Many professors argue that the stock market is efficient by quoting their “efficient market theory”. That is, the stock prices reflect everything that is known about a company’s prospect and about the state of the economy. There are no under-valued stocks because there are smart security analysts who utilize all available information to ensure unfailingly appropriate prices. Investors who seem to beat the market year after year are just lucky. Is it true?
Well, may be. But the Oracle of Omaha, Warren Buffett presented a group of investors, who have year in and year out, beaten the Standard & Poor’s 500 stock index. The hypothesis that they do this by pure chance is questionable. This group identified by a common intellectual home is worthy of study. Academic studies have been conducted on the influence of such variables as price, volume, seasonality, capitalization size, etc., upon stock performance, but no interest has been shown in studying the methods of this unusual concentration of value-oriented investors. In this group of successful investors that we want to consider, there has been a common intellectual patriarch, Ben Graham. But the children who left the house of this intellectual patriarch have made their investment choices in many different ways. They have gone to different places and bought and sold different stocks and companies, yet they have had a combined record that simply cannot be explained by any random chance. The patriarch has merely set forth the intellectual theory for making decisions, but each student has decided on his own manner of applying the theory.
The common intellectual theme of the investors from Graham-and-Doddsville is this: they search for discrepancies between the value of a business and the price of small pieces of that business in the market. Essentially, they exploit those discrepancies without the efficient market theorist’s concern as to whether the stocks were bought a certain specific way. They simply focus on two variables; price and value. Attached Table shows the record of the Sequoia fund, which was managed by Bill Ruane who Warren Buffett met in Ben Graham’s class in 1951 in Columbia Business School. Bill Ruane graduated out of Harvard Business School, worked in Wall Street before taking Ben Graham’s class. Bill’s record from 1951 to 1970, working with relatively small sums was far better than average. Sequoia fund was set up by Bill at the request of Warren Buffett to handle his partners when Warren wound up Buffett partnership. Bill was the only person who Warren recommended to his partners. Warren also said that if Bill would achieve a four-point-per-annum advantage over the Standard & Poor’s, that would be solid performance. Bill has achieved well over that, working with progressively larger sums of money.
Walter Schloss, Tom Knapp and Ed Anderson who are all disciples of Graham, produced similar results where practically, there is no duplication in their portfolios. These are men who select securities based on discrepancies between price and value, but they make their selections very differently.
I am an ardent follower of Buffett’s principles in value investing, managed (self-directed) my own IRA (Individual Retirement Account). My portfolio consists of Stocks and Calls and Puts Options. The longest running bear market helped me achieve a yearly ROI (return on investment) of 30.21% whereas the bench mark S&P Index made 19.66% (see attached) during the same period. One of the Super Investors of Graham-and-Dodsville, Bill Ruane had similar returns from his Sequoia fund, in the year 1982, viz., 31.2% and 21.4% respectively. Am I a Super Investor of Graham-and-Doddsville? I also followed the same set of rules and produced similar results.
In 2008, Warren Buffett issued a challenge to the hedge fund industry, which in his view charged exorbitant fees that the funds’ performances couldn’t justify. Protégé Partners LLC accepted, and the two parties placed a million-dollar bet.
Buffett has won the bet, Ted Seides wrote in a Bloomberg op-ed in May. The Protégé co-founder, who left in the fund in 2015, conceded defeat ahead of the contest’s scheduled wrap-up on December 31, 2017, writing, “for all intents and purposes, the game is over. I lost.”
Buffett’s ultimately successful contention was that, including fees, costs and expenses, an S&P 500 index fund would outperform a hand-picked portfolio of hedge funds over 10 years. The bet pit two basic investing philosophies against each other: passive and active investing.
Therefore, none of the fund managers could beat the market, viz., the S&P 500 index!
Berkshire Hathaway, Inc. 2013 Annual Report by Warren E. Buffett: (about passive investing)
I have good news for these non-professionals: The typical investor doesn’t need this skill. In aggregate, American business has done wonderfully over time and will continue to do so (though, most assuredly, in unpredictable fits and starts). In the 20th Century, the Dow Jones Industrials index advanced from 66 to 11,497, paying a rising stream of dividends to boot. The 21st Century will witness further gains, almost certain to be substantial. The goal of the non-professional should not be to pick winners – neither he nor his “helpers” can do that – but should rather be to own a cross-section of businesses that in aggregate are bound to do well. A low-cost S&P 500 index fund will achieve this goal.
The antidote to many kinds of mistiming is for an investor to accumulate shares over a long period and never to sell when the news is bad and stocks are well off their highs. Following those rules, the “know-nothing” investor who both diversifies and keeps his costs minimal is virtually certain to get satisfactory results. Indeed, the unsophisticated investor who is realistic about his shortcomings is likely to obtain better long-term results than the knowledgeable professional who is blind to even a single weakness.
Here is the incentive for the investors to learn active investing from the masters, Graham and Buffett and by following their value investing principles, can indeed become one of the Super Investors of Graham-and-Doddsville with investment returns beating the street by a large margin just like I have demonstrated here.
The heavy-hitters in investment business and their beat-the-street-stellar returns are shown below:
Recommended Reading: The Intelligent Investor, the definitive book on value investing, by Benjamin Graham (Appendix 1: The Super Investors of Graham-and-Doddsville)
Notable Quotes by Warren Buffett:
“I am a better investor because I am a businessman, and a better businessman because I am an investor.”
“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
“Give a man a fish and you feed him for a day. Teach him how to arbitrage and you feed him forever.”