Louis A. Simpson, chairman of the finance committee at Geico Corp., has his own formula for dealing with success. He tells you it can't last.
"We're going to run out of luck, sometime," he says. "We haven't done it yet. But just by the nature of the odds, we're bound to. . . . "
Simpson, who has developed a reputation in the Washington area as something of an investment wizard, manages $1.5 billion of Geico's money. While he clearly has had some luck in the last few years, he also has managed to put the insurance company's money into the right investments at the right time.
The "right" investments have turned out to be mostly stocks -- stocks that represented the "right" companies in the "right" industries. These have included food companies, telephone companies, electric utilities and even some oil firms.
By good stock selection, Simpson has beat the S&P 500 by about 16 percent a year for the last 4 1/2 years. And that really worries him.
"There's no way we can continue to have that kind of excess performance," he says. "I don't think the market will give you that opportunity. Maybe I'm wrong. We recognized certain areas of undervaluation and made very big bets in those areas -- which worked out. Today, I don't see those areas in the market."
Simpson, a 48-year-old Princeton-trained economist and investment manager, says it is getting harder and harder to find undervalued stocks. One reason is that there are more and more people -- often using computer programs -- searching for those companies. That scarcity of undervalued companies makes it difficult to replace the current stocks, which, having gone up so nicely, have become overpriced.
"The problem we have had with our portfolio," Simpson says, "is the fact we have done so well, the undervaluations in much of the portfolio have been recognized by the market. I've said to people, 'I don't think I've had any really good ideas for the last six to nine months.' The kinds of things we like, and we own, have done much better than the market -- really closing the gap of valuation.
"So, I think much of our portfolio is okay," he says, "but I'm really not that enthusiastic about it."
Simpson, who came to Geico six years ago after serving as president of Western Asset Management in Los Angeles, is a value-oriented investor in the tradition of Benjamin Graham, the father of value investing, and Warren Buffett, one of its most successful practitioners. Graham disciples look for companies whose stock is selling for less than the company is worth. "Buying $1 for 50 cents" is the way the philosophy is often expressed.
Simpson says that investors seeking quality should look for companies that offer good returns on equity and capital and have good balance sheets, companies that generate excess cash and have a unique franchise. Beyond that, he said, investors should try to invest in businesses they understand.
When Simpson came to Geico, its portfolio was just over $900 million, but most of its funds were invested in tax-exempt and corporate bonds. He moved Geico's growing investment pool into stocks.
"We felt the opportunities for maximizing economic values were very much with common stocks and away from tax exempts," said Simpson.
Today, the Geico portfolio has about 40 percent of its funds in common stocks and convertibles, 27 to 28 percent in municipal bonds and 23 to 24 percent in preferred stocks. The remainder is in cash or cash equivalents.
Stocks have been good for the Geico portfolio. Simpson achieved a 21.26 percent annualized return for his total portfolio for three years, 1982, 1983 and 1984. The common-stock portion of his portfolio returned 34.16 percent annually. By comparison, the S&P 500 produced only 16.45 percent.
Although 1984 was not a great year for the stock market, Geico's total portfolio rose 15.18 percent, with the common stock portion up 21.82 percent, compared with an S&P 500 increase of only 6.25 percent.
Yet, even the 1984 performance failed to keep Simpson from worrying.
"I am quite apprehensive about our ability to duplicate these outstanding results in the future," Simpson told stockholders in the 1984 annual report.
Halfway through 1985, it appears Simpson may have worried in vain. Geico's stocks already are up 26 percent so far this year. But that doesn't mean Simpson is ready to celebrate. Like the true buy-low, sell-high investor, rising markets make him uncomfortable.
"The better that the markets do, the more concerned and the more cautious I become," Simpson said. "If this market continues to be strong from here, we would be likely to be raising money selling, and also likely to be keeping the money in cash, and looking for opportunities."
Simpson's combination of savvy and luck was demonstrated dramatically in the last several weeks. At the end of 1984, Geico's portfolio included 464,000 shares of Nabisco Brands. The average cost was $28.89 a share, and the end-of-year share price was $51.25 for a market value of $23.8 million. Then, early last month, R. J. Reynolds Industries announced it planned to acquire Nabisco for $4.9 billion -- or about $85 a share. The stock quickly rose.
The increase from the year-end price of $51.25 to the present price of $82.75 a share represents a gain of 61.5 percent for Nabisco. Although Geico sold some of its Nabisco shares in the last few months, it still has substantial holdings and thus substantial profits.
Similarly, it didn't hurt Geico's portfolio when rumors circulated recently that General Foods Corp. might be a takeover candidate. General Foods stock leaped upward. Fortunately for Geico, Simpson was also holding a big chunk of General Foods stock.
At the end of the year, Geico listed 290,300 shares of General Foods at an average cost of $33.99 a share and a then-current market price of $55.88, for a total value of $16.2 million. The difference between $55.88 and the present price of $81 is a gain of 45 percent. Here again, Geico recently sold some of its General Food shares but still has large holdings and profits.
Geico's largest single equity investment is in Pitney Bowes, the postage meter folks. At the end of 1984, Geico held 852,800 shares of the firm, at an average cost of $28.60 a share. The price at year-end was $35.50, for a total value of $30.3 million. From $35.50 to the present price of $44.88 is an increase of 26.4 percent.
Simpson's portfolio has included several Washington-area stocks, including Bell Atlantic, Pepco, CSX Corp., Norfolk Southern Corp, Suburban Bancorp and United Virginia Bankshares. The two banks have had especially good moves.
In addition to running Geico's portfolios, with the help of a six-person staff, Simpson helped create a subsidiary called Geico Investment Services, which operates an $80 million money market fund and a $55 million preferred stock fund. Geico Investment Services recently joined with Johnston, Lemon & Co. to act as the investment adviser for the newly created Growth Fund of Washington. To avoid any conflict between his investment role at Geico and the new fund, Simpson resigned as a director of the investment services branch.
Simpson has great faith in the future of Washington business and believes Washington will, in time, draw more major corporations and develop a larger financial community as New York institutional firms open offices here. "This is a place where an awful lot of things are happening," he says, "a lot of things that can impact your business."