(MONEY Magazine) – Lou who? That's the response many investors had to Warren Buffett's recent announcement that Louis A. Simpson is the man who will manage Berkshire Hathaway's investment gazillions if, one day, Berkshire's Cherry Coke-fueled chairman cannot. Even the legions of Berkshire loyalists who have heard Simpson's name bandied about over the years know very little about the very private and very accomplished man tapped to become the next "Oracle of Omaha."

Among the investing cognoscenti, however, this man's name is legend. Michael Horowitz, a principal at money-management firm EnTrust Capital, sums up the sentiment of many top investors: "Lou Simpson, to me, is one of the deans of investing."

Simpson's presence on several high-profile corporate boards is a telling sign of his status. At AT&T, fellow directors include cable magnate John Malone, Citigroup CEO Sandy Weill and Johnson & Johnson CEO Ralph Larsen. It's also telling that when Buffett helped right a troubled Salomon Bros. in the early 1990s, the person he brought on to the board was Lou Simpson.

Simpson, 64, already plays an important role at Berkshire. Officially, he manages $2 billion-plus in equities for Berkshire subsidiary Geico, the auto insurer, but "I think he's been key in the last few years in bringing new ideas to Mr. Buffett and Mr. Munger in terms of asset allocation," says David Braverman, an equity analyst with Standard & Poor's.

Who is this mystery man, and how might he shape the Berkshire of the future? Months ago, back when Simpson, who is now co-chief executive of Geico, remained the rumored, but unofficial, candidate, MONEY began exploring the world of this intensely private figure. We found a highly confident, self-disciplined, intellectual loner, a man with a rare intuitive sense for evaluating businesses and people. What we didn't find is a Buffett clone. While Simpson shares core values with the master, he seems willing (and better able, with his smaller pot of funds) to move faster than Buffett. Moreover, his penchant for investing in telephone and cable companies, combined with his venture-capital experience, may make him more comfortable with technology stocks than the notoriously tech-averse Buffett. "Lou is very much his own man," says former Geico CEO John J. Byrne. "His most important distinguishing trait is his stark independence of judgment."

While Buffett seems comfortable in the limelight--or at least resigned to it--the reserved Simpson does all he can to keep the media at bay. He declined interview requests, as did some of his friends and former associates. ("He really doesn't want this story to be done," said one.) Buffett also kept mum, explaining that while he's delighted to talk about managers if they want him to, "most of them just enjoy running their business and are not looking for publicity." Over time, however, dozens of conversations with ex-employees of Simpson, former colleagues, executives of companies that Simpson has invested in or serves on the board of, fellow trustees, and major Berkshire shareholders came together to provide a rare window into how Simpson thinks and operates.

JUST HOW GOOD IS HE?

In Berkshire's annual report for 1995, the last year that Simpson's returns were reported separately, Buffett proudly noted that "between 1980 and 1995, the equities under Lou's management returned an average of 22.8% annually vs. 15.7% for the S&P 500." Perhaps even more impressive, Byrne notes that Geico achieved a 30% annual return on capital for 10 years and that "it was Simpson, that one single man out of 6,000 people, that took the return on capital from 20% to 30%." (Buffett has said that Simpson has underperformed the S&P 500 in recent years, as he has himself, and that it "bothers me not a nickel.")

Simpson runs Plaza Investment Managers, the investment arm of Maryland-based Geico, out of the small, exclusive community of Rancho Santa Fe, Calif., home to the likes of WebMD chief executive Martin Wygod and McDonald's heiress Joan Kroc. Simpson didn't come into the Berkshire fold at Geico until he was in his mid-forties. On his way to that post he had several jobs that helped shape his investing philosophy. Simpson's hands-on investment education began in 1962. After earning a degree in accounting and economics from Ohio Wesleyan and a master's in economics from Princeton, he won a coveted spot at tightly-knit investment firm Stein Roe & Farnham. He worked closely with one of the more aggressive partners but in 1969 moved on. "Lou, in part, left Stein Roe because he thought they were too conservative and therefore missing--this is a young Lou Simpson--many great opportunities," says former Stein Roe colleague Richard Peterson.

