Warren Buffett's Favourite Security 1952: Western Insurance Securities

This article was written by Warren Buffett...

Again my favorite security is the equity stock of a young, rapidly growing and ably managed insurance company. Although Government Employees Insurance Co., my selection of 15 months ago, has had a price rise of more than 100%, it still appears very attractive as a vehicle for long-term capital growth.

Rarely is an investor offered the opportunity to participate in the growth of two excellently managed and expanding insurance companies on the grossly undervalued basis which appears possible in the case of the Western Insurance Securities Company. The two operating subsidiaries, Western Casualty & Surety and Western Fire, wrote a premium volume of $26,009,929 in 1952 on consolidated admitted assets of S29,590,142. Now licensed in 38 states, their impressive growth record, both absolutely and relative to the industry, is summarized in Table I below.

Western Insurance Securities owns 92% of Western Casualty and Surety, which in turn owns 99.95% of Western Fire Insurance. Other assets of Western Insurance Securities are minor, consisting of approximately $180,000 in net quick assets. The capitalization consists of 7,000 shares of $100 par 6% preferred, callable at $125; 35,000 shares of Class A preferred, callable at $60, which is entitled to a $2.50 regular dividend and participates further up to a maximum total of $4 per share; and 50,000 shares of common stock. The arrears on the Class A presently amount to $36.75.

The management headed by Ray DuBoc is of the highest grade. Mr. DuBoc has ably steered the company since its inception in 1924 and has a reputation in the insurance industry of being a man of outstanding integrity and ability. The second tier of executives is also of top caliber. During the formative years of the company, senior charges were out of line with the earning power of the enterprise. The reader can clearly perceive why the same senior charges that caused such great difficulty when premium volume ranged about the $3,000,000 mark would cause little trouble upon the attainment of premium volume in excess of $26,000,000.

Adjusting for only 25% of the increase in the unearned premium reserve, earnings of $1,367,063 in 1952, a very depressed year for auto insurers, were sufficient to cover total senior charges of $129,500 more than 10 times over, leaving earnings of $24.74 on each share of common stock.

It is quite evident that the common stock has finally arrived, although investors do not appear to realize it since the stock is quoted at less than twice earnings and at a discount of approximately 55% from the December 31, 1952 book value of $86.26 per share. Table II indicates the postwar record of earnings and dramatically illustrates the benefits being realized by the common stock because of the expanded earnings base. The book value is calculated with allowance for a 25% equity in the unearned premium reserve and is after allowance for call price plus arrears on the preferreds.

Since Western has achieved such an excellent record in increasing its industry share of premium volume, the reader may well wonder whether standards have been compromised. This is definitely not the case. During the past ten years Western's operating ratios have proved quite superior to the average multiple line company. The combined loss and expense ratios for the two Western companies as reported by the Alfred M. Best Co. on a case basis are compared in Table III with similar ratios for all stock fire and casualty companies.

The careful reader will not overlook the possibility that Western's superior performance has been due to a concentration of writings in unusually profitable lines. Actually the reverse is true. Although represented in all major lines, Western is still primarily an automobile insurer with 60% of its volume derived from auto lines. Since automobile underwriting has proven generally unsatisfactory in the postwar period, and particularly so in the last three years, Western's experience was even more favorable relative to the industry than the tabular comparison would indicate.

Western has always maintained ample loss reserves on unsettled claims. Underwriting results in the postwar period have shown Western to be over-reserved at the end of each year. Triennial examinations conducted by the insurance commissioners have confirmed these findings.

Turning to their investment picture, we of course find a growth in invested assets and investment income paralleling the growth in premium volume. Consolidated net assets have risen from $5,154,367 in 1940 to their present level of $29,590,142. Western follows an extremely conservative investment policy, relying upon growth in premium volume for expansion in investment income. Of the year-end portfolio of $21,889,243, governments plus a list of well diversified high quality municipals total $20,141,246 or 92% and stocks only $1,747,997 or 8%. Net investment income of $474,472 in 1952 was equal to $6.14 per share of Western Insurance common after minority interest and assuming senior charges were covered entirely from investment income.

