Berkshire Hathaway CEO Warren Buffett can always be counted on for some choice words of wisdom in his annual shareholders letter, and among them were some perceptive remarks about one of his holding company’s investments: Geico.
The Oracle of Omaha talked about the value of the insurance company has grown over the years, even though the goodwill associated with it has stayed at the conservative level at which Buffett acquired half the company a decade and a half ago. Forget about goodwill impairments. “When, in 1996, we bought the 50% of Geico we didn’t already own, it cost us about $2.3 billion. That price implied a value of $4.6 billion for 100%. Geico then had tangible net worth of $1.9 billion.
“The excess over tangible net worth of the implied value – $2.7 billion – was what we estimated Geico’s ‘goodwill’ to be worth at that time. That goodwill represented the economic value of the policyholders who were then doing business with GEICO. In 1995, those customers had paid the company $2.8 billion in premiums. Consequently, we were valuing Geico’s customers at about 97% (2.7/2.8) of what they were annually paying the company. By industry standards, that was a very high price. But Geico was no ordinary insurer: Because of the company’s low costs, its policyholders were consistently profitable and unusually loyal.
“Today, premium volume is $14.3 billion and growing. Yet we carry the goodwill of Geico on our books at only $1.4 billion, an amount that will remain unchanged no matter how much the value of Geico increases. (Under accounting rules, you write down the carrying value of goodwill if its economic value decreases, but leave it unchanged if economic value increases.) Using the 97%-of-premium-volume yardstick we applied to our 1996 purchase, the real value today of Geico’s economic goodwill is about $14 billion. And this value is likely to be much higher ten and twenty years from now. Geico – off to a strong start in 2011 – is the gift that keeps giving.”
It may be that a certain little gecko may be sitting on Mr. Buffett’s desk giving him some Cockney-accented words of wisdom of his own.