In Poor Charlie's Almanack, Charlie Munger talks about 'Lollapalooza Effects'. A Lollapalooza is the term that Munger coined which describes situations when 2, 3, or more strong forces come together and are all operating in the same direction. When these strong forces act together, it often produces an effect much greater than the sum of its parts. Munger characterized it as getting critical mass in a nuclear explosion. Unless you get critical mass, nothing much happens. But if you do get critical mass – Watch Out!
This can happen in any aspect of life, but Lollapaloozas have great applications to investing. Usually when investing in a business, there are positive factors and negative factors acting against each other, and they cancel each other out and you get mediocre results. For example, you could have a great business with fantastic growth, but it could also be priced really expensively and have lots of competitors. In this scenario your results will not be exceptional because the bad factors will cancel out the good. Sometimes though, the factors will all be pulling together to a dramatic effect. These opportunities are few and far between, but when they happen, they can produce spectacular results.
A good example of a purchase of a business with Lollapalooza effects is Warren Buffett's purchase of GEICO. Buffett actually had purchased and sold GEICO earlier in his partnership days in the 1950s, but he became interested in the company again in 1977. GEICO was in terrible shape in the late 1970s due to improper and overly optimistic underwriting which had saddled the company with bad losses in the previous years. But nevertheless GEICO had a number of positive forces that were all pulling together to create a new Lollapalooza Effect.
These factors included:
- GEICO sold its insurance direct to consumers and did not employ agents. This allowed GEICO to sell its insurance at a significant discount to its competitors.
- GEICO sold its insurance to a group of people who typically were lower risk. The name GEICO actually stands for Government Employees Insurance Company and they predominantly insured public employees and their families, a traditionally low risk group of customers. This meant that GEICO's losses were below the industry averages.
- The auto insurance industry, was and remains highly fragmented to this day. That meant that there was a lot of room for expansion and growth for GEICO.
- Although GEICO had suffered bad losses in the recent past, they had recently replaced their management, hiring Jack Byrne as CEO. Byrne was an insurance prodigy and is one of the best insurance executives ever. This gave GEICO top quality management.
- GEICO, as an insurance company generates insurance float, meaning that premiums they collect immediately can be invested until they have to be used for liabilities which will arise in the future. This means that significant sums of cash can be effectively borrowed from policy holders at very low or even negative interest rates effectively. This float could then be invested by Buffett or his counterparts at GEICO to generate investment returns, something that Buffett specialized in.
- Because of the recent losses and overhang of potential bankruptcy the shares of GEICO were trading at very cheap prices. This meant that Buffett was getting this great business at an unbelievable price.
We can see in the GEICO example there was at least six major factors which all were pulling in the direction of positive returns for a GEICO investment. This is a common theme in all of Buffett's investments and its something we would do well learn from. Even in Buffett's earlier partnership days when his investments were more of the traditional Ben Graham 'Cigar Butt' type of investment, he still liked to look for businesses that had potential Lollapalooza like effects happening.
In addition to finding businesses with extremely cheap prices (the first strong force in favour of investing), he also only invested in businesses that had potential catalysts for improving the business. He never invested in companies where the business fundamentals were completely broken or deteriorating. Even his investment in Berkshire Hathaway itself, and its textile business which they were eventually forced to shut down was not a hopeless situation at the time of the investment. There was several potential reasons for optimism. Although these didn't work out for Berkshire's textile business, they did work out well in a number of other scenarios, not the least of which was Buffett's investment in American Express, a business with Lollapalooza like effects in its own right.
Part of finding a Lollapalooza is avoiding investments with strong negative factors as well. And here again Buffett shows us the way. He's never invested in a business where there was a serious cash burn and avoided businesses where the management situation was unclear or negative. This allowed him to avoid a lot of negative situations which would have drastically hampered his results over the years.
Identifying these Lollapalooza like opportunities are tough to find as they are few and far between. But when they happen, they can really generate extraordinary results for shareholders. When you find them, you should invest heavily to take advantage.
- Craig White, BA, LL.B., CIM
Craig White is an Investment Advisor at Endeavour Wealth Management with Industrial Alliance Securities Inc, an award-winning office as recognized by the Carson Group. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.
This information has been prepared by Craig White an Investment Advisor for Industrial Alliance Securities Inc. (iA Securities) and does not necessarily reflect the opinion of iA Securities. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered.
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