The casualty insurance industry during the past several years has suffered staggering losses on automobile insurance lines. This trend was sharply reversed during late 1952. Substantial rate increases in 1951 and 1952 are being brought to bear on underwriting results with increasing force as policies are renewed at much higher premiums. Earnings within the casualty industry are expected to be on a very satisfactory basis in 1953 and 1954.

Western, while operating very profitably during the entire trying period, may be expected to report increased earnings as a result of expanding premium volume, increased assets, and the higher rate structure. An earned premium volume of $30,000,000 may be conservatively expected by 1954. Normal earning power on this volume should average about $30.00 per share, with investment income contributing approximately $8.40 per share after deducting all senior charges from investment income.

The patient investor in Western Insurance common can be reasonably assured of a tangible acknowledgement of his enormously strengthened equity position. It is well to bear in mind that the operating companies have expanded premium volume some 550% in the last 12 years. This has required an increase in surplus of 350% and consequently restricted the payment of dividends. Recent dividend increases by Western Casualty should pave the way for more prompt payment on arrearages. Any leveling off of premium volume will permit more liberal dividends while a continuation of the past rate of increase, which in my opinion is very unlikely, would of course make for much greater earnings.

Operating in a stable industry with an excellent record of growth and profitability, I believe Western Insurance common to be an outstanding vehicle for substantial capital appreciation at its present price of about 40. The stock is traded over-the-counter.

Thanks to Investor's Consigliere: Article

Bruce Berkowitz Stays In The Sunshine

The fund has been busy buying health care stocks, ranging from generic drug makers to health maintenance organizations. What do you like about the health care sector right now?

There are predictions about the demise of this industry, with a new president coming in. The bottom line is that we want--especially baby boomers--to live until we're 100 years old. We want a very high quality of life until the last day. The unintended consequence is that health care costs are going to skyrocket. The only chance we have to control skyrocketing health care costs, while still trying to improve services, will be through the large HMOs.

But investors might be worried about committing capital to pharmaceutical and managed care companies because we don't know who will be in the White House next year and what that change in administration will mean for these industries.

So there is a simple question: Who else will do it? Barack Obama talks about having health care like they have in Congress. Who does the health care in Congress? It's the HMOs. The government can only write a check. When all you can do is write a check, you can't control costs. So costs will go through the roof, even more so. The government needs the HMOs. Who helps the government develop the pricing that's paid for products and services? It's the HMOs. The HMOs are the system. Then look at the pharmaceutical industry, which develops these miraculous drugs.

One of your top picks is drug giant Pfizer. How come?

$17 billion of free cash, which turns out to be over $2 per share of free cash for a triple-A quality company. This is the largest pharmaceutical company in the world trading under $20 per share.

Let me make sure we all understand what I mean by free cash: It's the amount of money that is possible to pull out of the business without hurting the franchise. Ten years ago, everybody loved Pfizer. It was trading between 40 and 50 times earnings. Today, it's under 10 times earnings and nobody wants it.

How come?

Because they are all worried about Lipitor and the new president. Lipitor doesn't come off patent for another three years, and the company is dramatically changing. There is a new CEO with a wonderful strategy.

You will see Pfizer, in my opinion, do a lot more joint ventures. I think they will become almost like Exxon Mobil, which is really a merchant bank that has the distribution, size and cash to partner up with a lot of people around the world. Pfizer will do that. People just don't realize the number of joint ventures they have and the power of their distribution channel.

Also, the pharmaceutical companies in the past have been quite stodgy and lazy in not pursuing generics. They have given the generics away. I don't think we will as much now. We will see Pfizer become a larger generic manufacturer. As their drugs go off patent, you will see them compete more with the generics too.

They are the 800-pound gorilla. They and UnitedHealth have one-fifth of the entire insured population in the United States. That's it. They are the answer.

