Note: This article was originally published as a Friday File for the Stock Gumshoe Irregulars on October 26. At that time I did not own shares personally, but I now do own shares and have an additional limit order in to buy more if the price drops. The ad has still been running recently, and the company and stock have not changed particularly since publication. The article below has not been edited or updated since it was originally published.
Well, no, probably not. But it is a great investment thesis to work with. And it might be a fun and worthwhile newsletter teaser to sniff out.
“The Golden Cross” is Tom Dyson’s description of a big setup for a certain class of companies — he’s trying to recruit subscribers for the Palm Beach Letter, which he publishes with Mark Ford. And the stock they tease in this ad is one I’ve been meaning to look at for a long time, and it’s in an industry that’s been proven quite capable of creating huge long term growth for the better companies, so I thought we’d take a look today.
Is that enough to tease you to keep reading? OK, OK — since you are my delightful Stock Gumshoe Irregulars and you’ve paid to read this far, I can jump the gun and tell you that the fabbo industry being teased is insurance, and that the one stock that is specifically hinted at by Dyson is Greenlight Capital Re (GLRE), David Einhorn’s captive reinsurance company.
But I don’t want to spoil the fun as we take a look at the teaser, so we’ll also have a gander at what Dyson calls this “Golden Cross” and at how he teases and touts Greenlight … OK?
Insurance is a great business in part because it can create free leverage for good investors — that’s something you probably already know if you’ve paid any attention to Warren Buffett’s annual letters (which are required reading for folks who want to understand investing basics, though if you’re brand new to the investing game you might want to read Greenblatt’s The Little Book that Beats the Market first, that’s the simplest explanation for why you’d want to buy a piece of a company, and how to figure out which companies are the best bets — not that Greenblatt talks about insurance, but I often get asked what my favorite introductory book is, and that’s it).
Basically, it works like this: Insurers collect premiums, and they have to hold money aside to back up the liability they’re assuming in exchange for those premiums. So if they collect $600 from you to ensure your house, they have to hold part of that money in reserve in case your house burns down. If the year passes and the insurance coverage is over, they “earn” that premium. For some kinds of coverage, like worker’s compensation insurance when big issues like asbestos work through the courts for decades before big payouts happen, liability doesn’t expire for a long time, so an insurance company might have to hold the cash for years and years until the potential liability is exhausted and they actually get to “earn” the premium money.
But during the time that they hold these “unearned” premiums, they can invest the premium money they’re holding (it’s usually called the “float,” though that isn’t an accounting term that’s standardized in SEC filings) and they earn the investment returns on that money, even though the money has not been earned yet and it isn’t really theirs yet. In most cases, this float is invested in safe stuff, because a big chunk of it will end up being paid out eventually … so insurers often suffer when interest rates are low because they can’t just break even on their underwriting and collect a free 5% from long term government bonds.
But insurers who can write their policies profitably, breaking even or making money on the actual core business of taking risk in exchange for premium payments, get free leverage for their investment portfolio and, if they’re good investors, can dramatically ramp up their earnings as a result. In Buffett’s case, part of the reason he’s been able to build Berkshire Hathaway into such a colossus is that his effective insurance companies, like GEICO, were so well-run that they consistently made money on underwriting and therefore he not only got to use other people’s money to invest … he actually got paid by those people to invest that money.
So the key is: Underwrite profitably and invest profitably. Most insurers don’t do either all that well on a consistent basis, many are better at one or the other, and a select few, like Warren Buffett, do both really well over a long period of time and get godawful rich.
With that in mind, let’s look at Tom Dyson’s tease and see how he describes the situation:
“This rare, little-known strategy only works under specific market conditions. For the past 38 years it has been out of reach… but the window has just opened once more….
“The Golden Cross is very simple…
“If I had to explain it as an equation, it would look like this:
Cash-Rich Insurance Company
Genius Money Manager
Thankfully, he doesn’t just stick with the “equation” but goes into the story of Warren Buffett building Berkshire Hathaway, one example of this kind of “golden cross” …
“Buffett was a great investor, but the greatest thing he ever did was take advantage of a rare but amazing window of opportunity that opened up for him some forty years ago….
“The window for the Golden Cross opens up when all of the following elements are in place:
- First, you need a major market crash. Stocks are cheap… companies are hungry for cash… it is a perfect time to buy… if you have cash and know what you are doing.
- Second, you need a slow recovery period. A big drop, followed by rapid recovery, does nothing for quantum growth. The reason being that people get back their confidence and begin buying again. This pushes prices back up too fast for Golden Cross investors to get in at the right price.
- Third, you need access to large quantities of liquid cash. All the opportunity in the world is nothing without the cash to take fast and immediate action. And, as you’ll see in a minute, nothing spins off ready cash like a well-run insurance company.
- Fourth, you need a true investment genius. This is essential. You cannot do it without a brilliant money manager to create the growth. There were many people who began investing at the same time as Buffett… but they did not have his genius.
“When you combine these four elements in one investment, you have a rare opportunity for Golden Cross-type returns.
“The Golden Cross Window Is Open Now”
There’s obviously a danger in taking one or two historical occurrences and extrapolating into the next occurrence — which is basically what you’re doing when you say that now is similar to the time when Berkshire Hathaway started really building steam in the 1970s and 80s, and that not only is the time similar, but that the company you’ve chosen or the manager you’ve chosen is going to be equally brilliant and fortunate.
But we can dream, can’t we? And you don’t have to be the next Warren Buffett to run a good company that might make investors money, of course — we hear about the next Warren Buffett at least a few times a year, whether it’s Prem Watsa or Bruce Flatt or whoever, but it’s kind of like trying to find the next Michael Jordan when he’s playing in high school … you’ll find a lot of really good players, but finding exceptional, once-in-a-lifetime talent that fulfills its promise is, well, rare. Duh. And until the last ten years or so, when he has become essentially deified, you could have always found folks to say Warren Buffett was just lucky, or had lost a step, or missed the tech revolution, or what have you. So the next Warren Buffett won’t seem like that until we look back.
So Dyson thinks that this “Golden Cross” window is open now, and he also goes on to add that having an atmosphere of political mistrust helps — comparing the political chatter now to the 1970-early 80s period of OPEC embargo, Carter’s malaise, Iranian hostages, etc.
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