John Hussman: What I've Learned From Warren Buffett

by: John Hussman

Excerpt from fund manager John Hussman's weekly essay on the U.S. market:

In 1984, Warren Buffett gave a talk at the Columbia Business School in honor of his mentor, Ben Graham. He began by relating the academic argument that investors having long-term records of outperforming the market really owe their success to randomness. Buffett responded by describing a hypothetical coin-flipping contest, where each participant flips a coin each day for 20 days, and those who come up with all heads are declared winners.

Buffett continued, "if (a) you had taken 225 million orangutans distributed roughly as the U.S. population is; (b) 215 winners were left after 20 days, and if (c) you found that 40 came from a particular zoo in Omaha , you would be pretty sure you were onto something. So you would probably go out and ask the zookeeper about what he's feeding them, whether they had special exercises, what books they read, and who knows what else. That is, if you found any really extraordinary concentrations of success, you might want to see if you could identify concentrations of unusual characteristics that might be causal factors.

"I think you will find that a disproportionate number of successful coin-flippers in the investment world came from a very small intellectual village that could be called Graham-and-Doddsville. While they differ greatly in style, these investors are, mentally, always buying the business, not buying the stock."

Buffett concluded his talk by explaining why he had no fear of diluting the performance of value investing by winning more converts to it -- "I can only tell you that the secret has been out for 50 years... yet I have seen no trend toward value investing in the 35 years that I've practiced it. There seems to be some perverse human characteristic that likes to make easy things difficult. The academic world, if anything, has actually backed away from the teaching of value investing over the last 30 years. It's likely to continue that way. Ships will sail around the world but the Flat Earth society will flourish. There will continue to be wide discrepancies between price and value in the marketplace, and those who read their Graham & Dodd will continue to prosper."...

Readers of Graham's books will notice that his specific tests of value slightly changed from edition to edition and from earlier books to later ones, but his underlying principles did not. Among his key measures of investment merit included a market price near or below tangible net asset value, and a wide spread between normalized, fully-diluted earnings yields and high-grade bond yields. That spread between earnings yields and corporate bond yields had originally been enormous in the early part of the 20th century, and gradually eroded to nothing by the mid-1980's. Indeed, at this point, Wall Street analysts hasten to accept any excess earnings yield over-and-above the 10-year Treasury yield, even on the basis of "forward operating earnings" as the earmark of a cheap market. Graham would be appalled...

Aside from an affection for cheeseburgers and cherry Coke, one of the personal facts commonly known about Warren Buffett is his love of bridge, which he periodically plays online with Bill Gates.

Why bridge? Though Graham wasn't talking about Buffett at the time, he offers a clue:

"I recall to those of you who are bridge players the emphasis that bridge experts place on playing a hand right rather than on playing it successfully. Because, as you know, if you play it right you are going to make money and if you play it wrong you lose money -- in the long run. There is a beautiful little story about the man who was the weaker bridge player of the husband-and-wife team. It seems he bid a grand slam, and at the end he said very triumphantly to his wife 'I saw you making faces at me all the time, but you notice I not only bid this grand slam but I made it. What can you say about that?' And his wife replied very dourly, 'If you had played it right you would have lost it.'"

It seems to me (and it has certainly been my experience) that it takes an enormous amount of restraint to focus on playing every investment hand "right," according to an established discipline, allowing the law of averages to work in your favor, rather than trying to win every hand. I would guess that this is exactly what appeals to Warren Buffett's temperament. Over the long-term, good investing requires it.

Read more John Hussman weekly essay excerpts on Seeking Alpha.