington.6 Lamenting his lack of success in filling the position in over a year, Getz told his friend Lou Simpson about the little insurance company with big problems that no one wanted to tackle. He asked Simpson, the chief executive of California-based investment firm Western Asset Management, if he was interested in the job. Simpson was reluctant.7 Western Asset Management had been a subsidiary of a big California bank holding company. Simpson was sick of politicking within the confines of bank bureaucracy, and didn’t have any great desire to repeat the experience in an insurance company. He also knew that GEICO had almost gone belly up just three years earlier.

      As a favor, Getz asked Simpson to interview with the company’s chairman, John “Jack” Byrne Jr., the man who had almost single-handedly pulled GEICO back from the brink of insolvency.8 Simpson agreed if only to help out an old friend. He traveled to Washington to meet with Byrne, who Simpson judged as being “a very, very smart guy,” but also a micro-manager involved in everything GEICO did.9 Simpson found the role interesting, but not compelling. He craved autonomy, and Byrne, who had just saved GEICO, seemed unlikely to grant it. Byrne called Simpson back for a second interview. Though he had reservations he dutifully traveled back to Washington. In the second interview, Byrne told Simpson, “We’re really interested in you. But the one hoop you’re going to have to go through is to meet with Warren Buffett.”10 With about 20 percent of GEICO, Buffett was the largest shareholder through Berkshire Hathaway. Byrne said, “Warren thinks we need a new investment person. The person before was really not up to the job.”11 Though Buffett didn’t yet have a high profile, Simpson had read about the Nebraska-based value investor who was just renewing a longstanding interest in GEICO.

“Unstoppable” GEICO

      Buffett has a storied 65-year association with GEICO, beginning in 1951 as a 20-year-old graduate student in Benjamin Graham’s value investing class at Columbia. He recounted the first 45 years of that association in his 1995 Chairman’s Letter following Berkshire’s purchase of the half of GEICO it didn’t own.12 It was then the seventh-largest auto insurer in the United States, with about 3.7 million cars insured (in 2015, it is second, with 12 million policies in force). Buffett attended Columbia University’s graduate business school between 1950 and 1951 because he wanted to study under Graham, the great value investor and investment philosopher, who was a professor there. Seeking to learn all he could about his hero, he found that Graham was the chairman of Government Employees Insurance Company, to Buffett “an unknown company in an unfamiliar industry.”13 A librarian referred him to Best’s Fire and Casualty insurance manual – a large compendium of insurers – where he learned that GEICO was based in Washington, DC.

      On a Saturday in January 1951, Buffett took the early train to Washington and headed for GEICO’s downtown headquarters. The building was closed for the weekend, but he frantically pounded on the door until a custodian appeared. He asked the puzzled janitor if there was anyone in the office the young Buffett could talk to. The man said he’d seen one man working on the sixth floor – Lorimer Davidson, assistant to the president and founder, Leo Goodwin, Sr. Buffett knocked on his door and introduced himself. Davidson, a former investment banker who had led a round of funding for GEICO before joining it, spent the afternoon describing to Buffett the intricacies of the insurance industry and the factors that help one insurer succeed over the others.14

      Davidson taught Buffett that GEICO was the very model of an insurer built to succeed. Formed in 1936, at the height of the Great Depression by Goodwin and his wife Lillian, GEICO was set up to be low-cost from the get go.15 Goodwin had been an executive at the United Services Automobile Association (USAA), an auto insurer founded to insure military personnel, and a pioneer in the direct marketing of insurance. He had seen data that showed federal government employees and enlisted military officers tended to be financially stable, and also low-risk drivers. Those two attributes, he surmised, would mean that premiums were paid

2

“A Class Apart: Warren Buffett and B-School Students,” NDTV, May 24, 2011, https://www.youtube.com/watch?v=4xinbuOPt7c, as discussed in Shane Parrish, “What Makes Warren Buffett a Great Investor? Intelligence or Discipline?” Farnam Street Blog, April 19, 2014.

3

Charles Munger, interview, February 23, 2012.

4

Warren Buffett, “Chairman’s Letter,” Berkshire Hathaway, Inc., 2010.

5

Miles Weiss, “Buffett Stock Picker Simpson Opens Florida Firm after Retiring from GEICO,” Bloomberg, January 20, 2011.

6

Lou Simpson, interview, June 8, 2011.

7

Ibid.

8

Ibid.

9

Ibid.

10

Ibid.

11

Ibid.

12

Warren Buffett, “Chairman’s Letter,” Berkshire Hathaway, Inc., 1995.

13

Ibid.

14

Ibid.

15

“GEICO’s Story from the Beginning,” https://www.geico.com/about/corporate/history-the-full-story/.