News flash: Buying what Buffett buys makes you money
moneyrelations :: Nov.26.2007
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A couple of weeks ago, a study by two university professors was circulating in Warren Buffett land that buying whatever the ol’ man buys makes you money.
Egads, you don’t say!
Okay, I’ll turn off the sarcasm because it really is an interesting read. The new study is entitled, “Imitation is the Sincerest Form of Flattery: Warren Buffett and Berkshire Hathaway“.
Berkshire Hathaway had bested the market an incredible 28 out of 31 years. From 1976 to 2006, Berkshire outperformed the S&P 500 index by 14.65%. The study investigated if this achievement is due to luck, portfolio risk, or a “Buffett effect”.
The Efficient Market Theory suggests that given enough investors, a few people would surely beat the market all 31 years by sheer dumb luck. The professors showed that with Berkshire, this was due to skill.
What I took away was this nugget of information:
Efficient Market Theory does not claim that stock prices are correct at all times, it only states that stock prices are correct on average. At any point in time, stocks may be mispriced but one does not know whether they are underpriced or overpriced.
Also, we presume that Berkshire’s investment style is not risky since Buffett is a noted value investor. However, this study made a case that Berkshire is really a large-cap growth investor.
Finally, there’s the “Buffett effect” that given his name and reputation, whatever Buffett touches turns to gold. Well, would you believe that investors under-react to Berkshire investment disclosures?
The market also appears to under-react to the news of a Berkshire stock investment since a hypothetical portfolio that mimics Berkshire investments created the month after they are publicly disclosed earns positive abnormal returns of 14.26% per year.
A recent example would be the fact that when it was disclosed Berkshire had bought a stake in CarMax, the share price rose 7.5%, or $1.62 to $23.09 on Thursday, November 15. A little more than a week later, it closed this past Friday at $20.65.
It was later found that it wasn’t Buffett doing the buying but rather Berkshire subsidiary GEICO’s Lou Simpson (chief investment officer and no slouch himself). However, the study made note that it was the collective investment skill of Warren Buffett, Charles Munger, and Lou Simpson that made Berkshire a success.
Overall, it was a good read and I learned a lot from the report’s surprising discoveries. It will be interesting to know if other academics will dispute the number crunching.
Still, given Berkshire’s track record, buying whatever it discloses a month later might not be a bad idea.
In the news, Investing, Warren Buffett ::
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But if markets are efficient and current prices fully reflect all information, then buying and selling securities in an attempt to outperform the market will effectively be a game of chance rather than skill.”
I also found Chapters 15 and 21 in James Pardoe’s book “How Buffett Does It”, to be particularly relevant in this regard.
Here’s an extract from the writings of someone else who had his own views on Company Analysis, EMT and ‘Random Walks’ ….
“Many books have been written stressing the random nature of the price movements of shares listed on Stock Exchanges. Many Master degrees in commerce have been awarded to proponents of what is termed the ‘Random Walk Movement’.
I differ fundamentally with these people. I maintain that the Stock Exchange should never be viewed as a whole. There are hundreds of different companies listed on Stock Exchanges. For very good quantitative mathematical reasons, the shares of some will definitely rise in price, and others, for equally good mathematical reasons, will definitely fall in price in the forthcoming year.
The first requirement of the successful investor is that he/she be capable of distinguishing between these two very different categories of shares. To accomplish this end I formulated the approach which proposes several criteria with which a share, considered for purchase, should comply. It will be found that my criteria are sufficiently strict that only a select minority of shares satisfy them. This feature effectively removes the element of gambling from the scene.
One cannot stress this strongly enough … Correct Stock Exchange investment is most definitely not gambling, it is in fact highly erudite.”
Of course, for every quote I can come up with, I’m sure someone will come up with an alternative.
Therefore, like most aspects of investment strategy, I believe it’s up to individuals to decide for themselves what they want to use, and what they don’t want to use.
If someone wants to incorporate EMT into their strategy, then their own personal future experiences will show them how effective it is, or isn’t.
IMO it’s generally a case of “What Works, and What Doesn’t Work.”
“Buffettology” is a MYTH, Buffett really invests the way he thinks on a particular year. There are themes, but overall he’s very versatile and not a one trick pony, whether you called the pony “growth” or “value”.
Egads, jen! Thanks so much for taking the time to comment!
I totally agree that Buffett is not a one trick pony. He’s a charming man but he’s also a very shrewed one. And there’s absolutely nothing wrong with that. I just think that the moat and buy and hold forever strategy has been played out as a feel good story for us mortals.
Obviously Buffett has many other investment vehicles such as junk bonds or his foray into foreign exchange market in 2002.
I could go with the EMT but I just feel as though there are so many layers of investing I don’t know about. And I think part of the fun in the journey is finding out