Buffett Beyond Value

Oracle or octopus? Unlike Snowball, the recent biography of Warren Buffett, the even more recent Buffett Beyond Value promises to help us understand and emulate the World’s greatest investor, rather than tell his life story. It does, to a degree. Author, Prem C Jain, a finance professor,  has studied 50 years of annual reports and earlier partnership letters from Berkshire Hathaway, Buffett’s investment company. Jain’s fascination is fuelled by the scepticism of fellow academics, many of whom dismiss Buffett’s 44 year record beating the stock market as the exception that proves the rule that it is impossible to make above average returns. Clearly it is possible, so how does Buffett do it? The answer is a familiar one, that Buffett married the value school of investing championed by his mentor Benjamin Graham, to elements of growth investing. Hence Buffett’s adoption of principles like intrinsic value, the value a skilled analyst puts on a company, as opposed to market value, and margin of safety, buying shares only when they cost considerably less than intrinsic value. Jain explains the jargon well and despite its horribleness, the calculation of intrinsic value is well established in financial theory, and not particularly difficult. It’s the value of future earnings (or cash flows) in today’s money. The calculation may be easy, but estimating the inputs, future earnings and how much to discount them by to work out their current value, is very, very difficult. For some, the heroic assumptions required render the results meaningless, a case of garbage in, garbage out. What we need to know is how Buffett estimates earnings growth. What we get are Jain’s estimates, which are based on past growth rates, exactly what analysts around the globe do. It’s a reasonable introduction to company analysis, but it doesn’t tell us how Buffett does it better. Perhaps his estimates aren’t better. Jain says Buffett’s secret growth ingredient, is high quality management. He says Buffett favours businesses where the founding family owns a significant number of shares, where the managers have a long record of success, and pursue shareholder friendly policies like share buy-backs, not self-aggrandising policies like rewarding themselves with share options. Too often, though, Jain bestows greatness on a particular manager, simply because Buffett does, which isn’t very illuminating. Although the book has a chapter on the efficient market hypothesis summarising the academic research and Buffett’s views (you can beat the market, but it’s hard work) he doesn’t take it on directly. Buffett appears to be a living contradiction of EMH, but is he? Just as Paul the Octopus ‘predicted’ World Cup Winners, an investor can amass a fortune through luck, not judgement. EMH merely states the market processes information efficiently, meaning it is impossible to beat the market skilfully. Some investors will beat it by chance. If Buffett’s methods can be emulated, though, then there’s more to them than luck. So where are all the clones, and how are they doing? Nearly thirty years ago Buffett himself showed how you could answer this question in a talk on The Superinvestors of Graham & Doddsville. Buffett argued that because a group of successful investors whose records he analysed all shared the same intellectual heritage, they had all been taught by Benjamin Graham and his co-author David Dodd, there was more to their success than chance. Since Buffett has been writing about his methods for half a century there must be emulators, other investors demonstrating the efficacy of them. An updated version, the Superinvestors of Buffetsville would validate value plus growth. Emulating Buffett could be dangerous, though, for private investors and my main beef with the book is it distils advice from Buffett’s writings uncritically. Jain recommends investors buy low and play it safe, concepts few value investors would disagree with, and project what the company will look like in 10 years, an activity perhaps better left to octopi and Buffett. Berkshire Hathaway has a market capitalisation of $200bn, so today Buffett’s perspective is very different from that of an average investor. He buys shares in big companies and holds them for long periods not just because he likes them, but because he has to. The size of Berkshire Hathaway renders all but the biggest companies insignificant, and the infrequency with which these companies meet his criteria for soundness and price mean good ideas don’t come along very often. So his success limits him, and needn’t limit lesser investors. It’s also a huge advantage. Most of Berkshire’s investments are wholly owned, the product of deals made possible by Buffett’s reputation. It’s fascinating how he’s created a refuge for owners of family businesses wishing to continue running their companies under Berkshire’s protective umbrella. Buffett’s relevance, though, to someone like me, hoping to make more of his modest pension than a fund manager would, is not obvious. With, perhaps, a little more detail than usual this book does answer the question: What does Warren do? A more relevant question is perhaps, What would Warren do, if he had less than £1m to invest? I doubt he’d do what he does now, or emulate another investor in the way Jain slavishly decodes him. Buffett didn’t copy Graham, and neither did any of the superinvestors he wrote about. I’m worried this review is ending too negatively. BBV is an interesting book, it contains many discussions of companies Buffett has invested in, and its exposition of value investing is clear and concise. It’s sharpened up my views on identifying good management. On Buffett’s almost mythical ability to project a company’s future, though, I found Jain had little to add beyond advising investors to read a lot, and think a lot. We all know Buffett does a lot of reading and thinking, I’m not sure how far it gets us though, or indeed how far it’s got him. - When money dies  Adam Ferguson, the author of ‘When Money Dies’ rediscovered by Warren Buffett, says: In Britain today there is this debate between neo-Keynesians who want to postpone any tightening of the economy and those who say it should be done at once. To my mind it is a nondebate, because politically now is the only time tightening can be done. In a year or so it won't be possible, politically, any more. Ken Rogoff says his 800 year study shows recoveries are slow after financial crises, but unless governments cut debt sovereign crises will follow as surely as night follows day. Behavioural economist Dan Ariely explains how markets don’t efficiently cancel out mistakes by individuals, they sometimes aggregate them. John Plender says high frequency trading is front-running, so why is it allowed? Diageo plans to plug its pension gap with immature whiskey. Research from Gurufocus.com shows insiders are like value investors, buying when shares are cheap and selling when they’re expensive. James Montier is stung out of a two-year blogging slumber by an uppity economist who thinks bloggers shouldn’t blog about things they don’t understand. Montier says the economics profession is in a state of ‘learned helplessness’.

Comments

I agree Richard, Buffett is great to learn from but you will have to come up with your own ideas.

But that is good news because we as private investors have infinitely more opportunities because we have less to invest.

Until we're really successful :-)

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