Examining Berkshire Hathaways Purchase of Geico

Examining Berkshire Hathaways Purchase of Geico

Berkshire Hathaway and GEICO Insurance © 2001 Tim Glowa

September 12, 2001 -1-

White Paper:

Examining Berkshire Hathaway's

1995 Purchase of GEICO Insurance

Tim Glowa

Tim@Glowa.ca

September 12, 2001

© 2001 Tim Glowa

Berkshire Hathaway and GEICO Insurance © 2001 Tim Glowa

September 12, 2001 -2-

Table of contents

Executive Summary.................................................................................................... 3

Introduction................................................................................................................. 4

Review of the case: Berkshire Hathaway purchasing GEICO.................................... 4

Strategic Outcome....................................................................................................... 7

Finance........................................................................................................................ 7

Time Value of Money................................................................................................. 8

Assessment of the GEICO purchase ........................................................................... 8

Time value of money ................................................................................................ 11

An examination of the GEICO acquisition in hindsight........................................... 13

Limitations of Discounted Cash Flow ...................................................................... 15

Limitations of this Analysis ...................................................................................... 16

Issues for subsequent research .................................................................................. 16

Conclusions............................................................................................................... 16

About the author ....................................................................................................... 17

Appendix A – Hypothetical examples of value creation. ......................................... 18

Berkshire Hathaway and GEICO Insurance © 2001 Tim Glowa

September 12, 2001 -3-

Executive Summary

In 1995, Berkshire Hathaway purchased GEICO insurance for a 25% premium over its

traded share price. Many investors, including major brokerage houses and financial

reporters, questioned the wisdom of such an investment, especially since Berkshire

Hathaway with its near mythical chairman, Warren Buffett, was involved.

After reviewing the history of GEICO, Berkshire Hathaway, and the investing philosophy

of Warren Buffett, this paper reviews and evaluates the purchase of GEICO. This paper

examines two primary tools available for analyzing possible investments. The first is the

dividend growth model, which examines how a stock can be valued through examining

the dividend cash flow. The second examines the time value of money, through the

assumption that future dividends will flow directly to Berkshire Hathaway.

Additionally, the paper evaluates the profitability of the purchase of GEICO after a five

year period, assuming that all profits flowed to Berkshire. This five year window was

selected since financial data on GEICO is reported through the Berkshire Hathaway

annual report for the period 1995 to 2000. Finally, a discussion of the limitations and

assumptions associated