Can the last value investor out the door please turn off the lights?
Trust me, you're it - Uncle Warren left the party a decade ago.
The Oracle of Omaha continues to put up the folksy "value investor" front. But if you comb through his annual shareholder letters and analyze his investments through the years, you'll see he's not really a value guy anymore.
When the Facts Changed, Warren Buffet Changed His Mind
As you know, the Oracle pays homage to Benjamin Graham's pioneering work in demonstrating the virtues of value investing. "Buy cheap," Graham implored readers in his revered "Security Analysis".
Buffett took Graham's advice one step further. He didn't "just" search out bargains. Uncle Warren also figured out that if he bought the stocks of great companies, his returns would outsize a simple "buy cheap" approach.
Buffett's early chairman's letters showed his satisfaction with Berkshire's (BRK.A), (BRK.B) investing patience. As far back as 1978, he expressed his optimism for Berkshire's long-term equity holdings - obtained via its "buy and hold" value approach.
Later, his 1991 letter to shareholders took the value preaching a step further, waxing about Berkshire's "Rip Van Winkle" approach to investing:
Our stay-put behavior reflects our view that the stock market serves as a relocation center at which money is moved from the active to the patient.
By the end of the decade, though, Buffett had grown frustrated with the lack of opportunities his patient, value-based approach was coming up with.
From Self-Content to Self-Loathing
The tenor of this changed permanently in 1999, when Buffett lambasted his own performance in his letter's opening:
The numbers on the facing page show just how poor our 1999 record was. We had the worst absolute performance of my tenure and, compared with the S&P, the worst relative performance as well. Relative results are what concern us: Over time, bad relative numbers will produce unsatisfactory absolute results.
Even Inspector Clouseau could find last year's guilty party: your chairman.
My grade for 1999 most assuredly is a D.
I think this was the moment Warren Buffett crossed his investing Rubicon. This was the moment he ditched pure value investing and became a contrarian.
From Value Handicap to Contrarian Advantage
One year later, he was still mulling the need for a new approach…
We see our equity portfolio as only mildly attractive. We own stocks of some excellent businesses, but most of our holdings are fully priced and are unlikely to deliver more than moderate returns in the future. We're not alone in facing this problem.
Fast-forward three years to 2003 and he's talking about his purchase of the euro! It was a trade that worked out great for him. It was also a far cry from buying and holding the likes of Coca-Cola (KO) and Geico.
At the depth of the Great Recession in 2008, Buffett made a fantastic contrarian macro call about the U.S. economy. He described himself as the "token Pollyanna" among a sea of bears and expressed confidence in the future of American business.
Notably absent from his spot-on macro call was discussion of valuations. Perhaps this is because the collective earnings of the S&P 500 were dipping into negative territory!
When his discounted cash flow models didn't compute, Buffett turned contrary.
His recent calls have also been pretty prescient. In 2011, he wrote that U.S. housing would come back strong. He also slammed gold, which drew a lot of criticism. Both calls were a bit early, but if you'd followed them, you'd be well "in the money" in each trade today.
The "Warren Buffett" of Thailand Still Uses Value
Thai-focused hedge fund manager Doug Barnett has outperformed Buffett over the past 22 years by using a value-based approach. His secret? Easier competition.
"I compete with housewives and day-trading speculators," Barnett explained at the 2012 Agora Financial Symposium in Vancouver. "Our portfolio's price-to-earnings ratio is between 10.5 and 11, with 30% earnings growth."
You read that correctly - 30%!
Barnett admits that he runs a much smaller fund than Buffett - so he can focus entirely on an inefficient market.
A value approach works in Thailand. It does not work in more efficient markets such as the U.S. When Buffett's holdings grew too large to deploy in obscure markets, he dropped the value-based approach.
Try running an "old school" Benjamin Graham stock filter - you won't come up with many domestic options! Perhaps today's market is expensive, but even then, very few stocks over the past 15 years have met the old Ben Graham criteria. His strict value approach is a nice fundamental framework, but it's not as good for making money in today's more efficient market.
Instead, we need to do as Buffett does… not as he says.
We need to be contrarian.