The problem now is that everybody is blaming everybody else: the doctors, the insurance companies, the government, the patients. Things have to change. The system needs to change more toward wellness. You should not be able to get a new pair of knees if you are 300 pounds overweight and you haven't made a valiant effort to lose weight. What's the point? You will just blow out your new knees. There has to be a huge shift. It is starting with the baby boomers as they try to keep their weight down and do some exercise. If the shift doesn't happen, then the costs are going higher and higher.

Frankly, the companies aren't making that much money. They look great now because their prices have fallen 50%.

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MUST-WATCH: A Conversation with Charlie Munger

Charles Munger presented the Institute's 2008 DuBridge Distinguished Lecture in Beckman Auditorium on March 11. Munger, the vice chairman of Berkshire Hathaway Inc., a business partner of Warren Buffett, and one of the richest people in the United States, was joined in conversation by Caltech's Tom Tombrello, chair of the Division of Physics, Mathematics and Astronomy, and Kenan Professor and professor of physics.

Video Link

Whitney Tilson and Andy Kilpatrick on Berkshire Hathaway

Prem Watsa: Fairfax Financial beats bad markets

Q: Everybody else is running for the exits and melting down and Fairfax just had its credit rating upgraded so how did you pull this off?

A: “Very simply it goes back to this 100-year storm concern of ours. We took action that reflected our belief that everything was headed downward. Predicting rain doesn’t count, but building an ark does. And that’s what we did. We built an ark and we had a little bit of good fortune. This is why our rating went up.”

“Our focus has had a tremendous effect on our results. Last year we made in excess of US$1.1 billion and in the first quarter of 2008, US$631 million. Our capital, shareholders equity in 2006, was US$2.9 billion and it grew by 50%.”

Q: What was your thinking that led to these results?

A: “We have always taken a long term view and in 2003 we started worrying. We were concerned about asset-backed paper. We saw the moral hazard in all this credit that we saw was being blended and blown out. This was because interest rates were dropped to 1% to bail out the technology companies after the bubble burst in 1999 and we saw that this would lead to the real estate and auto loans and credit card problem. We saw that half of consumer spending was from home equity loans. So we protected ourselves. Credit default swaps are why our ratings went up.”

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Charlie Rose: A Conversation with Mohamed El-Erian

For the 1 hour conversation, please visit: Video Link

Tom Brown: Is it a Bottom in Financial Stocks?

One never knows until long after the fact, of course, when stock prices reach the exact top or bottom of a given cycle. And, besides, trying to pick precise tops and bottoms always turns out to be a pointless, unprofitable game. So don't even try.

Have I hedged myself sufficiently? Good. For, as it happens, I believe July 15, 2008 will turn out to be as good a date as any to mark the end of the long, painful bear market financial stocks have endured for the past 18 months. And more to the point, it marks the beginning of the greatest financial stock bull market in our lifetime, one that will be much broader than the bull market that began in 1990.

Caution! The observation above is offered to investors only. If you can't stand the idea of seeing another, say, 20% on the downside, please stop reading at once and head back to CNBC.com. If you measure your investment horizon in weeks or months, please, for your own good and sanity, leave this site pronto.

But if you understand what drives stock prices, and have an investment time horizon of at least one year, feel free to keep reading. And if you are a patient value investor, get out your highlighter and get ready to buy stocks.

I believe the current valuations of scores—even hundreds—of financial companies are wildly out of whack with the companies' long-term earnings potential. The companies are extraordinarily undervalued, in my view. In the vast majority of cases, I can get comfortable with their potential future credit losses and (in the cases where they're needed) the possibility of future, dilutive capital issuance.

With the gap between current market values and business values so wide, investors shouldn't even worry too much whether July 15th was indeed rock bottom for the stocks. The margin for error today is so wide that any investor with at least a one-year horizon and a little analytical ability can pick huge winners. We wouldn't buy across the board, but the vast majority of the depressed financial stocks will survive, recover, and deliver high investment returns from these levels.

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Lollapalooza Investing: My New Blog

I have launched a new blog: Lollapalooza Investing, which I will use as a platform to share stock ideas. I have just posted my first write-up: A.H. Belo (AHC).

