On May 6th, as the world switched on their live-streams and settled in for the show, I was one of the fortunate few who got up bright and early, and walked through the brisk May air to the centre of town to see the event in person. The crowd buzzed in anticipation of the arrival of the people we had come to see. I, like many others, hoped to have the opportunity to listen intently to the proceedings, learning from the many years of accumulated wealth and wisdom that had been the hallmark of those at the helm of the firm. Warren Buffett and Charlie Munger did not disappoint.
Noting the concurrent coronation of King Charles III by mentioning only that there was reportedly a “conflicting broadcast” occurring at the time in UK, Warren Buffett opened the annual shareholder’s meeting of Berkshire Hathaway by offering, by way of substitution “our own King Charles”, his 99-year-old Vice Chairman, Charlie Munger. Thus began the annual pageant of profits, presided upon by the Oracle of Omaha himself, still sprightly and active at 92. With an unsurpassed record of investment returns – with per-share book value of his company, Berkshire Hathaway, growing at an annualised 20% for the past 57 years, [1] – Warren Buffet is considered one of the greatest, if not the greatest, investor of all time. The fact that people from all over the world, professional investors and amateur enthusiasts alike, make the pilgrimage for an all-day Q&A session is testament to the respect and regard in which he and Charlie Munger are held. As usual, the topics varied widely, from advice on familial wealth and inheritance to portfolio concentration. In almost every respect, the venerable pair agreed on the answers to the questions raised, bouncing insightful and humorous comments off each other in what was both an educational and entertaining display.
In one intriguing area, however, the Chairman and Vice Chairman disagreed. The question, framed through the lens of the recent breakthroughs in AI technology, was around whether value investing was still a bright prospect for future above-average returns, given the increasing number of people in the field, and the vastly improved technological tools at their disposal. After all, long gone are the days when Jay Gould – the venerated robber baron of the 1860’s – could buy gold in New York and sell it simultaneously for more in London: once an obvious disparity has been identified, and its profit potential publicised, it quickly disappears beneath the weight of eager investors. The question, in effect, asked if the same was true, or might eventually be true, for the value investing approach espoused for so many decades by the peerless capital allocators at Berkshire Hathaway.
Charlie Munger (of the two, more the pessimist) retorted that yes, he believed the market was now more competitive, and that value investors “should get used to making less”.[2] Warren Buffett disagreed. Noting that Charlie has been telling him the same thing since they met, Buffett put forth the argument, with which we agree, that the opportunities for value investing have little to do with technology, intelligence or analysis alone. Rather, they come from being patiently willing to take advantage of rare opportunities that arise from weak marketplace behaviours, or, in his words, from “other people doing dumb things”. He went on to explain that, not only did he think the opportunities to exploit poor behaviour would persist, but that they were now, in his view, greater than ever:
“I would argue that there will be plenty of opportunities… new things coming along don’t take away opportunities, what gives you opportunities is other people doing dumb things. In the 58 years we’ve been running Berkshire, I would say there’s been a great increase in the number of people doing dumb things… the world is overwhelmingly short-term focussed – if you go to an investor relations call, they are all trying to figure out how to fill out a sheet to show the earnings for year, and the management is interested in feeding them expectations that will slightly be beaten; that is a world that is made to order for anyone who is trying to think about what to do that should work over 5 or 10 or 20 years"
This answer, I think, addresses the core concern of a crowded field: after all, it should be self-evident that not everyone can avoid the traffic by taking the back roads. Why should the same not be true of value investing? Embedded in Buffett’s answer, I believe, is the realisation that the value approach itself is necessarily to look where others are not, to look beyond popular opinion and consensus to find the unloved, underowned and undervalued.[3] You simply won’t find these sorts of opportunities in areas that attract interest and attention, and therefore, by definition, you can’t truly crowd the value approach. Once people pile into an opportunity, pushing prices up to and beyond the true intrinsic value of the business, it ceases to be a prudent investment by the standards of the value approach. Inherently, the value investor walks the lonelier road.