He found the antidote to Stein Roe's conservatism at Shareholders Management, a Los Angeles firm that was getting lots of press for its red-hot Enterprise Fund--but he picked the wrong moment to join. Enterprise, under maverick investor Fred Carr, had been tearing up the performance charts by investing in emerging growth companies. But soon after Simpson arrived, the climate on Wall Street shifted dramatically, and the fund tumbled. Carr left, and Simpson himself stayed only eight months. It didn't help that in 1970 the Securities and Exchange Commission filed a complaint against the firm, alleging record-keeping violations. "It was a painful, searing experience for Lou," says Peterson. "Before then, Lou was a pure growth investor--a shoot-for-the-moon guy. I think he learned the importance of going into really good situations that are relatively low risk--that you need growth, but also low valuation."

Simpson landed at Western Bancorporation in 1971. There, he helped create a new unit to develop a consistent investment policy for the bank's far-flung trust operations. Simpson became president of the unit, Western Asset Management, six years later.

It was in 1979 that Simpson came onto Buffett's radar screen. At that point, Berkshire owned about 30% of Geico. Byrne, Geico's CEO, was looking for a chief investment officer and sent three candidates to see Buffett. "He called me as Lou was leaving his office," recalls Byrne. "He said, 'Stop the search. That's the guy.'" Geico didn't pay "outlandishly" to get Simpson, adds Byrne, because "Simpson really wanted to get back to picking good stocks and being a good investor rather than managing a company."

Simpson's investment gains helped shore up Geico, which had been teetering on the brink of bankruptcy in 1975. Simpson's mandate: Before the stream of premium payments must be paid out in claims, invest some of that money (the "float") to get a return that beats that of Standard & Poor's 500--with low or no risk of permanent loss. His steady success in achieving that goal is what has made him Buffett's heir apparent.

LOU'S RULES

Simpson laid out his basic investing guidelines in an old Geico annual report: Think independently; choose high-return businesses that are run for the shareholders; pay only a reasonable price, even for an excellent business; invest for the long term; and do not diversify excessively.

Glenn Greenberg, co-head of money manager Chieftain Capital and a former Simpson employee, elaborates: "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." Adds fund manager L. Roy Papp, who worked with Simpson at Stein Roe: "Lou is very definitely a growth-stock buyer--but it could be modest growth, and surely growth at a reasonable price."

Here are three other key elements of Simpson's style.

--Strong management. Simpson spends a lot of time getting a feel for an organization's culture and the motivation and skills of its CEO. Simpson wants management that "has done things to show they're good people," such as share repurchases, and "not giving away the house in terms of stock options," says a major Berkshire shareholder. Ron Rogers, chief financial officer for Shaw Communications, recalls when his team met with Simpson's people: "They wanted more insight into how we think and interact."

--Strong cash flow. When Simpson turns to the financials, he takes a hard look at a company's free cash flow--defined as the cash generated by the company's operations minus the money it needs to maintain the business. It's a good indicator of how much money the company has available to boost shareholder returns. Specifically, Simpson assesses free cash-flow "yield"--that is, cash flow per share divided by the stock price. "In essence, he looks for companies that have a free cash-flow yield significantly higher than prevailing interest rates," says a money manager who knows Simpson well. "If he thinks the prevailing rate is 7%, then he wants at least 10%."

--Concentration. Byrne recalls that when he was at Geico, Simpson kept 50% to 60% of his assets in his best four ideas. Things haven't changed much: The most recent detailed data available for Geico (as of Dec. 31, 1999) show a seven-stock portfolio: Jones Apparel, First Data, Freddie Mac, Shaw Communications, U.S. Bancorp (which is being acquired by Firstar), Nike and Great Lakes Chemical.

So how does Simpson apply his rules? Look at Jones Apparel. Jones doesn't need to make big cash outlays; it has strong management and good brands. Clothing is a notoriously fad-driven business, but Jones focuses on more basic styles. While the absolute growth prospects are "not great," compared with the likes of, say, Cisco, Chieftain's Greenberg notes that "after you analyze the quality of the business, you have to look at what price you're paying." You can buy Jones for about 14 times its free cash flow; for Cisco, you'd pay 71.3 times its cash flow. In sum, you've got reasonable valuation, strong brands and good cash flow--a classic Simpson scenario.

SHADES OF DIFFERENCE

While Simpson and Buffett share some basic investment tenets, there are defining differences between them. "Simpson's been more willing to go with lower-return businesses, like Burlington Northern, and into franchises that seem more fashion-related, like Nike," observes one money manager. And Simpson will buy stocks that he'll sell in three to four years. During 1999, Simpson whittled positions in First Data, Manpower and Nike. Three stocks disappeared from the portfolio entirely: Corus Entertainment (a Shaw spin-off), Cox Communications and Robert Half International. Less detailed filings show that this year he's done some buying, paying $611 million for Dun & Bradstreet, Gatx and several unnamed stocks. Of course, should Simpson come to manage all of Berkshire's billions, he may find that he has to move more slowly than he does today.

