A Critical Look at Warren Buffett

The inimitable, sagacious Warren Buffett is known for his aphorisms, but is this useful investment advice, and second, is Warren Buffett really the great investor as he’s cracked up to be?

Don’t overtrade/Hold stocks forever. Continued:


Buy When There’s Blood in the Street. Continued:


The Oracle’s tips are easily countered with some obvious examples

It’s a matter of fact that the Enron/Worldcom/pets.com investors who made two trades (buy and then GTFO) did better than those who only bought and ‘held forever’. Holding stocks forever is terrible advice because you have no way of predicting or controlling the outcome of anything. When we’re talking multi-year buy & hold timeframes, there is so much you don’t know, that you cannot back-test or develop quantitative models for risk management. Your fate is entirety in the hands of the management, external micro & macro economic factors, and the whims of the market. I have traded in and out of hundreds of stocks and without hesitation can list dozens of companies that many years later are duds; RIMM, maker of the Blackberry that was superseded by Android and Iphone; numerous potash, emerging market, coal, steel, commodity, and energy companies that are trading at a fraction of their 2008 highs; and many more. In his most recent shareholder letter, he advices to just buy an index fund, an anti-climatic repudiation of his legacy as a great stock picker.

How ‘bloody’ is subjective. Citigroup seemed pretty bloody when it fell from $50 to $30 in 2007, but the actual bottom was $1, and so on. There’s too many examples to count when buying when the streets were bloody only yielded more blood. Buffett says to invest in companies that will be around a long time. Fair enough, but existence and solvency are not mutually inclusive. A business can technically still carry out its functions even if it’s undergoing bankruptcy proceedings. Such examples includes Hostess, Sbarros and Arbys. Under bankruptcy, the common shares are canceled and you lose, with few exceptions, everything. So the real question is: what company will never go bankrupt? Harder to answer. And still, a company can exist, not go bankrupt, but still provide a terrible return to shareholders (Radioshack, Sirius XM Radio, Walter Energy to name a few).

Let’s look at the Oracle’s own history. According to Wikipedia, in 1956 at the age of 26, he stopped working for Benjamin Graham and had a net worth of $1.5 million in 2012 dollars. This is impressive, but not unheard of since there are many 20-30 years-olds today with that much money, like celebrities, athletes, entrepreneurs and heirs. What happens next is overlooked. Many just assume he bought some stocks and became the richest man in the world.

In 1957, Buffett had three partnerships operating the entire year. He purchased a five-bedroom stucco house in Omaha, where he still lives, for $31,500. In 1958 the Buffetts’ third child, Peter Andrew Buffett, was born. Buffett operated five partnerships the entire year. In 1959, the company grew to six partnerships operating the entire year and Buffett was introduced to Charlie Munger. By 1960, Buffett had seven partnerships operating: Buffett Associates, Buffett Fund, Dacee, Emdee, Glenoff, Mo-Buff and Underwood. He asked one of his partners, a doctor, to find ten other doctors willing to invest $10,000 each in his partnership. Eventually eleven agreed, and Buffett pooled their money with a mere $100 original investment of his own. In 1961, Buffett revealed that Sanborn Map Company accounted for 35% of the partnership’s assets. He explained that in 1958 Sanborn stock sold at only $45 per share when the value of the Sanborn investment portfolio was $65 per share. This meant that buyers valued Sanborn stock at “minus $20” per share and were unwilling to pay more than 70 cents on the dollar for an investment portfolio with a map business thrown in for nothing. In 1962, Buffett became a millionaire because of his partnerships, which in January 1962 had an excess of $7,178,500, of which over $1,025,000 belonged to Buffett.

Buffett was able to convince some strangers and acquaintances to give him millions of dollars. Had this not happened, he would not have been so rich because differences in initial inputs are magnified when compounding. It was much easier in the 50’s and 60’s to find clients due to the novelty of investing and the stock market, just like Nigerian Email spammers made the bulk of their fortunes in the 90’s when email was an unregulated novelty and people were more trusting of the new medium. Not only was it easier to find clients, but it was also easier to buy stocks because the markets were less efficient. Serial correlation (how likely stocks are to ‘trend’) peaked in 1971, floated around zero-ish from 1980 to 2000, and is now negative. A market with a high serial correlation exhibits a lot of redundancy, meaning an up-day is more likely to be followed by another up-day, and so on. This makes the market easier to ‘game’ by an astute investor. Not only that, but stocks went up much more, and kept going up. In the 50’s and 60’s it wasn’t all that uncommon for a stock to go from $5 to $50 in a year or two. Nowadays, that’s very rare. As you can see below, serial correlation was highest during Buffett’s period of peak rate of return during the 40’s-70’s.

Is he the greatest investor ever? He’s pretty good, but probably not the greatest, especially after factoring in outside money, the tailwinds of an easier market, and the special arrangements he has with management to buy shares at abnormally low prices with abnormally high dividend yields, such as Bank of America and Goldman Sachs in 2008.

Some more from the expert on Warren Buffett, James Altucher