Tuesday, July 15, 2014

Buffett and Ben: That’s As Good As It Gets—Redux—Part IV

How many Chinese Nationals does it take to bestow the title of “gu shen” on Warren Buffett? The answer would be a whopping 1,000, all of whom showed up in Omaha, Nebraska for Berkshire Hathaway’s annual meeting this past May. In addition, Chinese media outlets, anxious to transmit the goings-on back to the homeland, outnumbered their colleagues from other foreign nations. Oh! You don’t know the meaning of the Chinese word “gu shen?” Apparently, that appellation identifies Mr. Buffett as “the God of Stock Investing.” To his revering shareholders worldwide, that phrase may be considered even more relevant than the popular “Oracle of Omaha” cognomen used in the U.S.

The appeal for Buffett’s Chinese disciples (that included Chinese asset management firms) was the opportunity to learn about Buffett’s investment philosophy, return to China, and proclaim first hand knowledge of how to mimic the strategies practiced by the God of Investing. Of course, they could have saved significant time, energy, and travel expenses with a simple expenditure of $15 for a one-year subscription to Money Magazine. After all, what more would one need than, as trumpeted on the cover of the June issue, “BUFFETT’S SECRET FORMULA REVEALED.”

Money Madness

WOW! Really? If Buffet is considered the God of Investing, he is also known as the King of Transparency when it comes to his “secrets” of investing. Each of his shareholder letters could be considered an investment primer; the hundreds of books and articles devoted to his “secrets” tell it all––supposedly. Did Money really divulge some obscure, abstruse, enigmatical precepts, heretofore unknown to the investment world? Not really. The magazine describes two different investing systems, both of which rely on two primary determinations–– 1) invest only in textbook value plays; 2) Invest only in quality entities.

This is the big secret? Anyone familiar with Warren Buffett knows that he is the ultimate value investor who buys only high quality companies. Even the author of one of the “secret” systems is quoted as declaring that a big part of “the secret behind Buffett’s success is the fact that he buys safe, high quality, value stocks.” What the two systems attempt to decipher, is how to quantify the concepts of “value” and “quality.” Buffett still abides by his mentor at Columbia, Benjamin Graham’s (considered the “father of value investing”) definition of value as assets minus debt, now known as book value. One team’s gauge of quality combines 21 measures, and is too complex to even consider.

The author of the other system however, argues, “something called ‘gross profitability’ (sales minus the cost of goods sold, divided by assets) can help explain long-run returns.” To prove his point, he maintains that “a theoretical portfolio of big companies with a high combined score on value and profits, would have beat the market by an annualized 3.1 percentage points from 1963 through 2012.”

This information was published in the influential Journal of Financial Economics. However, what the author, the financial journal, and Money magazine neglected to reveal is, during an almost identical long-term period, under Warren Buffett’s management, Berkshire Hathaway exceeded the performance of the market by an annualized 9.9 percentage points. That’s more than triple that of a system that seems to have impressed Money. The folks at Money apparently were asking its readers the oft quoted question posed by Chico Marx (Yes, Chico, not Groucho), “Who you gonna believe, me or your own eyes?”

What You Should See

Unfortunately, too few investors are willing to believe that sometimes the most sensible decisions are right before their own eyes. While the presence of some 1,000 Chinese nationals at the Berkshire Hathaway shareholder meeting was impressive, even more so was the estimate by the Wall Street Journal that there were “roughly 40,000” people in attendance. According to Buffett himself, this was 3,000 to 5,000 more than last year, and the largest shareholder meeting for any company, ever.

It is obvious from these and other metrics that Berkshire Hathaway shareholders agree with the Chinese that Warren Buffett is indeed the God of Investing. With a market capitalization of more than $313 billion, (the fifth largest in the U.S.) its holdings are larger than those of the largest mutual fund (Vanguard’s Total Stock Market fund). In fact, some consider it to be a virtual mutual fund because of its diverse portfolio. If that is the case, it certainly has the most successful mutual fund manager of all time.