It also seems likely that a Berkshire portfolio under Simpson would be heavier in tech. Says fund manager Papp: "Mr. Simpson is a little more broadminded than Mr. Buffett and would be more willing to deviate from a given prescription, from a set of rules."

Take Simpson's 1999 investment in Shaw Communications, for example. At first glance Shaw may seem to violate one of Simpson's guidelines: avoid capital-intensive businesses. After all, wiring a city for cable requires huge outlays. But cable companies have the potential to achieve a monopoly-like position in their territories and, once they finish upgrading their systems, to throw off tremendous free cash flow. "Shaw is probably the best-run cable company in Canada by far," says BLC Securities' Mary Anne Demonte-Whelan. "It's been far more focused than other cable companies." Observes CIBC World Markets analyst Robert Bek: "Simpson looked outside the box and found a way to play the sector in a very inexpensive way and in a very high-quality way."

"It's not unlikely that Lou's team would define a broader range of industries as predictable than Warren would," says a close observer of Berkshire. "For example, telco stocks might be something they felt capable of understanding and investing in, whereas Warren might lump them in with technology." It's not that Warren doesn't understand tech, but he feels tech firms are too vulnerable to change. Adds the source: "Lou's team is mostly guys age 30 or so, who are more comfortable with stocks like telcos."

Nowhere are the contrasts between Buffett and Simpson more striking than in how they invest their own money. Buffett has well over 99% of his money in Berkshire stock. Simpson seems to cast a wider net, and judging from Securities and Exchange Commission filings and the list of assets divvied up in Simpson's recent divorce from his wife of 40 years, he seems willing to take fliers in tiny, relatively untested companies. For example, he has holdings in $5.8 million market-cap Apache Medical Systems (trading at 78[Cents]), $42.7 million market-cap CollaGenex Pharmaceuticals (trading at $5.44) and health-care outsourcing firm Cohr, which is privately held. These investments were probably made via a venture-capital firm in which he has an interest, Fairfax Partners/The Venture Fund of Washington. sec filings show that Simpson also owns about 23% of International Dispensing Corp. (trading at 0.59[Cents]), a small company developing an "aseptic gravity flow valve." A database search also shows him on the advisory committee of Castle Creek Capital, a private firm specializing in bank turnarounds, and on the board of Direct Stock Market, a company that offers high-net-worth investors access to private equity offerings over the Web.

Simpson also gets exposure to emerging technologies through his work on the board of SAIC Venture Capital Corp., a subsidiary of Science Applications International Corp., a private company that describes itself as "the largest employee-owned high-tech firm in the nation." SAIC Venture chairman William Roper says Simpson's "advice and counsel on some venture stage investments has been invaluable."

"HE THOUGHT BIG"

Our picture of Simpson the investor, then, is fairly clear. Simpson the man is harder to figure. Driven, but not by ego. An East Coast Ivy Leaguer who feels more at home in a small California town. A loner who eschews attention, yet stands to inherit perhaps the highest-profile position a professional investor can hold. One of his defining traits is his commitment to civic pursuits. For instance, years after his three sons, Irv, Ken and Ted, graduated from the Cate School, a top boarding school, Simpson continues to provide investment expertise as a trustee. In 1990 he established a financial aid fund that gives away more than $1 million a year. "Typical of Lou, he gave the most generous gift in the world of development--one with no conditions," says Meg Bradley, the school's director of development. "He is a remarkably good and generous man."

Simpson also advises the Woodrow Wilson National Fellowship Foundation at Princeton (he was a Fellow in 1958). "He thought big, thought we should take more ambitious steps, go after more money," says Eleanor Elliott, former chairman of the board. "He gave us $500,000 in challenge money" for a program to help humanities Ph.D.s find jobs in the business world.

Simpson is "the opposite of CEOs with their private planes, drivers, limos and phones," Elliott adds. Rather than wanting everyone to be in awe of him, "he comes on gentle, assumes that you know your stuff and have something to contribute," she says. She met him one day in New York City's Penn Station on his way to a meeting. Not only was he lugging his own heavy suitcase, she says, but he also offered to lug hers. That's the kind of down-to-earth touch that the current Oracle of Omaha would appreciate.