Please visit: Lollapalooza Investing

John Templeton, Global Investing Pioneer, Dies at 95

John Templeton, the billionaire U.S. philanthropist who made his fortune as the pioneer of global investing in the postwar boom, has died. He was 95.

Templeton died today at Doctors Hospital in Nassau, the Bahamian island that was his home, his spokesman, Don Lehr, said in a statement. The cause was pneumonia.

The Templeton Growth Fund was one of the first mutual funds to give Americans access to investments in companies abroad. Since its start in 1954, the fund has returned 13.5 percent a year on average, meaning a $10,000 investment would be valued at about $8.5 million as of March 31, including reinvested dividends and capital-gains distributions.

Like Warren Buffett, Templeton developed a cult following, with fund investors flocking to annual meetings to hear his pronouncements. Money magazine in 1999 called him ``arguably the greatest global stock picker of the century.''

A devout Presbyterian, Templeton may be remembered as much for financing the study of spirituality as for his canny investments. In 1972, he set up the $1 million-plus Templeton Prize. Mother Teresa was the first recipient, six years before she collected the Nobel Peace Prize. He always made sure that his award offered more money than the Nobel Prizes.

``What we say about investments isn't as lasting as what we say about spiritual matters,'' Templeton, who was a board member of the American Bible Society, said in a 1993 interview from his home in the Bahamas.

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Bill Gates and Warren Buffett Discuss "Creative Capitalism"

Warren Buffet: I would rather have Bill, if he will, give me the main points.

Bill Gates: Well it’s not completely well defined. It’s a phrase that I used in a speech at Harvard a year ago, because I totally believe in markets as such powerful forces for drawing out innovation and creating things that are sustainable. And yet, you do get trapped in this situation where the markets serve where the dollars are, so you don’t get markets meeting the needs of the poorest. And so how do you bootstrap or support the needs of the poorest so markets are reaching out to them. I mean, when I view the last hundred years as an experiment in how good markets are, the answer is very, very clear and very strong. It’s one of those things that’s so clear people won’t even discuss it with you anymore. Like in this [Edward] Teller biography: he says, Look, if he didn’t believe in innovation, he would have been a communist. If the economy is a zero-sum situation, then you ought to try some crazy sharing thing. It’s only the innovation and pie-growing activity that made Teller feel comfortable with the capitalistic approach. And I think that that’s been validated.

You often hear people saying that companies should do something besides profit maximization. And it’s amazing how strong a message is hidden in words like “diversity” or the broad term “corporate social responsibility.” Warren and I were just at the Microsoft CEO Summit for the last couple days and it was amazing how many of the talks were about how a company needs to have core values of who they are and what they do as the thing that makes the employees feel they have a purpose and guides their action. And how that needs to be really at the center, even more so than the short-term profit metrics. Jack Welch was very good on that and Lee Scott [CEO of Wal-Mart] was very good on that, I think in a very sincere way. I think it’s more true all the time.

Bill George [of Harvard Business School] ran the leadership panel, and he was saying how the younger generation really wants to go to work with people who have a purpose. So what I’m saying is when people write down that purpose, when they write down their values, that an element of that should be: what can we do based on our skill set, our innovators, whatever unique capacities we have as a company--what can we be doing for the poorest 2 billion? And that can either be taking more risk in terms of trying to develop markets there, which is C.K. Prahalad-type stuff, or just doing things like the Merck donation that are not profit seeking and yet not giving up huge percentage of profit.

So somebody can read the words “creative capitalism” and say, “Okay, Bill Gates said that you should serve the poorest 2 billion and ignore profit.” That is not what I intend to say at all, but then I am being a bit ambiguous about how far you go in being willing to give up something. Am I saying one percent? Two percent? Three percent? Nobody who sets these dual roles is very good about being clear. I mean, what do they say you’re supposed to give up for corporate social responsibility. Well, they’re not willing to be numeric because they feel like the two goals, profit and social responsibility, aren’t totally at odds over time—or diversity, or whatever the value is.

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