Many of Warren Buffett’s biggest fans don’t know the name Lou Simpson, but Simpson is probably the greatest investor you’ve never heard of and arguably a big part of what made Buffett’s investment in Geico such a success.
Simpson was the Chief Investment Officer of Geico, and his record there from 1979 to 2010 rivals that of Buffett himself. Buffett so admired Simpson that he said Simpson could step in should something happen to him and his closest aide, Charlie Munger, and said in his 2010 letter to Berkshire Hathaway that “Lou has never been one to advertise his talents. But I will: Simply put, Lou is one of the investment greats.”
Warren Buffett hired Simpson in 1979 to invest Geico’s insurance float. He was given free reign to make investments and Simpson was the only one apart from Buffett who was allowed to make investment decisions at Berkshire Hathaway.
“Lou has made me a lot of money,” said Buffett. “Under today’s circumstances, he is the best I know. He has done a lot better than I have done in the last few years. He has seen opportunities I have missed. We have $700 million of our own net worth of $2.4 billion invested in Geico’s operations, and I have no say whatsoever in how Lou manages the investments. He sticks to his principles. Most people on Wall Street don’t have principles to begin with. and if they have them, they don’t stick to them.”
While their investment choices may differ, their investment philosophies are very similar. But in an interview last year, Simpson noted an interesting difference between he and Buffett:
“The biggest difference between Warren and me is that Warren had a much harder job. He was managing 20 times the amount of money we were. We were managing five billion. In equities, he might have been managing 80, 90, 100 billion. So he was much more limited in what he could buy if he wanted to have a concentrated portfolio, which he did,” Simpson said.
His advantage over Buffett resulted in Geico’s equity portfolio gaining an average of 20.3% a year, compared to the S&P 500’s 13.5%. To put that into context, consider that a $10,000 investment compounded at a rate of 13.5% for 25 years would become $237,081, while at a 20.3% annual rate, that same $10,000 would have become $1,015,408 after 25 years.
Simpson did underperform for three years in a row in the late 1990s dot-com boom. As a value investor, Simpson couldn’t buy into the irrational exuberance of the time but stuck to his principles and delivered outstanding results in the years after the 2000 crash.
Since retiring from Geico, Simpson founded an investment advisory firm, SQ Advisors, with his wife. The firm is largely a labor of love offering separately managed accounts for friends, family, and charities, charging a flat 1% management fee. As of the end of 2017, the firm managed $2.9 billion in assets under management.
Here are a few of Lou Simpson’s greatest investing principles:
Read All Day, Every Day
Simpson is a voracious reader of financial newspapers, intelligent press, annual reports, industry reports, and typically reads 5 to 8 hours a day. Like Buffett, Simpson isn’t trading intensive, but rather is reading intensive and thought intensive.
A former Geico director said of Simpson, “The most important attribute in that job once you have the basic training is to read, and keep reading and reading until you come up with ideas. In this modern world, everybody would rather talk on the phone than do the basic work. Lou does the basic work. He doesn’t talk to that many people.”
Jack Byrne said, “I ponder for eight years what makes Lou knock the cover off the ball. Lou is very bright, with an economics background from Princeton. But the woods are filled with bright guys. It has more to do with his personality. He is very, very sure of his own judgments. He ignores everybody else.”
Charlie Munger agrees, “I would argue that good stock-picking records are held by people who are a little cranky and are willing to bet against the herd. Lou just has that mindset and that’s what impressed us.”
For Simpson, obtaining your own information and doing your own analysis will lead to better investments. Smart investors shouldn’t get caught up in waves of irrational behavior and should be willing to look at the companies everyone hates as they usually make the best investments.
In his own words, Simpson said, “We try to be skeptical of conventional wisdom and try to avoid the waves of irrational behavior and emotion that periodically engulf Wall Street. We don’t ignore unpopular companies. On the contrary, such situations often present the greatest opportunities.
Simpson admits that this is difficult to do because it “is very boring,” but it’s usually the right thing to do.
“Warren used to say you should think of investing as somebody giving you a fare card with 20 punches. Each time you make a change, punch a hole in the card. Once you have made your 20th change, you have to stick with what you own. The point is just to be very careful with each decision you make. The more decisions you make, the higher the chances are that you will make a poor decision,” Simpson said at Northwestern.
He practices what he preaches too. At his SQ Advisors investment firm, he adds just one or two investments a year to a portfolio of just 10 to 15 stocks. When he adds, he drops the losers. And sometimes, the plan is to do absolutely nothing.
“We do a lot of thinking and not a lot of acting. A lot of investors do a lot of acting, and not a lot of thinking. Sometimes the best thing to do is to do nothing. The hardest thing to do is to sit with cash,” Simpson said.
Finding companies that meet his investment criteria is hard to do, so when he finds one, he makes a big commitment.
Only Pay A Reasonable Price – Even If It’s An Excellent Business
“We try to be disciplined in the price we pay for ownership even in a demonstrably superior business. Even the world’s greatest business is not a good investment if the price is too high,” Simpson said.
Simpson uses indicators such as earnings yield and price to free cash flow. Cash-flow return, rather than profit return, can also be a useful metric as its more difficult to manipulate than profit.
Cut Your Losses & Examine Your Mistakes
When an investment hasn’t worked out, cut it loose. Investors tend to hold on to losing shares while selling early those positions that are doing well.
Simpson has some words of wisdom on this, “One thing a lot of investors do is they cut their flowers and water their weeds. The sell their winners and keep their losers, hoping the losers will come back even. Generally, it’s more effective to cut your weeds and water your flowers. Sell the things that didn’t work out, and let the things that are working out run… If I’ve made one mistake in the course of managing investments it was selling really good companies too soon. Because generally, if you’ve made good investments, they will last for a long time.”
And when you do make a mistake, learn something from it:
“When we make mistakes, we always try to do postmortems. I think its very important to look at your mistakes and determine why you made them.”