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50 Letters, 750,000% Returns

The secret to Warren Buffett's success is out! Was out 80 years ago, in fact...
 
On the 50th anniversary of Warren Buffett's taking control of the Berkshire Hathaway company, his annual letter to shareholders has been keenly anticipated, writes Tim Price on his ThePriceOfEverything blog.
 
It does not disappoint.
 
The compounded annualised gain in book value per share for the company from 1965 to 2014 equates to 19.4%. The annualised percentage gain for the S&P 500 over the same period, with dividends reinvested, equates to 9.9%.
 
That differential has delivered astronomical comparative performance. The overall gain for the US market comes to 11,196% over the period. The overall gain for Berkshire Hathaway stock comes to 751,113%. If the efficient market hypothesis were correct, a differential of that magnitude could not possibly exist, in this or any other universe. As Buffett himself has remarked,
"I'd be a bum on the street with a tin cup if the markets were always efficient."
So it is something of a shame that Buffett has never been awarded a Nobel prize for economics, as opposed to Eugene Fama, the father of the efficient market hypothesis, who has. No doubt Buffett's net worth of roughly $60 billion takes some of the sting away.
 
Buffett in this year's letter takes an explicit swipe at another piece of conventional investment wisdom – the idea that risk is essentially encapsulated in price volatility (step forward, Harry Markowitz, and any number of cheerleaders and 'consultants' who claim to be professional investors):
"For the great majority of investors, who can – and should – invest with a multi-decade horizon, quotational declines are unimportant. Their focus should remain fixed on attaining significant gains in purchasing power over their investing lifetime.
 
"For them, a diversified equity portfolio, bought over time, will prove far less risky than Dollar-based securities [ie, cash and bonds]. If the investor, instead, fears price volatility, erroneously viewing it as a measure of risk, he may, ironically, end up doing some very risky things.
 
"Recall, if you will, the pundits who six years ago bemoaned falling stock prices and advised investing in 'safe' Treasury bills or bank certificates of deposit. People who heeded this sermon are now earning a pittance on sums they had previously expected would finance a pleasant retirement."
In October 2009, Buffett's business partner and Berkshire Hathaway vice-chairman Charlie Munger was interviewed on the BBC and was asked about how much concern he had for the company's latest stock price decline. His response:
"Zero. This is the third time that Warren and I have seen our holdings in Berkshire Hathaway go down, top tick to bottom tick, by 50%. I think it's in the nature of long-term shareholding of the normal vicissitudes, in worldly outcomes, and in markets that the long-term holder has his quoted value of his stocks go down by, say, 50%. In fact, you can argue that if you're not willing to react with equanimity to a market price decline of 50% two or three times a century you're not fit to be a common shareholder, and you deserve the mediocre result you're going to get compared to the people who do have the temperament, who can be more philosophical about these market fluctuations." [ Emphasis ours]
There will be plenty of commentary online about Buffett's letter and we don't intend to distract readers from the source material. There's just one line from it we'd like to reiterate:
"Although our form is corporate, our attitude is partnership."
Berkshire's structure is unusual. It's a diversified holding company but clearly for many shareholders it has acted extraordinarily well as an investment manager.
 
Berkshire and Buffett have benefited, in turn, from access to genuinely permanent capital and to unusually patient shareholders – a fact Buffett is only too happy to acknowledge. But the bottom line is that the relationship has been symbiotic: a partnership between co-investors, as opposed to an adversarial relationship between lots of mouths needing to be fed, and customers who are second in the queue for capital returns after all those mouths have been fed.
 
As at year-end 2014, Berkshire was a business with $526 billion in assets, with a corporate headquarters employing just 25 people. Now that is decentralised capital allocation.
 
But the most striking thing about Warren Buffett at Berkshire Hathaway is not even the absurdly enviable track record of demonstrable investment success. The 'value' methodology, originally developed by Benjamin Graham, and subsequently adapted by Buffett to take account of Berkshire's ever-increasing size, is almost entirely transparent, and a matter of historical record, not least in the Berkshire shareholders' letters.
 
Buffett himself acknowledged the perversity in his 1984 Appendix to Graham's The Intelligent Investor:
"I can only tell you that the secret has been out for 50 years, ever since Ben Graham and David Dodd wrote Security Analysis...yet I have seen no trend toward value investing in the 35 years that I've practised it. There seems to be some perverse human characteristic that likes to make easy things difficult.
 
"There will continue to be wide discrepancies between price and value in the marketplace, and those who read their Graham and Dodd will continue to prosper."
No, the most striking thing about Benjamin Graham, Warren Buffett, Berkshire Hathaway, and 'value' investing is why on earth anybody would want to invest any other way.
London-based director at Price Value Partners Ltd, Tim Price has over 25 years of experience in both private client and institutional investment management. He has been shortlisted for the Private Asset Managers Awards program five years running, and is a previous winner in the category of Defensive Investment Performance. Tim regularly shares his views on his blog, The Price of Everything.
 
See the full archive of Tim Price articles.

 

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