Don’t Just Sit There

What puzzles me is why anyone would attempt, and believe they could copy Warren Buffett’s investment style based on a magazine article, or book, or a suggestion by any kind of investment manager, when the better solution is so obvious. This is best illustrated by a not so new story I’ve used in past articles. It goes like this:

A deeply religious man, whom I will call Dave, finds himself in dire financial trouble. He prays earnestly to his God to help him out of his predicament. “God, I'm about to lose my car. Please help me. Let me win the lottery.” Lottery night comes, but sadly, Dave is not the winner.

Things go from bad to worse. Without a car to get to work, Dave loses his job. Without a job, his mortgage is foreclosed on, and he loses his home. Without a home, his wife leaves him, taking the kids. After each horrible step in the mounting crisis, he pleads with God to let him win the lottery, but he never does.

Finally, broke, hungry, living on the street, he tries again. “God, please, my life is a wreck. I have no car, no home, no family. Please let me win the lottery just this once so that I can turn my life around. I beseech you.”

Suddenly, a flash of light rends the sky, and the resounding voice of God echoes down from the heavens. “Dave, you have to meet me halfway on this. Buy a damn ticket.

How does this apply to Berkshire Hathaway? It would seem certain that if left to the opinion of the 40,000 shareholder meeting attendees, their response, in one resounding voice that echoes down from the meeting auditorium would boom: Buy the damn stock.

The Million Dollar Bet

That decision has been one of two investment possibilities that have been mentioned in this series of articles. The other possibility also involves Warren Buffett even though the fortune he has accumulated consists entirely of Berkshire Hathaway stock. As mentioned numerous times in this newspaper, he has also been a strong advocate of a particular index fund as the best single investment for the average investor.

Buffett has so much faith in that position that in 2008 he placed a $1 million bet with New York asset manager, Protégé Partners, that over a ten-year period, a low-cost S&P index fund will outperform the averaged returns of five hedge funds of funds (after all fees) that the firm carefully picked for the contest. Now, at the end of 2013, Vanguard’s Admiral shares — the S&P index fund that’s carrying Buffett’s colors — were up for the six years that began Jan. 1, 2008 by 43.8%. For the same period, Protégé’s five funds of funds, on the average, gained only by an estimated 12.5%. Go Buffett!!

The Real Shocker

In the May article in this series I wrote that in his new shareholder letter, Buffett describes a decision he made relating to his personal wealth that created shock waves through the professional investment community. More importantly however, it read “that decision provides the average investor with a free piece of invaluable advice by the best investor manager ever, advice that only the most honest money managers would advocate.”

If you can stand one more joke, the shock and surprise that Buffett’s decision provoked is similar to what happened when a beloved Pope died and went to heaven. Saint Peter greeted him in a firm embrace. “Welcome your holiness, your dedication and unselfishness in serving your fellow man during your life has earned you great stature in heaven. You may pass through the gates without delay and are granted free access to all parts of heaven. Is there anything special which your holiness desires?”

“Well, yes,” the Pope replied. “I have often pondered some of the mysteries which have puzzled and confounded theologians through the ages. Are there perhaps any transcripts that recorded the actual conversations between God and the prophets of old? I would love to see what was actually said, without the dimming of memories over time.”

St. Peter immediately ushered the Pope to the heavenly library and explained how to retrieve the various documents. The Pope was thrilled and settled down to review the history of humanity's relationship with God.

Two years later, a scream of anguish pierced the quiet of the library. Immediately several of the saints and angels came running. They found the Pope pointing to a single word on a parchment, repeating over and over: “There’s an ‘R’. There’s an ‘R’. There’s an ‘R’... It's not CELIBATE, its CELIBRATE,”

Celebrate Option #2

If you really want something to celebrate, it’s Warren Buffett’s following declaration in his most recent shareholder letter, emphasizing what he has been advocating for years. If what follows, a most personal admission, posted in the most public manner possible, doesn’t convince you that what I have been citing as option #2 throughout this series is advantageous, nothing will.

“My money, I should add, is where my mouth is: What I advise here is essentially identical to certain instructions I've laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife's benefit. (I have to use cash for individual bequests, because all of my Berkshire Hathaway shares will be fully distributed to certain philanthropic organizations over the 10 years following the closing of my estate.) My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard's.) I believe the trust's long-term results from this policy will be superior to those attained by most investors –– whether pension funds, institutions, or individuals –– who employ high-fee managers.”

Now That’s As Good As It Gets!


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