Very good analysis of how he caculates economic goodwill and instrinsic value in regard to Geico and a nice review of how he originally became infactuated with Geico and the power of insurance float. Value theorists recognize his divergence from classic Graham thought along these lines. More specifically, that a company can be worth far more than the sum of its tangible equity if it holds certain characteristics that enable it to sustain a long term competitive advantage resulting in a steady stream of future cash flows. He further notes that not only does Geico have the luxury of the perpetual interest free loan (float) to invest but unlike State Farm, the company is operationally profitable in virtually every year. In other words, the cost stucture of Geico is such that they can reap all the benefits of the insurance float while employing underwriting standards that virtually ensure a much larger hold of the float compared to State Farm.
He also has a section on the danger of employing margin and ends the letter with a hand written note from his Grandfather on the importance of holding a certain amount of cash as a safety measure. Of course Buffett learned how to use leverage to accelerate profits, by employing a much "safer" liability, namely prepaid insurance float. It cares no interest, no covenants, and in most cases does not require full repayment, so long proper underwriting is employed.
Best analogies were that credit is like oxygen, no one notices until it is removed, and his jab at Sears and Wards vs. Walmart on reinvestment of profits. One turns a dollar of profit into two, while the others turned a dollar into 50 cents. That of course is the essense of buying and holding a stock for the long term. Businesses which reinvest profits at a high rate of return over time, magnify earnings, creating shareholder value, while the opposite is true of companies that reinvest profits at a negative rate of return.
Buffett will be on CNBC on Wednesday from 6AM to 9AM Eastern, that will be quite enlightening for early risers, I intend to set my alarm.