The ability to invest in such a manner for any length of time is a strength that originates from the same place as the weakness which creates mispricing: behaviour. Even when investors are aware of the approach – and, given that Graham and Dodd’s value bible Security Analysis is still in print almost ninety years later, one has to assume people know about it by now – it is simply extremely difficult for investors to ignore the constant churning opinion poll that is the market, trust in their own analysis and work, and sit back to allow other investors to catch on. This is the case even when individuals invest their own capital: it is doubly true when institutional investors (a larger portion of the market) are at work, with layers of career risk and committee-based decision-making acting as grease to the wheel of human misjudgement. As he has made clear throughout his career, this is an area in which Warren Buffett actively and deliberately seeks to excel; in his Partnership letter dated January 1965 (prior to his acquisition of Berkshire Hathaway), he wrote:
“To many people conventionality is indistinguishable from conservatism. In my view, this represents erroneous thinking. Neither a conventional nor an unconventional approach, per se, is conservative. Truly conservative actions arise from intelligent hypotheses, correct facts and sound reasoning. These qualities may lead to conventional acts, but there have been many times when they have led to unorthodoxy. In some corner of the world they are probably still holding regular meetings of the Flat Earth Society. We derive no comfort because important people, vocal people, or great numbers of people agree with us. Nor do we derive comfort if they don't. A public opinion poll is no substitute for thought. When we really sit back with a smile on our face is when we run into a situation we can understand, where the facts are ascertainable and clear, and the course of action obvious. In that case - whether other conventional or unconventional - whether others agree or disagree - we feel we are progressing in a conservative manner”
Indeed, the very structure of Berkshire Hathaway, with its permanent capital base and seemingly impenetrable fortress of financial strength, is testament to the fact that Buffett and Munger value – almost above all else – reducing the risk of serious behavioural bias in their decisions. This, in turn, allows them to walk the lonely road: whether buying banks in 2008, or Amazon junk bonds in the post-dotcom world of 2003. By its nature, value investing arguably takes advantage of the inherently human behavioural biases that throw the baby out with the bathwater, leaving certain parts of the marketplace – be they regions, industries, or even individual companies – left for dead or ignored to the point of irrelevance. Here, where others are unable or unwilling to spend their time, is where the rewards can potentially be reaped to those able to look through the mirage of misery. Being able to do so consistently over time is another key reason that Buffett and Munger have amassed such a phenomenal fortune for themselves and their investors: over twenty years after the partnership letter above was penned – a timespan often encompassing a portfolio manager’s entire career – Buffett was still hard at it, writing that :
“The most common cause of low prices is pessimism - sometimes pervasive, sometimes specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It's optimism that is the enemy of the rational buyer. None of this means, however, that a business or stock is an intelligent purchase simply because it is unpopular; a contrarian approach is just as foolish as a follow-the-crowd strategy. What's required is thinking rather than polling” – 1990 Berkshire Hathaway Annual Report, Chairman’s Letter to Shareholders
Even investors a world apart from Omaha can’t help but agree with Buffett: from the leafy hedge fund capital of Greenwich, Connecticut, the quantitative investment firm AQR – led by finance PhD Cliff Asness – has published numerous papers demonstrating the persistence of the long-run outperformance of value strategies. In fact, they demonstrated that not only was value an approach that performed in US equities – where many studies have focussed – but in markets across the world, and in numerous asset classes, both in and out-of-sample.[4] In essence: when humans set prices and make judgements, often making knee-jerk decisions about what to love and what to shun, there is – and almost always will be – an opportunity for the long-term, fundamental investor.
The cherry on the value investing cake is that, unlike an arbitrage strategy that relies on a sale to justify a purchase, the value investor needs other market participants to behave irrationally – but doesn’t rely on them realising the error of their ways. In the very worst case, if you have paid a very low price compared to the long-term earnings power of the business, corporate cashflows – in the form of dividends or buybacks – can do all the work for you. If you buy a company on a 20% free cashflow yield, and the price doesn’t move an inch, the company can distribute a sizeable portion of your initial investment every year in cash; no sale is required to justify your purchase. A strategy that can work with no need for behavioural biases to correct themselves is a pretty sturdy thing.
Sources:
[1] Berkshire Hathaway Chairman’s Letter to Shareholders, 2022. For context, if you compounded $1,000 at 19.8% for 57 years – what Buffett has done with Berkshire per-share book value – you would today be sitting pretty with $29.7m.
[2] Berkshire Hathaway Annual Shareholders Meeting, May 6th 2023. Note that he did not argue that value investing would no longer outperform the market, but rather implied that, in his view, the margin for outperformance through time would be smaller
[3] This is not to argue that Buffett believes in the behavioural argument for value’s persistence, rather than the risk-based argument: in either case, investors are unwilling to own certain assets, and are willing to forgo (knowingly or unknowingly) a long-run positive expected return to avoid the short-term periods of underperformance they will inevitably suffer. The unwillingness to accept short-term volatility, or to own “boring” assets, in exchange for a long-run positive return is what I believe Buffett is referring to as “dumb” behaviour, allowing more patient and longer-term investors to gain over time.
[4] Aghassi, M., Asness, C., Fattouche, C. and Moskowitz, T.J., 2022. Fact, Fiction, and Factor Investing. The Journal of Portfolio Management, 49(2), pp.57-94.
Key Information
No investment strategy or risk management technique can guarantee returns or eliminate risks in any market environment. Past performance is not a guide to future results. The prices of investments and income from them may fall as well as rise and an investor’s investment is subject to potential loss, in whole or in part. Forecasts and estimates are based upon subjective assumptions about circumstances and events that may not yet have taken place and may never do so. The statements and opinions expressed in this article are those of the author as of the date of publication, and do not necessarily represent the view of Redwheel. This article does not constitute investment advice and the information shown is for illustrative purposes only.
