Lou Simpson is perhaps the greatest investor you have never heard of.
But don’t take my word for it; listen to Warren Buffett: “Lou has made me a lot of money. 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.”
In his 2010 letter to Berkshire Hathaway shareholders Buffet added: “Lou has never been one to advertise his talents. But I will: Simply put, Lou is one of the investment greats.”
That you have never heard of him is no accident. Simpson lives a simple life, keeps a low profile, and never discusses his investments.
But his investment record speaks loud and clear. From 1980 to 2004, the last time his investment results were broken out from Berkshire Hathaway’s, his investments had compounded annually at 20.3%. That is 6.8% better per year than the S&P 500. For comparison, one dollar invested with Lou in 1980 had become $101.25 by 2004. One dollar invested in the S&P 500 had become $25.33.
Warren Buffett hired Simpson in 1979 to invest GEICO’s insurance float. He was given carte blanche to make investments. Lou was the only one outside of Buffett allowed to make investment decisions at Berkshire Hathaway.
Simpson retired in 2010 and started SQ Advisors with his wife. The firm offers separately managed accounts to friends, family, and charities and charges a flat 1% management fee. As of June 30, 2015 SQ Advisors managed over $3 billion.
One of Simpson’s distinguishing traits is that, “He sticks to his principles,” says Warren Buffett. “Most people on Wall Street don’t have principles to begin with. And if they have them, they don’t stick to them.”
Below are some of Lou Simpson’s principles.
1. Think independently.
“I pondered for eight years what makes Lou knock the cover off the ball,” Jack Byrne said. “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, vice chairman of Berkshire Hathaway, shares Byrne’s sentiment. “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 thats what impressed us.”
In his own words, Lou says: “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.”
2. Invest in high return businesses.
“Over the long run appreciation in share prices is most directly related to the return the company earns on its shareholders’ investment. Cash flow, which is more difficult to manipulate than reported earnings, is a useful additional yardstick.”
When he was asked what the most important quantitative aspect of company is. He responded:
Return on capital. That really tells you a lot. One of the basic problems is that there is so much noise around earnings that you really have to rip apart the financials to understand what the real numbers are. Its really the basic returns on equity capital [that are] important, but sometimes there’re not obvious. Even so, I think you have to look at a lot of things. You have to figure out what the earnings growth rate of the company will be over an extended period of time, and then apply a discount rate to it so you can come up with the best valuation. It’s easy in principle but its extremely difficult in practice.
“One of the things I have learned over the years is how important management is in building or subtracting from value. We will try to see a senior person and prefer to visit a company at their office, almost like kicking the tires. You can have all the written information in the world, but I think it is important to figure out how senior people in a company think.”
These are the questions Simpson asks when he is evaluating management:
“Does management have a substantial stake in the stock of the company? Is management straightforward in dealings with the owners? Is management willing to divest unprofitable operations? Does management use excess cash to repurchase shares The last may be the most important. Managers who run a profitable business often use excess cash to expand into less profitable endeavors. Repurchase of shares is in many cases a much more advantageous use of surplus resources.”
4. Pay only a reasonable price, even for 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.”
5. Do not diversify excessively.
“An investor is not likely to obtain superior results by buying a broad cross-section of the market. The more diversification, the more performance is likely to be average, at best. We concentrate our holdings in a few companies that meet our investment criteria. Good investment ideas-that is, companies that meet our criteria-are difficult to find. When we think we have found one, we make a large commitment.”
“If we could find 15 positions that we really had confidence in, we’d be in 15 positions. We’ll never be in 100 positions because we’re never going to know 100 companies that well. I think the merits of a concentrated portfolio are: ‘You live by the sword, you die by the sword.’ If you’re right, your going to add value. If you’re going to add value, you’re going to have to look different than the market. That means either being concentrated or, if you’re not concentrated in a number of issues, you’re concentrated in types of businesses or industries.”
“He gets one or two really strong ideas a year and then likes to swing very hard,” Byrne said.
6. Read voraciously.
“I’d say I try to read at least 5–8 hours per day,” Simpson said. “I read a lot of different things, including a variety of filings, annual reports, industry reports, and business magazines.”
In spring when many companies publish their annual reports, he will read 15 to 20 per day.
A former GEICO director said: “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.”
7. Speak honestly.
When Lou reads an annual report he starts with the management’s letter to shareholders. He likes when management addresses their triumphs and shortcoming objectively, in plain, simply language. Not surprisingly, he holds himself to this same standard.
In 1993 the Washington Post awarded Simpson their “Straight-talker” award, saying: “When Simpson does well, he tells you. And when he does poorly, he also tells you.”
In 2007 the New York Times described Simpson as “disarmingly honest about investments that have not worked out.”
8. Do not discuss investments.
“So many people broadcast what they buy or sell and it works against them. I’m in favor of people not knowing what we’re doing until the last possible time.”
“I have always felt I could do a better job in adding value by being somewhat removed from the circus and parimutuel atmosphere of the market.”
9. Make fewer decisions.
Lou has gone out of his way to design a lifestyle and workplace that maximizes his time to think about the truly important questions that have the biggest payoffs.
“The more people you have, the more difficult it is to do well,” he said. “You have to satisfy everybody. If you have a limited number of decision makers, they are more likely to agree.”
Simpson does not confuse with activity with results: “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. It is very boring.”
10. Study your mistakes.
“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.”
In short, Glenn Greenberg summed up Lou’s investment approach:
He tries to find businesses with few competitors, pricing that’s not volatile, steady demand for the product and low capital needs so that most of the earnings can be reinvested in the business or paid out to shareholders or used for acquisitions.
Bibliography
Buffett, Warren. “1986 Berkshire Hathaway Annual Report.” Letter to Berkshire Hathaway Shareholders. 1986. MS. Omaha, NE.
Buffett, Warren. “2004 Berkshire Hathaway Annual Report.” Letter to Berkshire Hathaway Shareholders. 2004. MS. Omaha, NE.
Buffett, Warren. “2010 Berkshire Hathaway Annual Report.” Letter to Berkshire Hathaway Shareholders. 2010. MS. Omaha, NE.
Fabrikant, Geraldine. “A Maestro of Investments in the Style of Buffett.” The New York Times. The New York Times, 22 Apr. 2007. Web. 20 Aug. 2015.
Griffen, Tren. “A Dozen Things I’ve Learned from Lou Simpson About Investing and Business.” 25iq. N.p., 04 Apr. 2015. Web. 20 Aug. 2015.
Harris, Melissa. “Lou Simpson Retiring from Geico.” Tribunedigital-chicagotribune. Chicago Tribune, 22 Aug. 2010. Web. 20 Aug. 2015.
Vise, David A. “Geico’s Top Market Strategist Churning Out Profits; Lou Simpson’s Stock Rises on His Successful Ideas.” The Washington Post. N.p., 11 May 1987. Web. 20 Aug. 2015.
