Buffett: Man or Myth

Warren Buffett is now more myth than man. The investors who claim to follow Buffetology, read the Berkshire Hathaway annual report and actually make the trip to Omaha (the value investing Woodstock) numbers in the tens of thousands, if not millions. I think that we do a disservice to Buffett, when we put him on a pedestal and treat every word he says as gospel. At the risk of sounding like a curmudgeon, here is my take on Mr. Buffett.

Let's start with the obvious. Warren Buffett has been an incredibly successful investor and his string of successess cannot be explained by luck. He has been able to make money with diverse investment strategies, but with a core philosophy that has remained unchanged over the last four decades. That core philosophy: you buy a business, not a stock. Hence, his competitive advantage has been assessing the value of an underlying business, especially in chaotic times, and buying stock in that business, when the price is down.

Buffett has never been an activist investor, i.e., he has seldom taken positions in poorly managed companies and tried to change the management. In fact, one of his criteria for investing in a company is that he admires the management. He has also never been comfortable straying from his niche, which is mature businesses: I cannot think of a single, big investment that he has made in a technology or young company.

I like to read Buffett's comments on the markets. Unlike many market strategists at investment banks, who cloak their recommendations in buzz words and hedge them until they are meaningless, Buffett is to the point and says what he means. His emphasis on corporate governance puts most institutional investors to shame.

My only real issue with Buffett is that he sometimes lets his "Aw, shucks! I am just a regular investor" persona cover up two things that he does that contribute to his success. One is his careful focus on cash flows; he might not use the terminology of valuation but Buffett has been using free cash flows to measure investments for as long as he has been investing. The second is that he is now an insider in many of the companies that he invests in; he has an advantage over you or I, when taking the same investments.

One final point about Buffett. The mythology is that Buffett does not adjust for risk, when he invests. I have even heard people say that he settles for the riskfree rate. Right? Buffett may not use betas or risk-adjusted discount rates but he certainly factors risk into the analysis by making conservative estimates of the cash flows. In effect, he reduces the expected cash flows of riskier businesses, i.e., uses certainty equivalents.

Be like Buffett, if that is what you want to do. But don't view this as a license to ignore risk and to just buy companies with good management (no matter what the price). You are almost certainly not going to make money that way.